The architecture of the National Electricity Market is the elephant in the room, says Clean Energy Finance Corporation chief executive Oliver Yates.

Because states have limited access to their neighbours’ energy markets, they are denied the benefits that flow from deeper and more liquid supply of and demand for energy – lower prices and lower volatility of prices.

As a result, cases are constructed for the placement of new renewable energy generation that wouldn’t stack up if energy were allowed freely to flow around the NEM.

“If you can’t transport the electrons you build facilities in the wrong place,” Yates told EcoGeneration. “That’s an inefficient way to run a market. You want to run a market by getting people to produce lettuces in the cheapest place to produce lettuces, don’t you?”

Following that logic, the case for more transmission is pretty clear.

“The problem at the moment is … in South Australia in certain places you’ll have wind assets which blow 50% of the time, so in other words the wind is blowing and blowing and blowing, because that’s a great location,” he says.

“They may start to build in NSW assets where the wind only blows 30% of the time. Well, that’s really inefficient. What you should be doing is building where you get the most energy for the same dollars and then just transporting the electrons.”

cefcs-oliver-yates

Yates, pictured, says the spot market will become more robust and cheaper as the NEM is incrementally redesigned. “When you add interconnects across the NEM what you’re doing is increasing the size of the market,” he says, “so it should drive down prices and reduce the volatility. Transmission is a very good thing for renewables.”

Merchant or PPA

Investors, however, face a conundrum. Energy prices may be less jittery once new transmission is built, but they may also be lower. That would inspire a surge of demand for power purchase agreements, before prices drop, rather than taking a risk on the spot market with a merchant sales model.

But having a level of contracted offtake is of significant value to a project, Yates says. Projects which are 100% merchant are finding it “very difficult” to secure finance.

“The reason people find merchant transactions more complex is that when you don’t have a national electricity market, which we clearly don’t because of the pricing difference between states, you need to look at the type of technology, where it’s wind or solar or biomass, as to whether you can determine the time of production. That will give you an idea of how that asset performs within the state.”

With a merchant deal you’re exposed to market prices, which can be very different at different times of the day. This is where solar and wind parts ways. For wind, you have to forecast the wind time and the price at that time to estimate revenue, whereas with solar at least you’re able to generally forecast the time of production although you may not necessarily be able to predict the price, he says.

“You have to look at the type of the project and you have to look at the state and then you have to look at the location of the project when you’re looking at a merchant case because you obviously want your assets to produce power at the time where in that state the power prices are as high as possible.”

Stand apart

It all comes around to correlation, he says. In South Australia, a wind asset near the coast will kick out a lot of energy but so will all the other coastal wind assets operating at exactly the same time, often in the evening, when there is lower energy demand, “and therefore you can end up with significantly depressed prices at the time of production,” he says.

“If you choose a wind asset in a different part of South Australia you may have a much higher capacity factor; it may blow more often and it may be more affected by the heating or the cooling of the land between the day and the night, in which case it will have more wind when the sun is coming up or when the sun is going down, which is at a different time,” he says.

“That’s very good overall for consumers but it’s also very good for the projects because volatility of price is terrible. If you’re producing at the wrong time when prices are very low you won’t build at all. That’s the problem in South Australia.

“Because South Australia cannot export any more power because it has a very limited transmission network, if you build a lot more renewables in South Australia there is no-one to buy them. So price becomes depressed.

“And then what happens is you might build some in NSW, but obviously when you’re building in NSW you’re also going to be cognisant and hoping that maybe the transmission might eventually get fixed and so prices may then fall. So you’re going to take that expectation into consideration when you’re looking at the project.”

The right spot

Volatility of income can cause a project to fail, Yates says. A more interconnected NEM reduces the volatility of price and therefore brings assets owners a lot more certainty that they’ll be able to service their debt and therefore they’ll go ahead and increase production.

“Transmission is very good for all participants because it will drive down the risk, because there is less volatility in price, and then having a level of energy [priced to a PPA] will reduce the risk of the project as well, because it’s got a fixed level of income coming into the project.”

As the physical energy market expands and more participants are attracted by lower risk of pricing and lower borrowing costs, a more sensible network of generation assets will evolve.

“More competition is actually very good,” Yates says. “It means you get the optimal placement of assets.”