Energy Action : The Costs and Risks of Reducing Wholesale Electricity Prices

Forecast wholesale electricity prices for the next few years are currently below $40 per MWh in all eastern states excluding NSW. These are 35 to 50 per cent reductions from prices just a year ago and at levels not seen since before 2006. At the same time, renewable electricity certificate prices are also at low levels and are forecast to continue to reduce.

The price reductions have been driven by a combination of factors:

· Increased supply of new grid-scale and rooftop renewable generation

· Market expectations of further increased supply from recently announced state government policy measures, in particular in Victoria and NSW to underwrite new build of renewable electricity generation and lower technology costs

· COVID-19 impacts such as changed customer demand and deferral of major planned outages at thermal generation plants

· Milder weather impacts and an unusually cool summer

There are clearly significant benefits to customers and energy users from reduced wholesale electricity prices flowing through to reduced retail prices.

Rapid and sustained reductions in wholesale electricity prices also presents some costs and risks.

Asset impairment and PPA contract value impacts

In early February 2021 AGL Energy announced that it intends to recognise a significant non-cash write down or cost in its financial statements for the period ending 31 December 2021.

AGL announced a $2.69 billion (post tax) or $3.55 billion (pre-tax) write down from a combination of:

· $1.92 billion (pre-tax) provisions due to unfavourable, or in their words 'onerous' wind farm off take agreements that were entered into between 2006 and 2012. The prices that these contracts were entered into are significantly higher than current and expected future prices; and

· $532 million (pre-tax) of impairment to their coal and gas generation fleet and other natural gas production assets. This is primarily due to their outlook for sustained reduced wholesale prices.

AGL's announcement did not amend their expected profit guidance for the current year as it had already reduced its profit guidance prior to Christmas 2020.

At roughly the same time in early February 2021, Origin Energy announced a downgrade in its full year profit guidance by 8.6 per cent or $150 million. This was again largely driven by reduced wholesale electricity prices.

Other retailers, generators and long term offtake renewable energy offtake purchasers are also likely to be impacted by the fall in wholesale electricity prices. For example, the Queensland Audit Office released a report which estimates at least a $1 billion reduction in the value of the state government owned coal and gas generators due to lower prices.

Uncertain generation exit

The writedown of several large coal and gas related generation assets due to the market outlook for sustained low wholesale electricity prices does increase uncertainty for investors and the market.

The current short to medium term expected environment naturally increases pressure on the financial viability of existing generation in the market and may prompt some investors to either change (reduce) the operating regime for these plants or alternatively seek permissible options for an early exit. Generation owners seeking an early exit will need to be cognisant of the regulatory requirements that require a process and minimum notice period for closure. These are intended to mitigate the market from an untimely exit of large scale generation as occurred in early 2017 with Hazelwood.

Reduced attractiveness of new generation investment

The current outlook for sustained low wholesale electricity and renewable certificate prices adversely impacts the payback and return on investment for new renewable generation, this includes technologies such as rooftop solar, grid scale solar, wind and even batteries.

Many stakeholders in the market suggest that some form of financial assistance will be required to adequately address the reduced returns for investors of new generation. This is likely to be in the form of government contracts such as those recently announced by the NSW government with their Electricity Infrastructure Investment Safeguard or the Victorian government's renewable energy auctions.

Conclusions

The reduced wholesale prices do have clear benefits, but those benefits also come with costs and risks that will impact not only generation investors but also some end users.

If you have any questions or need advice on the investing in renewable energy please contact your Energy Action account manager.