by Jasper Noort, Simon Vanderzalm, Brian Morris, and Lisa Zembrodt

Executive summary
Long-term electricity prices in Australia are uncertain and act as a risk to both energy-producing and energyconsuming firms. Schneider Electrics Energy and Sustainability Services Division tested price outcomes under several scenarios of market drivers to identify and understand how stakeholders can most efficiently influence long-term market conditions. Among the key findings of this study were the impacts of different scenarios of the Large-scale Renewable Energy Target (LRET) on market conditions. The influence of the LRET is forecast to reduce long-term electricity prices.

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Introduction

Energy industry stakeholders, including both consumers and producers, have a deep interest in managing long-term energy price risk exposures in Australia; Figure 1 demonstrates how quickly and significantly prices can change. Schneider Electric proposes that our clients take a more active role in the management of long-term energy price risk exposures. Energyconsuming clients engaged with Schneider Electric to conduct an in-depth study to identify and assess the impact of market drivers on future Australian electricity prices in order to develop strategies for influencing long-term electricity market conditions.

Figure 1
Real electricity and gas price increases 2003 to 2013 (courtesy of Australian Bureau of Statistics)

Schneider Electric prepared a benchmark forecast reflective of the energy industry regulatory framework at the time of modeling. The Reference scenario brings together a range of publicly available assumptions taken from government planning entities, regulators, and other official public sources. While not Schneider Electrics most likely view of market developments, which are reserved for clients of our recurring research and forecasting services, the Reference scenario serves as a useful baseline for comparison. Several scenarios of market drivers were tested and compared to the Reference scenario to assess the sensitivity of market conditions and prices to these market drivers. These include:

Carbon pricing Large-scale Renewable Energy Target (LRET) Demand growth Natural gas pricing Renewable generation capital cost development

This whitepaper focuses on the results of the Large-scale Renewable Energy Target (LRET) scenarios, and serves to inform Australian electricity market participants of the possible impacts of modifying or repealing the LRET. The research suggests the LRET yields three benefits to consumers:

1. The LRET acts as a hedge against increasing natural gas prices. 2. The LRET acts as a hedge against carbon emissions costs and may keep carbon
prices lower in the long run.

3. The scenarios investigated under the LRET in its current form result in lower prices
than do the scenarios with a reduced version of or a repeal of the LRET.

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The research data presented in this paper makes reference to a number of terms, initiatives, concepts, and organizations. Table 1 below defines the terms and acronyms utilized throughout the paper.

Term
Large-scale Renewable Energy Target (LRET)

Definition
An Australian government initiative that offers financial incentives for the establishment and growth of renewable energy power stations, such as wind and solar farms, or hydro-electric power stations. Australian government-issued instruments that can be sold or traded to liable entities. LRET Liable entities have a legal obligation to buy LGCs and surrender them to the Clean Energy Regulator on an annual basis. An Australian statutory agency whose role it is to advise the government on the setting of carbon pollution caps, to the review the carbon pricing process, and to report on progress towards meeting national targets. A report developed by The Australian Energy Market Operator (AEMO) which forecasts annual electricity consumption and maximum demand. A plan that provides an independent, strategic view of the efficient development of the National Electricity Market (NEM) transmission network over a 25-year planning horizon. A gas turbine or plant characterized by a power producing engine or plant that employs more than one thermodynamic cycle. A gas turbine generator generates electricity and the waste heat is used to make steam to generate additional electricity via a steam turbine. In most open cycle gas turbine, the gases that are produced by combustion go directly into the atmosphere. The Australian wholesale electricity market and the associated synchronous electricity transmission grid.

Large-scale Generation Certificates (LGCs)

Table 1
Glossary of terms, acronyms, and definitions

Climate Change Authority (CCA)

National Electricity Forecasting Report (NEFR) National Transmission Network Development Plan (NTNDP)

Combined-cycle Gas Turbine (CCGT)

Open-cycle Gas Turbine (OCGT)

National Electricity Market (NEM)

Examining the Renewable Energy Target

In the 13 years since the onset of the Mandatory Renewable Energy Target (MRET) Scheme (introduced in 2001), the Renewable Energy Target (RET) has sought to increase the amount of renewable energy generation in Australia. There have been several amendments and revisions since 2001, most recently the objective of having 20% of the energy supplied from renewable sources in 2020 was revised in 2011; the RET was split into the large- (LRET) and small-scale renewable (SRES) targets with a LRET target of 41,000 GWh by the year 2020. The Renewable Energy (Electricity) Act 2000 mandates a review of the RET every two years, the first of which was completed in December 2012. Although the findings of the review in 2012 were favourable toward the RET, the LRET scheme has come under increasing scrutiny as some blame the scheme for contributing to increases in electricity prices. Calls for amending the scheme have followed.

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Another review by a government-appointed panel is just getting underway and is expected to report to the Australian government its recommendations and findings by mid 2014. Within the context of identifying how energy-consuming clients can most effectively influence their energy costs in the long-run, the Energy and Sustainability Services Division of Schneider Electric performed detailed scenario analyses to better understand how changes to the LRET scheme can impact Large-scale Generation Certificates (LGC) prices, the overall generation mix, and crucially, energy prices. Based on an issues paper released by the Climate Change Authority (CCA), the scope of the mandated bi-annual reviews appears to be broad; therefore a broad range of possible changes to the LRET were examined in the Schneider Electric analysis. This paper first outlines the scenarios considered, and then investigates the impact of each scenario on the generation mix and particularly the contribution by renewable technologies. The impact of this generation mix on carbon emissions is then discussed, followed by a comparison of the resulting LGC prices under each scenario. Finally, and most importantly, the influences of these factors on future energy prices are examined.

LRET scenarios

Reference scenario
To set a baseline for the market investigations, Schneider Electric prepared a forecast based on a Reference scenario that reflected the current regulatory and policy framework at the time of the modeling. The Reference scenario is characterised by:

Gas prices in all regions except Queensland increasing steadily in real terms Queensland gas prices experiencing a large jump around 2014-2015 due to the impact
of Liquid Natural Gas (LNG) exports opening up a $2-3 / gigajoules (GJ) gap over the other regions, and otherwise increasing steadily in real terms

Electricity demand increasing modestly throughout the period based on planning

scenario of 2012 NEFR

A steadily increasing real carbon price for the first three years until July 2015 based on
currently legislated fixed price up to $25.16/tonne followed by a relatively flat price thereafter at around $20/tone

LRET scheme target as current legislated increasing steeply from 2015 to 41,000 GWh
between 2020 and 2030

New entrant fixed and capital costs based mainly on 2012 NTNDP assumptions
The Reference scenario results show 20,000 MW of additional generation is required before 2040 in addition to the assumed increase in the distributed solar photovoltaic (PV) of similar proportion. This consists of 8,400 MW of wind generation mainly driven by the LRET scheme, 6,000 MW of open-cycle gas turbine (OCGT) generation to cover demand growth, 3,200 MW of coal-fired generation constructed after 2029, 1,600 MW of combined-cycle gas turbine (CCGT) generation, and smaller amounts of large-scale solar and biomass. Carbon emissions in the Reference scenario are forecast to fall only during 2017 to 2020 as new wind generation is introduced due to the Large-scale Renewable Energy Target. Thereafter, emissions increase steadily to 2040, adding up to a 19% increase from 2013. For the Reference scenario, LGC prices are forecast to increase through 2020, as parties scramble to build enough capacity to satisfy the target, after which the LGC prices drop. The effective premium on prices as a result of the LRET therefore increases through 2020, after which time the premium falls with the declining LGC prices. Average annual contract prices around the National Electricity Market (NEM) are forecast to converge by 2016. From 2016 to

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2020, prices are generally flat before rising natural gas prices force electricity prices higher. As a result, prices increase through 2032, before remaining relatively flat afterward.

Scenarios for comparison

All scenarios considered include a carbon price that follows the Reference scenario. As a benchmark, the Reference scenario uses the current legislated LRET scheme. Four scenarios were designed to test two key parameters of the scheme the expiration date and targeted number of obligations. Regarding the expiration date, one scenario considered the case where the LRET timeline was shortened, resulting in an earlier removal of its influence (LRET Removed), while another considered extending its lifespan (LRET Extended). Regarding the targeted number of obligations, the third scenario considered the case where the target obligations were increased (LRET Increased), while a fourth considered a decreased obligation (LRET Decreased) . As a last scenario, the target timing was varied. In this scenario (LRET Delayed), the total number of obligations was the same as the reference scenario, but obligations were reduced in the near term and increased towards the back end of the scheme. The expiration time was kept the same as the Reference scenario at 2030. Details of all scenarios are provided in Table 2 below, and the corresponding LGC requirements are shown in Figure 2 on the following page .

Table 2
LRET scenarios and assumptions

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Figure 2
Annual LGC Requirements associated with each of the LRET Scenarios

Key impacts of the LRET

Impact on the generation mix

The LRET has a direct impact on the generation capacity mix, and particularly renewable capacity, as it targets specific amounts of renewable energy to be generated by renewable energy power stations annually through 2030; 41,000GWh of electricity generated in 2020 is targeted to be generated by renewable sources. The LRET in its current form serves as the Reference scenario in Figure 3.

Figure 3
Installed generation capacity expected by technology type under each LRET scenario

The LRET scheme target also strongly influences the amount of gas-fired generation capacity constructed. Particularly sensitive to the LRET is the amount of CCGT in the market. The LRET Removed scenario has 40% more CCGT capacity than does the Reference scenario in 2040, whilst the LRET Increased scenario has 20% less CCGT capacity than in the Reference scenario in 2040; which is a limited increase (550MW) from currently installed capacity.

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Under the LRET Removed scenario, not only was installed capacity the lowest of all the scenarios tested, but gas-fired generation capacity was also the highest. This heavier reliance on gas-fired generation has clear implications for the sensitivity of prices to the natural gas market.

Under the LRET Removed scenario, not only was installed capacity the lowest of all the scenarios tested, but gas-fired generation capacity was also the highest.

Of particular interest with relation to the LRET scheme is its influence on installed renewable generation capacity across different scenarios. Wind generation capacity is the most sensitive to the LRET, and remains the cheapest renewable technology over the forecast period. Biomass capacity is constrained, potentially due to resource constraints, while the growth in distributed solar PV is not subject to changes in the LRET scheme, as it is based on an assumed growth profile. Figure 4 details the expected installed wind generation capacity under our scenarios. There is only a limited increase (less than 400 MW or 3.7%) in installed wind generation under the LRET Delayed scenario despite a 13.9% increase in obligations in the final year of the scheme. Further investigation shows this is possibly due to considerable excess generation of certificates between 2020 and 2024, allowing the scheme to be satisfied with banked certificates, despite a lower level of generation. This suggests that under the LRET Delayed scenario, without an extension to the scheme, five years at the final target level is not enough time to push the installed renewable generation capacity to the higher target level.

Figure 4
Installed wind generation capacity under each LRET scenario

Removing the scheme reduces the amount of installed wind generation capacity by 53%

The reshaping of the timing of LRET obligations in the LRET Delayed scenario results in ~400 MW more installed renewable generation than in the LRET Extended scenario from 2030 onwards. Up to 2020, less wind capacity is built due to the lower target earlier in the scheme. Increasing the LRET target (LRET Increased) results in a significant increase of wind generation capacity (~40%). In contrast, decreasing the LRET target (LRET Decreased) reduces the amount of installed wind generation capacity by ~40% compared to the

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Reference scenario, whilst removing the scheme reduces the amount of installed wind generation capacity by 53% compared to the Reference scenario.

The LRET reduces the sensitivity of the electricity market to gas prices, and therefore acts as a hedge against natural gas prices

In summary, the LRET directly influences the generation mix. By reducing the reliance on gas-fired generation capacity, the LRET reduces the sensitivity of the electricity market to gas prices. The LRET therefore acts as a hedge against natural gas prices, which are expected to rise in the long-term due to growing global and domestic gas demand.

Impact on carbon emissions

Carbon emissions are being targeted globally, with efforts to reduce emissions or emissions growth in China, the United States, India, South Korea, New Zealand, Japan, Europe, and other countries. One of the stated purposes of the Renewable Energy Target is to reduce emissions of greenhouse gases in the electricity sector. This is achieved via the influence of the LRET on the generation mix. Figure 5 illustrates the forecast annual National Electricity Market (NEM) carbon emissions for the various scenarios. Relative to the Reference scenario, increasing the LRET target results in a much larger decrease in emissions from 2014 onwards. This is unsurprising, as the higher LRET target forces a more significant adoption of renewable energy, which results in a drop in emissions intensity. Decreasing or removing the LRET scheme will result in higher emissions, by 5% and 6% to 10% respectively. Extending or delaying the LRET scheme, however, results in emissions very similar to those of the Reference scenario. Increasing the LRET target results in a significant additional reduction in emissions of 5% compared to those of the Reference scenario.

By reducing carbon emissions, the LRET reduces the exposure of the market to carbon costs and may keep carbon prices lower in the long term.

It is worth noting that emissions under each scenario start to increase again after the LRET target is achieved. To drive long-term emissions reductions, either an increased LRET scheme target beyond 2020, complementary measures to reduce demand, or an increase of the carbon price would be required. By reducing carbon emissions, the LRET reduces the exposure of the market to carbon costs, acting as a hedge against potentially rising carbon taxes or permit prices. In addition, the lower emissions volumes under the LRET may help to keep carbon prices lower longer term.

Figure 5
Annual NEM carbon emissions forecast by LRET scenario

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Impact on Large-scale Generation Certificate (LGC) prices

Under the Large-scale Renewable Energy Target, liable entities (typically retailers) must purchase a predetermined number of Large-scale Generation Certificates (LGCs) annually. On the supply side, the generation mix, and specifically the amount and timing of renewable energy generated, directly impacts the price of these certificates, as they are created via renewable generators based on the amount of renewable energy generated . The certificates can then be sold or traded through the REC (Renewable Energy Certificates) Registry. The price of LGCs is determined by both the supply (how much renewable energy was generated) and the demand (the legislated requirement for entities to purchase). LGCs are clearly driven, therefore, by variation in the generation mix determined by the LRET target and timing. The impact of all considered scenarios on LGC prices are shown in Figure 6. The LGC forecasts in the Reference scenario have been set as zero in Figure 6, and all scenarios are then compared to the Reference scenario.

Figure 6
Annual LGC prices under each scenario, as compared to the Reference scenario

The true impact of the LRET on electricity prices is a combination of the LGC costs and the market price.

The LRET Removed scenario is excluded in Figure 6, as terminating the LRET scheme early keeps LGC prices as low as zero, as projects assumed currently committed are sufficient to satisfy the scheme. Some of these projects may not go ahead in case of planned RET removal though, while other projects may demand compensation. This could cause some near term volatility in LGC prices. Under an extension of the scheme from its current end date of 2030 to an end date of 2040, as described by the LRET Extended results in Figure 6, it is forecast that LGC prices would be very similar to those of the Reference scenario initially, up to 2022. Prices then decline in a rather step-like fashion. The lower LGC prices relative to the Reference scenario are not entirely surprising given the 10 extra years of LGC revenue available to renewable generators.

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Varying the target also has a significant impact on LGC prices, but mainly after 2019. By reducing the target, LGC prices are similar to the Reference scenario until 2019 before dropping well below the reference through the end of the scheme. In contrast, increasing the target causes a moderate rise in LGC prices relative to the scenario from 2015 through 2019 and 2021. In 2029, LGC prices as the forecast surplus nears zero, before dropping back in the last year. In the LRET Delayed scenario, LGC prices up to 2020 remain among the lowest of all the scenarios considered, second only to the scenario where the scheme is removed completely. It should be noted that over the course of the forecast horizon, the LRET Delayed scenario goes from the lowest to the second highest LGC price among the five variations of the LRET scheme considered. Hence, by keeping the total target the same but varying its timing, nearto medium-term LGC prices (up to 2020) remain low but are more expensive in the longer term. However, on average over the period between 2012 and 2030, the LRET Delayed scenario has the lowest LGC prices except for the LRET Decreased and LRET Removed scenarios. The legal liability for entities (typically retailers) to purchase LGCs is often cited as a mechanism through which the LRET contributes to rising prices. However, the true impact of the LRET on prices is a combination of the LGC costs and the market price, which is addressed in the next section.

Impact on Electricity Prices

In addition to the influence on LGC prices, changes to the LRET scheme also influence electricity prices via the additional competition in the market that results from increased generation capacity. To show the combined effect of LGC prices, total LGC liability (due the varying size of the LRET), and changing electricity prices, the average bundled energy price is forecast and compared to the Reference scenario in Figure 7. Aside from removing the scheme, the scenarios show the same general trend, with the largest difference in prices being before 2029. After 2029, the LRET Increased scenario drops back, while the other scenarios continue to increase. This opens up a substantial discount to the other scenarios until 2035 after which this discount steadily declines as additional base load generation is required. Decreasing the scheme results in the bundled price being amongst the highest early on and midway between the higher prices of the RET Removed scenario and the rest after 2020. The LRET Extended and LRET Delayed scenarios tend to sit close to the Reference scenario. The Reference scenario results in the highest electricity costs due to its high initial LGC price, but is among the lowest of the scenarios after 2020. Removing the LRET results in the lowest electricity costs initially, though costs quickly escalate well above prices in the Reference scenario. Removing the LRET results in the highest electricity prices due to the large dependency on gas-fired generation sources and the lack of competition in the market.

Removing the LRET results in the lowest electricity costs initially, though costs quickly escalate to well above prices in the Reference scenario.

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Figure 7
Forecast LRET-Inclusive electricity prices for each scenario, as compared to the Reference scenario

Conclusion

The LRET has a significant impact on the Australia electricity generation mix; the RET requires and incentivises a higher proportion of renewable generation capacity than would otherwise be achieved. As assumed in the Reference scenario based on industry expectations, natural gas prices are forecast to rise as LNG exports grow to Asian markets. The influence of the LRET on the generation mix results in less natural gas-fired generation capacity than in scenarios with the LRET Reduced, Removed, or Delayed. A reduced reliance on gas-fired generation means the requirements of the LRET, specifically the renewable generation capacity requirements, become a hedge against the potential for rising natural gas prices. Renewable generation has lower emissions and lower marginal costs than do fossil fuelsfired generation. As a result of the influence of the LRET on the generation mix, electricity generation emissions in Australia are forecast to be lower under the LRET than would be otherwise. Again, the LRET becomes a hedge against rising carbon prices, and may help to keep carbon prices lower as a result of the lower emissions. Finally, and most strikingly, is the impact of the LRET on long-term energy prices. The LRET is forecast to result in a generation mix with lower marginal cost, lower carbon emissions, and increased competition in the electricity market, all which serve to reduce prices. Even after taking into account the cost of Large-scale Generation Certificates, the LRET in its current form is forecast to result in prices lower in the long run than those under decreased targets or outright removal of the Large-scale Renewable Energy Target.

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About the authors

Jasper Noort is a Senior Analyst in the Energy and Sustainability Services division of Schneider Electric. With a background in engineering and management science, as well as experience in energy procurement, Jasper builds and analyses long-term electricity market forecasting models, develops sensitivity scenarios, and interprets results. Jasper holds a Master of Science in Industrial Engineering and Management Science. Simon Vanderzalm leads Schneider Electrics Markets & Strategy group based in Melbourne Australia. With a background in forecasting, trading, and account management, Simon delivers value to our clients with Australia energy market exposures through a focus on developing and implementing risk management strategies. Brian Morris is Vice President Energy and Sustainability Services. Brian held positions with both government organizations and private generators prior to founding what is now Schneider Electrics Energy and Sustainability Australia organization, leading clients through their energy dilemma from both the supply and demand sides. Lisa Zembrodt, ERP leads Schneider Electrics Global Research & Analytics team, which provides timely insights, research, and forecasts regarding global commodity markets to help clients make informed strategic and tactical decisions.

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2014

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