Bruce Mountain Director

1. Market power and generation from renewables: the case of wind in the South Australian electricity market Presentation to IAEE 35th International Conference Perth, 27th June 2012 Bruce Mountain Director

2. The question: Do renewable electricity producers gain as much as conventional generators from the exercise of market power in wholesale electricity markets ? • Theoretical analysis by Twomey and Neuhoff (2009) concludes: intermittent generation benefits less from market power than conventional generation and that allowing some level of market power as a means of encouraging investment in new generation may result in a bias against intermittent technologies. • Green and Vasilikos (2010) modelled outcomes in GB in 2020 assuming 1/3rd renewable electricity, concludes while wind generators gain less than conventional generators from the exercise of market power, the differential (15% for on-shore wind and 17% for off-shore wind) was much less significant when compared to the impact of market power on wholesale prices (more than doubling them) • We examined the situation in South Australia where wind generation accounts for more than 27% of grid-connected electricity production, and there has been significant market power

3. To start, a little background • South Australian wholesale electricity market - second smallest of five regions that make up the National Electricity Market (NEM) • The NEM • Energy only, mandatory spot market • 5 minute trading intervals, 30 minute settlement periods • Price cap at $12.500 / MWh, min price of -$1,000 /MWh. • Cumulative price cap threshold • SA power system • Max demand ~ 3,300 MW, average demand ~ 1,500 MW. • 1280 MW (gas thermal), 663 MW CCGT, 729 MW OCGT, 780 MW brown coal, 1,200 MW wind. • Retail market dominated by three retailers. • Wind produced 26.7% of SA’s (NEM-transacted) electricity in 2011 • Wind production generally poorly correlated to demand (and prices)

4. A little more background … extraordinary peak prices in the NEM

5. Which have had a remarkable impact on average spot prices

6. Wind generation has reduced demand, but mainly when its low

7. And at the peak demand, its impact has been relatively small

8. So, what’s the evidence of market power ? The performance of the gas thermal generator (the Torrens Island Power Station) from 2008 to 2010 average capacity factor in the highest priced 72 settlement periods in each year ranged between 42% and 57%. In these settlement periods the spot price peaked at $10,000 per MWh, averaged $6,034 per MWh and was never less than $376 per MWh. Conclusion: substantial capacity withheld from the market even when prices far above marginal costs.

9. Another way of looking at the same thing (in 2008)

10. Now, what is the case for a bias against wind?

11. A little more, this time in comparison to prices for other technologies ?

12. And what about spot market revenues ?

13. And hence, profitability

14. So, what are the main conclusions ? • High prices in a few settlement periods: beneficial to all generators but more so to conventional (fossil fuel) generators than wind farms – the impact in Australia has been bigger than Green and Vasilikos projected in Britain. • But if the prices – even the extremes - reflects competitive outcomes, then implausible to argue there is a bias against investment in wind farms - differential in prices reflects the value of controllability of conventional generation compared to the intermittency of wind generation. • So, where is the problem? • Exercise of market power, rather than genuine scarcity of generation capacity - reason for extreme prices in South Australia, particularly from 2008 to 2011. • Whereas the profitability of investment in conventional generators appears to be highly sensitive to the exercise of market power, the exercise of market power has made little difference to the profitability of wind farms. Therefore conclude that the exercise of market power results in a bias against investment in wind farms in favour of investment in conventional generators.

15. Why does this matter? • Australian Government seeking rapid expansion of renewable generation – meeting targets will require ~ 8,000 MW of additional wind gen ($24bn over next 8 years); • If the market is delivering a bias against investment in intermittent generators, greater subsidy will be needed to compensate for this bias, than would be the case if the bias did not exist. • Greater reliance on subsidies will diminish the locational and temporal price signals provided by the electricity market for the useful output (electrical energy) that wind farms deliver. Diminished price signaling is conducive to lower investment efficiency. • Wind farm investors are likely to discount future income from subsidies more heavily than they discount future income from the electricity market (lower investor confidence in the durability of Australia’s renewables subsidy policy, relative to investor confidence in income derived from the sales of electricity in the electricity market). Absent changes to the market design, higher subsidies will be needed to compensate for this policy risk.

16. Next steps • How is this problem of market power and consequential bias against intermittent generation to be resolved? • Many possibilities: • Changes to Australia’s competition laws at least in their application to energy markets; • Capacity payments to reduce the reliance on compensation for energy produced, and hence reduce incentives to exercise market power; • Price caps reduced to levels consistent with those in electricity markets in other countries. • While changes need to be considered carefully and often-competing objectives need to be traded-off, this latter option is worthy of urgent examination.