ITK has updated its price and new supply estimates as we do each quarter, and the results are not good news for the incumbent coal generators.
The main conclusions are that, rather than slowing down, there has actually been about 3.5GW of utility-scale wind and solar projects getting the final go-ahead so far in 2020. These projects have been driven by the Queensland government, the ACT government, Snowy Hydro and also by large PPAs, typically with US-based technology companies such as Amazon.
Secondly, in total we estimate there is still over 6GW and probably close to 7GW of wind and solar projects that are either in the commissioning, construction or have received go-ahead phases. On top of that, there will be around 6GW of rooftop solar built over the next four years at a capacity factor of, say, 15%, for another 6TWh.
Thirdly, ITK’s forecasts allow for even more projects to be announced and come into operation by 2025. This bit of ITK’s forecast is entirely speculative and was originally based on nothing more than an assumption that the NEM (National Electricity Market) would reach 50% renewable by 2030 and then back-solving to get to the annual new capacity additions for that target. That number comes to 1.3GW per year, and over 10 years it adds up to 13GW. But so far we are running well ahead of that target.
ITK now estimates that the NEM will be around 45% renewable as early as 2025. Even if you don’t believe any new projects will be announced, and why would you believe that, we still estimate 40% (33% wind + solar and 7% hydro).
In ITK’s view it is important to go beyond handing out gold stars for fast progress and look at what it means for prices, thermal generation output and other issues.
As we see it, even after closing Liddell, output from the remaining thermal generators is going to fall around 26TWh. Or if, unbelievably, no new wind and solar projects are announced, thermal output will still fall by 15TWh.
If you are a thermal generator these should be scary numbers. Yallourn’s output is about 9TWh and Vales Point about 7-8TWh. The biggest generator in the NEM, Eraring, has around 15TWh.
ITK’s modelling suggests that even if Yallourn and Vales Point both close there would still be a loss of market share for the rest. This is not 2030, this is in 2025, and if done formally would require announcements around 2022.
Readers should note that these are aggregate numbers, and the situation varies widely from state to state, but it’s crystal clear to us that if transmission capacity isn’t increased the problems will be way worse in some states than others.
There are other risks. What about Portland aluminium smelter? We don’t think the Victorian government will let it close but we don’t know, and no bank would want to lend to a coal generator based on that kind of bet alone.
On the other hand, the federal government could announce strong support for electric vehicles, boosting electricity demand. But that, would require sensible, forward looking federal government policy.
Prices will be low, but may well be volatile
ITK does not yet formally forecast early closure of a coal station, but perhaps we should. It’s not until we and others do that that the market will properly price it in.
Whether coal generation closures cause price shocks will largely depend on how well the closure is anticipated. Hazelwood, for instance, caused a massive price shock because the announcement was unexpected. Your analyst spoke to a large investment banking analyst less than a week before the closure was announced and he was even then forecasting it wouldn’t happen.
Equally, I had expected Portland to close and it stayed open. Not only did prices go up a lot but there were reliability and security issues. These were compounded by the anti renewable federal government stance at the time which had prevented a supply response.
On the other hand, the closure of Liddell is very well anticipated, and we strongly support AGL’s very early advice to the market. That’s enabled the market to adjust and get ahead of the game. More than that, there is no longer any real argument over whether there should be new coal or renewables to replace old coal. That battle is over.
The point is that we don’t think the market is really anticipating early closure of more coal.
Coal generation strategy – stick or twist
If you think there will be unexpected closures and a price shock you probably don’t want to be the generator closing. But if every generator thinks the same then prices stay low and high cost producers will likely move to losses.
When you game it out it’s important to understand whether a state can export its surplus power or not. Over the last 12 months the Victorian market has been close to in balance, but that’s going to change soon. ITK expects the share of renewables in Victoria to grow very quickly over the next 12-18 months putting immediate pressure on all the brown coal generators because they won’t like ramping up and down every day.
For instance, the average half-hourly output of the Yallourn units in the past 12 months is shown below. It’s pretty flat. The units do shut down and start up but in “campaign mode”. A quick glance at the data suggests a couple of units can ramp from zero to full output in about three hours, whereas other units seem to take five hours.
Management could take a unit out of action for an extended period, or just hold it in reserve, but that clearly increases the average unit cost as most of brown coal generation costs are fixed, that is they don’t vary with output.
We suspect, but do not know, that if the Yallourn units built in the mid ‘70s were asked to ramp up and down every day, reliability would reduce and costs increase.
By contrast, black coal plants ramp much more significantly. And that will only increase, probably quite quickly. I’ve shown the selected units as an index because, in absolute terms, Eraring is twice the size of the other units. Eraring is already ramping down 20% in the morning and up 25% in the afternoon from its daily average, which is a pretty good performance in my book.
Your strategy also depends on your coal price and capital expenditure outlook, and the balance sheet that stands behind you. It’s obvious that Vales Point owners won’t want to face losses even for a single year without a lot of confidence that things will improve.
Maintenance capital expenditure will be cut back to essentials. In that regard, the strong program run by AGL and EnergyAustralia over the past three years may stand them in good stead. However ITK suspects that the age of the plants and the increased ramping requirement will somehow throw up issues.
What VRE developers might do
To the extent that VRE (variable renewable energy, ie wind and solar) developers believe that coal plants will close in the foreseeable future, they will tend to see that prices will rise and they will bank on their low variable cost so they think they will be dispatched. As a result they will tend to build wind and solar farms and install batteries in anticipation of coal plant closures.
For system security as well as decarbonsisation reasons this will be encouraged by state governments. We see this in every state now, but particularly in NSW.
By committing to new plant VRE developers actually make more likely the closure of coal generators and thus it becomes a self fulfilling prophecy.
The risk is if too much wind and solar is built so that despite the closure of coal fired generators prices remain low.
In the end, we forecast more VRE development to be announced. We’ve been doing that as part of our forecasting methodology for more than two years and so far the new announcements have exceeded our forecast.
We expect NSW to be the focus, but for Victoria, where the risk of early closure is arguably highest, then the Victorian government will likely be thinking hard about how to avoid a repeat of the Hazelwood price shock and the obvious way is to build the new supply in advance of the closure.
So here at ITK, despite the low prices, despite the transmission issues, despite the questions around firming, we think the lights remain green for VRE development.
Date: Nov 9, 2020