AUDITOR-GENERAL’S REPORT FINANCIAL AUDITS Volume Three 2009 focusing on Electricity _part2 potx

4 __________________________________________ Auditor-General’s Report to Parliament 2009 Volume Three The Strategy comprises the following key elements:  continued Government ownership

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4 Auditor-General’s Report to Parliament 2009 Volume Three

The Strategy comprises the following key elements:

 continued Government ownership and operation of existing power stations and all electricity networks (the pole and wires) in New South Wales

 contracting the electricity trading rights of power stations to the private sector, commonly referred to as the ‘Gentrader’ model

 selling the retail arms of EnergyAustralia, Integral Energy Australia and Country Energy

 selling the following key power station development sites around the State

(MW)*

Fuel Progress

Bamarang (Delta) 300-400 Gas Full Development Approval obtained Tomago (Macquarie Generation) 500-790 Gas Full Development Approval obtained Marulan (EnergyAustralia) 350 Gas Director-General’s requirements issued (1) Marulan (Delta) 350-450 Gas Director-General’s requirements issued (1) Munmorah (Delta) 700 Gas/coal Planning process underway

Bayswater B (Macquarie

Generation)

2000 Gas/coal Planning process underway

Mt Piper extension (Delta) 2000 Gas/coal Planning process underway

(1) On 8 October 2007 the Director-General of the New South Wales Department of Planning declared the Marulan Gas Turbine Facilities Projects of EnergyAustralia and Delta Electricity were considered as Major Projects and would be

assessed under Part 3A of the Environmental Planning and Assessment Act 1979

* MW = Megawatts

The Strategy’s completion date is mid 2010 The Government retains the discretion to offer particular assets as part of an Initial Public Offering (IPO) should the first phase of the bid process not deliver the Strategy’s objectives

In September 2009 the Government called for Expressions of Interest (EOI) from national and international electricity industry operators and investors The EOI closes on 18 November 2009 Those offering an appropriate EOI will be invited to submit bids for the assets

The Government’s Strategy is intended to significantly increase private sector investment in new generation capacity for New South Wales Achieving this objective may require a trade-off between maximising the financial return to the Government and minimising potential ongoing Government liabilities

There are a number of challenges associated with implementing the Strategy Two of the more significant are uncertainty of the Federal Government’s proposed Carbon Pollution Reduction Scheme and the current global financial climate

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Auditor-General’s Report to Parliament 2009 Volume Three 5

Our 2008 report to Parliament ‘Oversight of Electricity Industry Restructuring’, included consideration points that are relevant to the current Strategy Most of the consideration points are reflected in the current Strategy The following table provides a comparison between the consideration points and the current Strategy:

Consideration points from ‘Oversight of Electricity

Industry Restructuring’, August 2008

Items included in the ‘New South Wales Energy Reform Strategy: Approach to transaction

implementation, September 2009’

Encourage new entrants and new investment to

promote competition in electricity generation and

retail markets by:

 using simultaneous rather than sequential

Generator/Retailer transactions

 holding separate tender(s) for a generation

development site(s)

The Strategy proposes that it will separately and on a simultaneous basis:

 contract the electricity trading rights of Government-owned power stations

 sell the retail arms of EnergyAustralia, Integral Energy Australia and Country Energy

 sell key power station development sites around the State

Treasury continuously evaluate the restructuring

process after the marketing effort and before the

first transaction

Treasury advised that it has conducted a considerable consultation process which included potential trade purchasers prior to announcing the strategy

Treasury continuously evaluate the likelihood of the

success of transactions and whether contingency

plans require executing

The implementation process advises that if the trade sale process does not deliver the Government’s objectives, the Government retains the discretion to offer particular assets as part of an Initial Public Offering

Reserve Price and Retention Value:

 Treasury documents contingency plans prior

to commencing the first transaction which

inter alia include the setting of a reserve

price for each transaction and considerations

if the reserve price is not achieved

 Treasury calculating a retention value for

each Generator and Retailer using consistent

assumptions prior to commencing each

transaction

The Strategy does not publically articulate Treasury’s approach to either of these points

Access to fuel supply

To support the sale by providing some certainty over coal supplies and coal costs, a new coal mine (Cobbora) will be developed to supply State owned generators

The Cobbora open-cut coalfield covers a 320 kilometre area in the Cobbora and Laheys Creek area

of Warrumbungle Shire

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The Government has approved an initial development budget of about $170 million for New South Wales generators to implement the project Of the seven State owned power stations five are in the Hunter region and can receive coal from the Cobbora mine by rail Existing rail infrastructure is

to be enhanced and expanded

Expressions of interest have been invited from parties interested in building and operating a large scale coalmine Indicative offers are due by 5 February 2010 with initial deliveries of coal due to commence from early in 2013

Electricity Prices

Electricity wholesale prices in the National Electricity Market (NEM) decreased during 2009 The average spot price for 2009 in New South Wales was $38.85 per megawatt hour, a fall of 6.75 per cent from the 2008 average of $41.66

The wholesale (spot) price of electricity has been subject to volatility since the inception of the National Electricity Market in 1997 Despite this volatility, the average spot price has remained around $40-$45 per megawatt hour

A report by IPART in 2004, ‘The Long Run Marginal Cost of Electricity Generation in New South Wales’, estimated the long run marginal cost (LRMC) for base load thermal generators to be an average of $36.33 per megawatt hour The same report concluded that the LRMC for two other technologies, combined cycle gas turbines and open cycle gas turbines, to be $41.77 and

$58.99 per megawatt hour respectively These costs currently do not include the cost of carbon

Renewable energy targets and carbon reduction schemes seek to use market forces to encourage investment in renewable and low carbon energy sources Both State and Commonwealth governments have progressively introduced renewable energy targets and carbon reduction schemes

Under the existing market rules for the NEM average spot prices can range between a minimum of negative $1,000 and a maximum of $10,000 per megawatt hour The price volatility initially impacted the valuation of generation assets by introducing uncertainty to cash flows and returns to investors In response, larger market participants manage the impact of price volatility through the use of electricity fixed price contracts (derivative financial instruments)

The following tables relate to the average annual wholesale spot prices of electricity:

$/MWh $/MWh Vic $/MWh Qld $/MWh SA $/MWh Tas

2009 38.85 41.82 34.00 50.98 58.48

Source: AEMO price statistics average annual prices per financial year

(a) Tasmania entered the National Electricity Market on 29 May 2005, and became an active participant on

29 April 2006

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The average price per megawatt hour for June 2009 of $34.15 was lower than the June 2008 price

of $41.82

The June 2009 average prices per megawatt hour were:

June NSW

$/MWh

Vic

$/MWh

Qld

$/MWh

SA

$/MWh

Tas

$/MWh

2009 34.15 30.07 30.76 31.29 173.80

Source: AEMO average regional reference price per region for the month

(a) The average price per MWh for June 2007 was affected by constraints (including drought) on generating capacity

The highest and lowest electricity prices recorded in New South Wales in the year to 30 June 2009 were:

 lowest average daily price was $17.06 per Megawatt hour on 18 January 2009 ($18.42 on

25 December 2007)

 highest average daily price was $2,207.11 per Megawatt hour on 31 October 2008 ($336.22 on

22 October 2007)

 lowest half-hour price was negative $170.76 on 18 January 2009 at 5:30 am (positive $7.58

on 19 October 2007 at 3:30 am)

 highest half-hour price was $10,000.00 per Megawatt hour on 31 October 2008 at 1:00 pm and 1:30 pm ($7,858.07 on 22 October 2007 at 10 am)

Sustainable Energy

The Government is developing and encouraging initiatives to promote the growth of sustainable energy sources Initiatives in this area are detailed below

Renewable Energy

The relatively higher cost of providing renewable generation has been a barrier to any large scale investment Renewable energy is energy sourced from alternative sources such as water, biomass, landfill methane, wind, organic matter and the sun

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Sourcing renewable energy reduces greenhouse gas emissions Approximately six per cent of New South Wales electricity is sourced from renewable energy sources The New South Wales Government has set a target of 15 per cent renewable energy consumption by 2020 This target has been largely superseded by the expanded national Renewable Energy Target (RET), which was developed through COAG and mandates that 20 per cent of energy production in Australia come from renewable sources by 2020

Source: Department of Industry and Investment NSW – October 2009

Coal continues to be the major source of electricity generation in Australia as shown below

Source: NEMMCO, An Introduction to Australia’s National Electricity Market July 2009

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Greenhouse Gas Reduction Scheme

The New South Wales Greenhouse Gas Reduction Scheme (GGAS), formerly known as Greenhouse Gas Abatement Scheme, pioneered emissions trading in Australia and is one of the first emissions trading schemes in the world The objectives of the GGAS are to:

 reduce greenhouse gas emissions associated with the production and use of electricity

 develop and encourage activities to offset the production of greenhouse gas emissions

GGAS requires retailers and other parties (benchmark participants) to meet mandatory targets set

under the Electricity Supply Act 1995 for reducing emission of greenhouse gases from the

production of the electricity they supply or use

The State’s greenhouse gas benchmarks under the Electricity Supply Act 1995 are as follows:

Source: Independent Pricing and Regulatory Tribunal, ‘Compliance and Operation of the NSW Greenhouse Gas Reduction Scheme during 2008’, July 2009

tCO2e = tonnes of carbon dioxide equivalent It is a measure used to compare different greenhouse gasses

The benchmark dropped to 7.27 tonnes in 2007 which represents a reduction of five per cent below the Kyoto Protocol baseline year of 1989-90

The GGAS is expected to transition into the Federal Government’s Carbon Pollution Reduction Scheme (see below) Most of the demand side abatement aspects of the GGAS were incorporated into the New South Wales Energy Savings Scheme on 1 July 2009, with the exception of on-site generation which remains an eligible activity under GGAS

Customer initiatives - GreenPower

GreenPower is a national accreditation program that sets stringent environmental and reporting standards for renewable energy products offered by electricity suppliers to households and businesses across Australia When customers choose to buy a GreenPower product through their electricity retailer the extra price they pay is invested in the renewable energy sector

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10 _ Auditor-General’s Report to Parliament 2009 Volume Three

Data sourced from the National Greenhouse Accreditation Program shows considerable growth in the number of customers opting to purchase green energy In New South Wales for the nine month period to 31 March 2009, GreenPower customers increased by 26,069 or 11.8 per cent from

30 June 2008

The increase in green energy purchases was not spread equally between residential and commercial customers The two graphs appearing below highlight that residential customers in New South Wales increased from 207,801 to 236,242 or 13.7 per cent at 31 March 2009, while commercial customer numbers decreased from 13,021 to 10,649 or 18.2 per cent for the same period The decline in green energy purchase by commercial customers may in part be indicative of the overall global financial crisis and its impact on the businesses in the economy

Source: data extracted from the National GreenPower Accreditation Program Status Reports for the quarters ended 30 June 2008 and 31 March 2009 ‘Greenhouse Gas Reduction Scheme’

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Auditor-General’s Report to Parliament 2009 Volume Three _ 11

Solar Feed-in Tariff Scheme

The New South Wales Government announced its intention to introduce a Solar Feed-in Tariff (FiT) Scheme from 1 January 2010 The FiT will apply to small scale, grid connected, solar photovoltaic (PV) systems A tariff of 60 cents per kilowatt hour will be paid to PV system owners for electricity produced by the systems that are fed back into the electricity grid (a ‘net’ tariff)

Electricity distributors are expected to bear the costs of the scheme with the costs being passed onto electricity customers Households are expected to pay on average between $2 and $9 per year over the life of the scheme to fund the Scheme

Carbon Pollution Reduction Scheme (CPRS)

All Australian businesses, including all electricity corporations in the New South Wales Public Sector, will be affected directly or indirectly by the Federal Government’s proposed CPRS

In December 2008, the Federal Government released a White Paper outlining its policy for a national CPRS emissions trading scheme On 4 May 2009, the Federal Government announced a number of adjustments to the scheme to address public concerns and help manage the impacts of the global recession

The key variations included: delaying the scheme’s commencement by one year to 1 July 2011; establishing a fixed price of carbon of $10 for the first year of the scheme; a global recession buffer, providing additional assistance to emission intensive trade-exposed industries (EITE) for the first five years of the scheme; announcement of a new emissions reduction target in the event of

an ambitious international agreement; and measures to account for the impact of voluntary action

to reduce abatement After the first year of the scheme, carbon prices will revert to being set by the market

Depending on the outcome of international negotiations, the CPRS will help achieve emission reductions of between 5 and 25 per cent below 2000 levels From the scheme’s outset it will cover around 75 per cent of Australia’s emissions, including those from stationary energy, industrial processes, transport, fugitive emissions, waste and forestry

Draft legislation was released earlier this year to implement this policy As at October 2009 this has been passed by the House of Representatives, but voted down in the Senate It is expected to be brought before the Senate again in November 2009

Electricity Supply and Demand Outlook

Projected electricity demand in New South Wales is currently expected to exceed supply by 2015-16

The AEMO provides the supply and demand outlook for each State, which includes:

 an indication of the capability of existing and committed supply to meet projected demand for the next ten years

 the Low Reserve Condition (LRC) point, which indicates when reserves will fall below the required level to avoid possible shortage of supply

 the Reserve Deficit in megawatts (MW), which indicates the additional reserves potentially required at the LRC point

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12 _ Auditor-General’s Report to Parliament 2009 Volume Three

Summary Overview of LRC and Reserve Deficit

Source: AEMO Statement of Opportunities 2009

Highest Demand in Summer

For New South Wales, the tightest supply-demand conditions are expected to occur during summer

The summer supply–demand outlook for the New South Wales region for the next ten years is shown

in the chart below:

Source: Extracted from AEMO Electricity Statement of Opportunities for the National Electricity Market 2009

(a) Allocated Installed Capacity: Represents the current projection of installed generation capacity allocated to meet

the reliability requirement for the region (Capacity for Reliability) It includes the available capacity within a region

plus the allocated net import from neighbouring regions

(b) Additional Capacity Required: Represents the difference between the Capacity for Reliability and the Allocated

Installed Capacity or the MT PASA (Medium Term Projected Assessment of System Adequacy) Available Capacity This

also represents the reserve deficit

(c) MT PASA Available Capacity: Represents the operational projection of installed generation capacity available to meet

the scheduled maximum demand This projection is taken from the preliminary MT PASA calculation performed using

available capacity bid into MT PASA as at 24 July 2007

(d) Capacity for Reliability: represents the capacity that needs to be allocated to meet the minimum reserve level

The New South Wales low reserve condition point occurs in 2016 when the additional capacity

required is 182 megawatts If this additional capacity is not created by this time, supply will fall

below minimum reserve levels (as indicated by the solid line), which may necessitate load shedding

and periods of blackouts for some customers

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