Australia’s energy markets are undergoing a significant period of transition. Two imperatives – decarbonisation and building customer advocacy – are central to AGL strategically maximising value as we navigate this transition.

The energy sector’s transition will span several decades and a long-term vision is required to support that transition. A nationally coordinated and consistent approach to climate and energy policy is needed to ensure a smooth transition towards decarbonisation and modernisation of the electricity sector. It is critical that policy makers integrate wholesale market design with climate change policy to ensure that ageing thermal power plants are replaced with new, low-emissions generation and complementary infrastructure. See the Public policy engagement section for more information on our views on climate and energy policy.

The energy sector's transition is also seeing customers playing an increasingly important role, driving a shift away from the traditional linear electricity supply chain, to a more decentralised and bi-directional market. In addition to one in four households across Australia with installed solar PV, a proliferation of more advanced distributed energy resources is entering the consumer market, such as digital metering, smart inverters, energy storage, energy management systems, and household appliances with smart controls. These distributed technologies offer new opportunities for customers to actively manage their energy use in the home. We discuss this in more detail in the Product innovation section of this report.

Integrating energy and emissions reductions

We are committed to playing a leading role in developing a pathway to a modern, decarbonised generation sector. We support the Commonwealth Government’s commitment to the Paris Agreement, which aims to limit average temperature increase to well below 2°C above pre-industrial levels. As our Greenhouse Gas Policy elaborates, we have made a strong commitment to a range of measures that will drive the decarbonisation of Australia's energy sector, including the closure of all our existing coal-fired power stations by 2050 and continued investment in new renewable and near-zero emissions technologies.

In seeking to meet Australia’s emissions reduction targets, we consider that the energy sector is in a unique position to act first and to unlock substantial emissions reductions in other sectors of the economy. Reductions in other sectors can be linked to the electricity generation sector, as low carbon-intensive electricity is a viable fuel source for other sectors looking to decarbonise, most notably the transport sector and manufacturing.

More than 80% of electricity generated in Australia is sourced from the combustion of fossil fuels, the majority of which is provided by coal-fired generation that is reaching the end of its design life. The transition to a decarbonised and modernised generation sector therefore requires large-scale investment to replace this infrastructure. Investment will be best supported by emissions reduction policy that provides macro-level certainty regarding the timeframe and operating life of incumbent plant and reduced levels of uncertainty on the market environment within which current investments will operate in post 2030. Greater certainty in these areas will support a more efficient transition, guiding decisions on new investments, management of existing capital stock, policy development, community transition and energy market development. Increased policy certainty also assists with minimising energy price volatility, which is vital for the affordability of energy for customers.

The development of the National Energy Guarantee (NEG) as proposed by the Energy Security Board (ESB) for the COAG Energy Council has been a welcome step in this direction. AGL has provided input into the ESB’s public consultations on the design on the NEG and will continue to advocate for bipartisan support on an emissions reduction policy that provides long-term certainty.

Additional action is required to provide macro-level certainty to support required investment, enable efficient management of existing capital stock and support a community and energy market in transition. Integrated policies are required to ensure that these objectives can be jointly pursued over time. As the decarbonisation and modernisation of the electricity sector will span several decades, a long-term vision and trajectory for this transition is essential to provide investors with confidence to develop the capital-intensive projects that will enable Australia to reduce its emissions efficiently over time, and at least cost. See the Public policy engagement section of this report for more information on how we are participating in the development of integrated energy and climate policies.

Energy prices and affordability

We recognise the impacts that the energy market transition is having on energy prices and affordability.

Significant increases in wholesale market electricity prices have contributed to increases in energy prices, due to a number of market-wide factors, including: the sudden closure of ageing, low cost, coal-fired generators; high gas prices and limited gas availability for gas-fired generation; and, an uncertain policy environment impacting investment in new capacity.

Electricity is an essential service and consumer protections are afforded to energy users to ensure that they have access to competitively priced, reliable and high-quality energy supplies. Especially through this period of energy market transition, we are acutely aware of the need to meet community expectations of affordable energy and support for vulnerable customers. Refer to the Energy prices and affordability section for further information.

Limited gas availability and high gas prices have also impacted the east-coast domestic gas market, influenced by Australia's gas export trade and unanticipated market pressures. In response to these challenges, we have been investigating options for gas import infrastructure. In August 2017, we announced Crib Point in Victoria as the preferred site for a potential gas import jetty and pipeline to increase energy security and supply for customers in south-eastern Australia, introducing price competition and helping to put downward pressure on wholesale gas prices. Learn more about the Crib Point project on our website. For further elaboration of the economics of the east-coast Australian gas market and the case for import infrastructure, refer to the AGL applied economic and policy research working paper series, below.

Ensuring power system security and reliability

Australia’s National Electricity Market (NEM) was established on the basis of thermal capacity investments and in most cases, assumes that demand is relatively inelastic and that dispatchable thermal generation is able to meet demand. The increase in penetration of renewable energy is showing the limitations of the NEM’s thermal-centric design.

As the generation mix changes to incorporate a growing amount of renewable energy, demand for energy services such as Frequency Control Ancillary Services, reactive power, and inertia will increase as the traditional suppliers of these services (i.e. thermal power stations) exit the market. The recommendations provided by the Independent Review into to Future Security of the NEM (known as the ’Finkel Review’) provide a useful outline of the policy issues that the energy sector faces in this regard. For further information on our responses to these policy issues, refer to the Public policy engagement section of this report.

We anticipate that the role of traditional generation will increasingly be met by flexible distributed energy services and a range of low-emissions generation. However, the proliferation of distributed energy services within a broader generation mix will require a commensurate ability to co-ordinate those assets in order to maximise the benefit to the primary and ancillary wholesale markets. Our virtual power plant (VPP) in South Australia is an example of how distributed energy services can deliver those services within a competitive market if it is orchestrated effectively. Read more about our VPP in the Product innovation section.

We consider that future industry scale investments will increasingly need to conform to the following design principles to effectively complement decentralised low-emissions generation:

• be modular and adaptable, capable of combining with multiple medium and large-scale fuel sources
• utilise conversion technologies to deliver high efficiency and low emissions outputs
• be scalable or grid-scalable, making it applicable to the grid as well as the distribution market (with its capacity to facilitate energy back flows), and
• be adaptable to the increased penetration of distributed energy services behind the meter.

Promoting competitive platforms and innovation

We believe that the electricity grid of the future will be a gateway to multiple competitive platforms that enable a range of markets for customers. The distribution network will increasingly become the platform across which customers expect to be able to connect and transact. Competing energy service providers are beginning to trial and offer innovative products and services that leverage the grid to provide customers with access to other markets and value streams.

Rather than simply enabling the consumption of electricity delivered from centralised generation plant, the grid will have an increasingly important role facilitating a range of other service markets. These include markets for grid stability services, services supporting the network in constraint conditions, and wholesale demand response at times of tight supply, as well as allowing 'peer-to-peer' energy trading.

Reflective of the diversity of customer needs and preferences, we expect product and service offerings from a broad mix of energy service providers to be similarly diverse. We see competition and innovation in technology and business models as the primary means to align the interests of energy service providers with those of the customers they serve. To learn more about innovative products and services that AGL offers, refer to the Product innovation section of this report.

AGL's applied economic and policy research working paper series

For several years, AGL economists have authored economic research that provides critical analysis of energy market trends and policy settings to industry stakeholders and policy makers. These articles are submitted to academic journals and are subject to formal (blind) peer-review processes prior to publication.

During FY18, the following new pieces of research were published:

• East-coast Australian gas markets – overcoming the lumpiness of capital allocation and temporal instability: Australia’s east-coast gas market has undergone significant transformation in the past decade. The discovery of non-conventional coal-seam gas reserves led to investment in three ‘lumpy’ LNG export facilities in Gladstone, Queensland. Drilling activity has subsequently slowed, a direct result of a soft global price for LNG. This slowdown, in an environment of a tripling of east-coast gas demand, has resulted in concerns about domestic gas shortages. The problem is not a lack of gas resources; rather, it relates to the relative lumpiness of capital allocation and temporal instability driven by changing global circumstances. This paper analyses options for overcoming these problems. Of these options, developing import infrastructure appears to be a ‘no regrets’ option that would ensure that the price floor – the LNG netback price – also becomes the market price cap.
• The future of electricity generation in Australia – a case study of New South Wales: The Australian electricity industry has found itself the subject of an intense political debate. At the centre is the role of coal-fired generation. The most economic form of new generation technology in Australia is wind on a levelised cost of energy (LCOE) basis. However, new wind generation must be ‘firmed’ to address variability in output. The analysis in this article finds the optimal plant mix will need to be increasingly ‘flexible’ to complement variable renewables.
• The impact of an ETS on the Australian energy sector: An integrated CGE and electricity modelling approach: This paper utilises a computable general equilibrium (CGE) model which integrates an electricity supply model to gauge the effects of a national emissions trading scheme (ETS) on the Australian energy sector and the broader economy. The modelling results show that an ETS can reduce emissions effectively and with a relatively small impact on the overall economy. But the impact of the ETS on individual sectors varies. Wind electricity generation is projected to benefit greatly. Brown coal electricity and gas electricity are expected to be adversely affected substantially. Somewhat surprisingly, the impact on black coal electricity is negative but relatively small.
• Price dispersion in Australian retail electricity markets: Simshauser and Whish-Wilson (2017) articulated that price dispersion within the restructured Victorian retail electricity market is welfare enhancing, as efficient pricing ensured the marginal unit produced was sold at marginal cost. This article expands on this analysis by considering the heterogeneous nature of electricity consumption when measured by volume sold (kWh). The authors find that customers on ‘standing offer’ tariffs use 18% less electricity than customers on ‘high discount’ products, indicating the presence of market segmentation and implicit second-degree price discrimination. Climate change policy and the emergence of new technologies such as household solar PV, battery storage and in-home energy displays will create further price dispersion in Australian electricity markets due to even greater product heterogeneity. The key finding is that policy makers will need to facilitate, rather than prevent, both price and tariff structure dispersion with the objective of improving consumer outcomes.

In addition, the following research was completed in FY18 and is currently under peer-review:

• Decarbonisation and energy-market design

• The drivers of energy-related financial hardship in Australia – understanding the role of income, consumption and housing

• What stalls a renewable energy industry? Industry outlook of the aviation biofuels industry in Australia, Germany, and the USA , and

• Service innovation and disruption in the Australian contestable retail market .

Importantly, the views are those of the authors and not necessarily those of AGL. For more information about economic and policy research authored by AGL economists, visit AGL’s blog: The Hub.

Related information

• Greenhouse Gas Policy
• The Hub