IEA Approves Australias Energy Liberalisation, Adds That Reforms Must Respect the Environment

(Canberra) — 9 July 2001

In a report released today in Canberra, Energy Policies of IEA Countries – Australia – 2001, the International Energy Agency (IEA) commends the progress Australia has made over the last decade in liberalising its energy markets, especially the power industry. Electricity market reform with the creation of the National Electricity Market (NEM) has led to impressive results: strong competition, significant price reductions and consumer choice. But the pace of reform has slowed, while transmission bottlenecks exacerbate reliability problems and local market power. And competition in the electricity market has so far favoured use of brown coal, leading to increased emissions. But gas market liberalisation has been under way since 1997, and may stem or even reverse this trend.

Since 1992, Australia has been in the vanguard of efforts to introduce competition into the power industry worldwide. The country has taken far-reaching steps, separating the functions of generation, transmission, distribution and retailing, which are now undertaken by separate companies in the five states that form the NEM. A competitive market has been established and features a mandatory spot market, similar to that in the early stages of reform in England and Wales.

The results tell the story, with benefits across the economy amounting to at least A$ 1.5 billion in the year 2000, according to government figures. Real electricity prices have decreased by 10% on average in the last ten years.

However, the reforms have not yet been completed and the pace of reform has slowed in recent years; the target date for full retail competition has slipped to 2002 or even later. Initially, all electricity users, including residential customers, were to be allowed to choose their supplier by June 2001.

Victoria experienced supply failures in February 2000 when a heat wave swept across south eastern Australia, causing extremely high peak demand at a time when an industrial dispute had reduced available capacity by 20% and two generating plants were unexpectedly out of service. While the immediate causes of the outages were unrelated to NEM operation, the incidents did raise questions about the adequacy of investment in the NEM, especially in transmission and interconnection.

Transactions in NEM are relatively modest by international standards and account for about 7% of total generation. This compares to 14% for the three members of the Nordic electricity market (Finland, Norway and Sweden). Queensland was not even interconnected with the rest of the NEM until February 2001.

Interconnection is also important to keep market power in check. In principle, each generator’s share of the NEM is relatively low. However, during peak demand periods, the NEM often separates into several markets, owing to transmission bottlenecks. The dominance of individual generating companies in each market is high. In New South Wales, the two largest generators account for 70% of generation and in most other NEM states this figure is above 50%.

The IEA believes that interconnection between states needs to be reinforced. There are significant price differences between NEM regions, which demonstrates that there is not enough trade. Efficient transmission pricing is needed to encourage investment in transmission and interconnection, as well as efficient plant siting. Transmission pricing should be reviewed to better reflect transmission costs, including grid congestion. One result of such a review might be that generators, too, should pay transmission charges, not only end users, as under the current system. Such a review of transmission pricing was initiated in 2000.

Due to Australia’s plentiful reserves of cheap coal, the liberalisation of the power industry has favoured its use, especially that of Victorian brown coal, which has become the primary fuel source for generation in the four southern states of the NEM. It has displaced hydro, natural gas and hard coal. This has halted the long-term nation-wide trend towards greater use of gas. Increased generation from Victoria’s brown coal plants with their relatively low thermal efficiencies has also lowered the average national thermal efficiency of power generation, leading to a corresponding rise in atmospheric emissions.

This trend could be reversed if competition in the gas market were to lower gas prices significantly. But gas market reform was begun later than electricity market reform when, in 1997 all seven states signed a binding commitment to introduce competition into the gas market. By end-2000, all had passed open access legislation, and most had developed grid access regimes.

The first benefits of gas reform are beginning to show. The adoption of a uniform national grid access code has reduced barriers to interstate pipeline construction and closed gaps in the national gas grid. A host of new projects is under way. This is important because most of Australia’s large gas fields are located far from demand centres.

New government data indicate that in the last two years, gas use in power generation has been increasing at a rate of 14.5% per annum, albeit from a low base. This may indicate that gas liberalisation is beginning to encourage fuel switching back to gas. But it is too early to discern a clear trend.

Incentives are needed to reduce adverse environmental consequences. One example is the new Mandated Renewable Energy Target (MRET), which requires an increase in renewable generation of 9,500 GWh per year by 2010. This figure is estimated to amount to 2% of Australia’s power generation in 2010. The system is market-based and compatible with the NEM, and is expected to raise consumer prices by less than 0.2 Australian cents. The IEA views this initiative as very promising.

The IEA welcomes the Australian government’s commitment to spend almost A$ 1 billion in the 1999-2004 period on climate change mitigation programmes, many of which are market-compatible. The government has announced that these programmes will be continued in spite of the uncertainty surrounding ratification of the Kyoto Protocol.