Research on state of PH LNG, page-4

I agree with SLee. This criticism of EWC's PH strategy has been aired many times on this board. I believe one of the posters who used to post much of this criticism was in fact associated with the authors of the report.

The main driver of the criticism is that EWC has made no progress into the wholesale contract off-wesm market, and will need to sell electricity into the WESM where the spot price will only reflect the short term marginal cost (generally the fuel cost) of the marginal generator dispatched. If the dispatch price is the income received by the generator then the generator will never cover its capital costs unless its fuel cost is significantly cheaper than the fuel utilised by the marginal generator. Imported LNG is most likely to be the most expensive fuel in the merit order.

This problem is compounded by the decline in coal generation being replaced by renewables where renewables have zero marginal cost.

The WESM however is not just used to price electricity. Sellers of electricity using forward contracts or CFDs use the WESM to dispatch electricity where the pricing risk is resolved outside the WESM. For example, I sell a forward at $0.10kwh, and then bid it into the WESM at $0 to ensure I need dispatched. I really do not care at what price I get dispatched, and nor does my customer, who will bid what it takes to receive the electricity, as the actual price (as opposed to the WESM price) is determined by the 0.10kwh price.

Now if we step back, the WESM is failing to reward the marginal generator for its capital costs. This is not an uncommon problem usually resolved when the marginal generator either has long term output contracts, or is able to set the price significant often to recoup capital costs. However renewables have upset this mechanism, not just in the PH, but in many markets. The zero (and negative) marginal cost of renewables mean the wholesale electricity markets are establishing prices below the level required to recoup capital cost for everyone.

One answer has been to bring into capacity pricing for renewables. There is no reason that capacity pricing can be extended to other forms of generation. After all shortages need new entry. And the author of this report appears to think shortages will occur.

One effect of the renewable, and fossil mix is potentially wild volatility in the spot market, and huge premiums in the forward market. I don't know if anyone remembers when NGL in NZ decided not to buy forward contracts for summer electricity perhaps 20 years ago. The summer melt did not happen, and NGL ended up holding a huge customer base of demand, but had no supply. The forward market went bonkers and NGL lost their shirt. Volatility in the spot market market drives premiums in the forward markets. Noone is going to believe that they can realistic buy electricity at next to zero as the spot market converges to near zero. Instead they will look to the markets that exist around the WESM, and the WESM will become a dispatch mechanism.

The real risk in the PH is that Mercalo will suppress the regulations and policy needed to effect these changes, and that corrupt politicians make more money from black outs than from new market entry. On top of this risk, is the risk that SE and BA have given no indication that the understand the risk of being a price taker in the WESM. The assumption seems to be that the markets will develop and it will be ok.