Independent Review into the Future Security of the National Electricity Market Blueprint for the Future, Jun 2017

Gas markets need to be highly efficient

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4.3 Gas markets need to be highly efficient

Domestic gas prices will likely be higher in the future compared with historical levels. If gas is to play an increasing role in affordable electricity supply, gas markets will need to be highly efficient, as gas-fired generation often sets the spot price for the wholesale electricity market when VRE generation is low. Increased wholesale electricity prices will inevitably flow through to higher retail electricity prices for consumers.

Securing firm gas supply as a stand-alone contract is difficult, as it requires a gas producer to commit a large amount of processing and production capacity for the sale of a small amount of commodity. In the past, gas producers were willing to provide relatively high levels of flexibility within gas contracts for modest price premiums.211 Gas producers are now increasingly seeking to recover the true cost of providing such flexibility. They have a strong incentive to run their processing and production facilities as ‘flat’ as possible. Coal seam gas (CSG) producers, in particular, have limited ability to vary production on a short-term basis.212

Consequently, it is becoming increasingly difficult, and more expensive, for gas-fired generators to secure firm gas supply contracts if they do not have access to a substantial portfolio.213 This uncertainty could lead to gas-fired generators over-contracting for gas, which they still have to pay for under take or pay conditions, or under-contracting and being unable to generate on a reliable basis.214

If gas-fired generators are unable to obtain long-term supply contracts, they become increasingly reliant on the Short Term Trading Market (STTM) and the Victorian Domestic Wholesale Gas Market to supplement their supply. The volatility in spot gas prices in these markets exposes gas-fired generators to significant fuel price risk, which is bid into the wholesale electricity market.

Figure 4.4 demonstrates the increasing domestic short-term gas prices. At the end of March 2017, spot prices were $10.10/GJ in Brisbane, $10.39/GJ in Sydney, $9.48/GJ in Adelaide and $9.11/GJ in Victoria.215 While spot prices are likely to be influenced by bilateral gas supply contract prices, they do not provide a clear guide to actual supply contract prices; rather they provide an indicator of market conditions.216 Anecdotally, compared with levels of around $3/GJ to $4/GJ in 2006,217 domestic gas supply contracts for large gas users, including gas -fired generators, now range from around $6/GJ to around $22/GJ with various onerous contract conditions.218

Figure 4.4: Spot prices - by quarter219

figure 4.4 shows the average daily weighted gas spot prices per gigajoule by quarter in adelaide, brisbane, sydney and victoria from december 2010 to march 2017. figure 4.4 shows gas spot prices in all four regions rising steadily. in adelaide, spot gas prices have increased from $2.41 per gigajoule in december 2010 to $9.48 per gigajoule in march 2017. for brisbane, spot gas prices have increased from $2.93 per gigajoule in december 2011 to $10.10 per gigajoule in march 2017. in sydney, spot gas prices have increased from $2.56 per gigajoule in december 2010 to $10.39 per gigajoule in march 2017. for victoria, prices have increased from $1.30 per gigajoule in december 2010 to $9.11 per gigajoule in march 2017.

As demonstrated in Figure 4.5, the fuel cost of generating electricity at a gas price of $9/GJ is estimated to be in the range of $60/MWh to $140/MWh depending on the efficiency of the plant. This does not include any other costs.

Figure 4.5: Indicative relative gas price impacts on generation fuel costs220

figure 4.5 shows the indicative relative gas price impacts on generation fuel costs for 54 synchronous generators. figure 4.5 shows that the short run marginal cost at $7.5 per gigajoule gas price is in the range of $50 to $120 per megawatt hour. the fuel cost of generating electricity at $3.9 per gigajoule is in the range of $20 to $60 per megawatt hour and at a gas price of $9 per gigajoule, it is estimated to be in the range of $60 to $140 per megawatt hour.

For gas-fired generators to operate on a more flexible basis and contribute to a reliable and secure NEM, efficient gas supply and transportation markets that are able to dynamically respond to changing conditions are required.

Recognising the need to address gas supply and competition concerns in the gas market, the COAG Energy Council (the Energy Council) has committed to a comprehensive Gas Market Reform Package. A Gas Market Reform Group has been established to develop and implement the Reform Package. This includes a new information disclosure and commercial arbitration framework for pipelines not subject to regulation under the National Gas Law (whether it be light or full regulation), transportation (pipeline and hub services) capacity trading-related reform, market transparency reforms, and wholesale gas market reforms.221

This work may further benefit gas-fired generators that are looking to use the gas market or bilateral deals to optimise portfolios over the short-term.

Technical efficiency

In the NEM, around 4,900 MW of proposed new gas-fired generation capacity has been publicly announced.222 Whether the proposed projects are built will depend on a positive investment environment and favourable electricity market conditions underpinned by access to a reliable and affordable gas supply and off-take arrangements.

A gas-fired generator must have sufficient gas available to generate the amount of electricity it has offered to the market. This includes having transportation arrangements in place to deliver the gas to the generation facility. Thus, adequate and flexible contractual arrangements for fuel, pipeline capacity and storage are critical for gas-fired generators. In some international jurisdictions, such as New York State, all gas-fired generators are required to have an alternative on-site fuel source such as diesel, sufficient to run for several days in the case of a gas supply constraint.223

Given the prevailing gas prices, most existing gas-fired generators cannot economically provide dispatchable power at current wholesale electricity prices.224 Alternatively, gas-fired generators run less often and seek to capture periodic price spikes. In operating as peaking generators, these generators need substantially higher spot prices in order to recover their fixed costs over a lower utilisation rate.225

Gas-fired generators will increasingly need to switch in and out of service, or ramp up and down while operating, depending on intermittent supply from wind and solar generation. This volatility means less predictability and more starts for gas-fired generators, resulting in higher costs.

The result may be that gas-fired generators close down rather than compete. Across the NEM it is possible that a number of gas-fired generators will become uneconomic when their current gas supply or electricity off-take contracts end. Rather than potential new gas-fired generation capacity being built, this could result in a reduction in gas-fired generation capacity, despite the inherent value of gas to security in a power system dominated by VRE generation.226

An alternative for investors to consider would be to replace their ageing, inefficient gas turbines with modern turbines at the same site. Improving the efficiency of the gas-fired generator would in some cases halve fuel costs and halve the emissions. By using the same site, existing gas supply pipelines, gas contracts and electricity transmission infrastructure could be used.

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