What’s the plan, Stan?

AEMO’s biannual plan for the future of the NEM, the Integrated System Plan (ISP) was released today. For consumers fed up with high electricity prices it holds out the promise of $11bn in savings if the “least cost” grid development plan is implemented.

Dig a little bit deeper and the risks and caveats around this number soon appear. Unfortunately AEMO doesn’t have a crystal ball, so its recommended grid build-out and the consequent costs and benefits is based on their best estimates. These have been tested against a range of scenarios and the $11bn net benefit is a weighted average of benefits that range from nil to around $40bn depending on the scenario. These extremes are rated as low probability (5-10%). The central estimate, which along with a handful of smaller sensitivities are rated as 60 per cent likely has a net benefit of around $7-8bn. The major source of benefits (c $10bn) is avoided fuel costs, i.e. coal and gas. Lower fuel costs would thus significantly reduce the benefits, as would competitive market dynamics that result in some of those gains being retained by generators.

Given the costs and benefits play out at different rates over 20-30 years, the figures above are presented on a net present value basis (NPV). Converting future dollars back to a consistent value today requires the use of a discount rate. A higher discount rate reduces the value of dollars further in the future. Given costs are incurred first, a higher discount rate will reduce the net benefits and vice versa. This means that the discount rate is an important input. Whether AEMO’s use of 5.9% (in real terms) is correct is a moot point, but it matters.

The ISP’s assessment of the costs of individual projects is necessarily very high level. So, each one has to go through a regulatory investment test (RIT-T) process to be signed off by the AER. At this point, costs start to get firmed up and net benefits are also tested again. But even then there is much uncertainty. Project EnergyConnect, a SA-NSW interconnector has been approved. But the proponents, ElectraNet and TransGrid are now saying the costs could be 30 per cent higher than when it was approved in February. They are also revisiting the benefits. The AER’s approval process entailed some additional modelling runs under which the net benefits were much lower (due to different fuel savings assumptions) – around $269-$315m rather than ElectraNet’s $924m. At these lower levels, a 30 per cent increase on the $1.53bn (undiscounted) project cost would wipe out the net benefits.

Other ISP projects have been subject to criticism on similar grounds. Consultants Goanna energy reviewed the RIT-T for Marinus link, the proposed second interconnector from Tasmania to the mainland. They argue that the fuel savings (again the key benefit by dollar value) are due to a switch from gas to hydro. But given Hydro Tasmania runs virtually all the generation in Tasmania they are sceptical that competition will be sufficient to ensure these savings get passed to consumers rather than be retained by Hydro Tasmania. Yet it is consumers who pick up the tab for the project.

Fundamentally this is the underlying paradox with the ISP. It claims to be based on an optimised “least cost” system. But while regulated transmission investment could plausibly be planned on a least cost basis, generation and storage are market investments. Individual participants underwrite these based on their assessment of whether they can make money from them, not whether they fit into a least cost system forecast.

AEMO do acknowledge this to some extent and note that a range of market reforms are likely to be required to ensure the right signals to market investors. They also note the impact that government policies can have. The New England Renewable Energy Zone (REZ) is not forecast to be required to be built out until the mid-2030s, “or earlier if the NE REZ is accelerated through NSW government policy”. But why would the NSW government accelerate this REZ if it’s not part of the least cost future? Who knows, but it looks like they are going to…

To be fair to AEMO, they have a duty under the rules to develop an ISP every two years, and they can’t afford to sit on their hands as Australia goes through “what is acknowledged to be the world’s fastest energy transition”. But is a rapid transition the best time to be committing consumers to billions of dollars in regulated investments that they will have to pay for the next several decades?