Electricity financial markets are still relatively new and higher electricity prices driven by the drought were the National Electricity Market's first major shock, Australian Energy Regulator board member and Australian Competition and Consumer Commission, Commissioner, Mr Ed Willett, has said.
"Wholesale prices in the National Electricity Market (NEM) have averaged around $70 per megawatt hour this quarter compared to around $25 at the same time last year," Mr Willett, who was speaking* at the Melbourne forum of the Energy Users Association of Australia (EUAA), said.
"Drought has reduced dam levels in the Snowy, Tasmania and Victoria reducing hydro generators' output and increasing their costs. Snowy Hydro, for example, is now pumping water at high cost to deliver a third of its output.
"The drought has also reduced availability of coal plant. While some coal plant is air cooled and others use sea water, most coal plant in the eastern states use fresh water for cooling. In Queensland water shortages have reduced output by around 8 per cent," he said.
"The bidding data shows that generators are responding to tight supply conditions by bidding into higher price bands. Some generators which do not face cost pressures may be taking advantage of this by raising their bid prices.
"In the short term, this is a normal response in a competitive market, and provides signals for new investment. In the longer term a scenario of persistent high prices above new entrant costs—with no investment response—would raise serious market power concerns.
"Higher prices are also flowing through to the forward markets for base and peak contracts through to 2010. These prices are more difficult to explain purely in terms of the effects of prolonged drought. Electricity financial markets are still relatively new and this is the NEM's first major widespread shock. These markets are maturing quickly, but it would not be surprising if inexperience is leading to sharp responses and corrections from time to time.
"The AER is monitoring the market closely. To date, bidding and price activity have been consistent with tight supply conditions and the AER has not detected any evidence of collusion between generators. Nevertheless the AER will be vigilant.
"At this stage there are no reliability concerns since most of the energy constrained plants can still run during peak demand periods."
Mr Willett said the recent high prices should not be viewed as a market design issue.
"The translation of supply issues into higher prices is the most efficient way of sending signals for new investment. Efficiently operating markets and market mechanisms deal with volatile markets better than any other form of regulation. Provided that sustained and substantial market power issues do not emerge, the market is well designed to deal with energy supply issues and problems at least cost.
"Looking forward there are some encouraging developments. Kogan Creek in Queensland should come on line in the next few months. This will add around 750 MW of air cooled capacity, and should help ease conditions in Queensland and NSW. In 2008 the Tallawarra plant should come on line in NSW. New water pipelines should also see some generation in Queensland come back on-line and Origin has announced an expansion of its Quarantine gas plant in South Australia."
The Australian Energy Regulator was established in 2005 as a part of the Australian Competition and Consumer Commission, but operates as a separate legal entity. It has been the regulator of the wholesale electricity market and transmission networks in the National Electricity Market since July 2005. In the wholesale market, the AER monitors the compliance of market participants with the National Electricity Law and Rules, and investigates and prosecutes breaches. This requires close monitoring of wholesale market activity, including rebidding behaviour, and the conduct of around 24 compliance audits each year. The AER provides extensive reporting on outcomes, including weekly and quarterly reporting on market activity, investigations of market incidents, and reporting on prices that exceed $5000 per megawatt hour. The reporting focuses on potential Rule breaches, but also comments on behaviour that may not be consistent with the objectives of the market.
While the AER has no regulatory role in the forward market for electricity derivative contracts, it monitors and reports on those markets because of the linkages with the wholesale market. In July, the AER will publish its first report on the state of the energy sector as a whole. This comprehensive report will cover the wholesale and financial markets for electricity, as well as the networks, retail and gas markets.