Electricity prices moving on up

Market insights

Summer is on the way and as the weather heats up, air conditioners across Australia will be running flat out. This will lead to increased electricity demand and higher electricity prices. But some big changes in the electricity market are likely to mean prices stay high for years to come. These changes are driven by two key forces:

  1. the shutdown of coal fired power generators, and
  2. the rising cost of coal and gas in Australia

There will be winners and losers in any market shift. In this note we explore the two big drivers of higher prices and take a brief look at the potential winners.


What’s driving prices higher?

1. Retirement of coal fired power stations

In 2015, coal fired power stations supplied 76% of energy used in the National Electricity Market. But the fleet is ageing. In fact, the average age of power stations in Australia is over 30 years old. Take AGL’s 45 year old Liddell Power Station in the Hunter Valley which was commissioned in 1971. At a recent investor update, AGL discussed the age of Liddell and the need to run it below capacity to ensure the plant runs reliably.

Australia’s coal fired power stations have been ageing for some time, but we have witnessed accelerated retirement action in 2016. In 2016, Northern Power Station (520MW) in South Australia shut down due to a combination of economics and coal sourcing issues. The shutdown which occurred in May 2016 saw South Australian power prices rise 80% soon after.

Source: Bloomberg, 2016

But the closure of Northern Power Station pales in comparison to the October 2016 announcement that Victorian based Hazelwood (1,600MW) would be shutting in 2017. The 52 year old plant, generates around 20% of Victoria’s power and will have a meaningful impact on prices. The whole National Electricity Market has risen on the back of this announcement. Below we show the significant rise in NSW and Victoria power prices during this period.

Source: Bloomberg, 2016

To replace the supply lost from Northern and Hazelwood, existing power stations will need to increase their supply. Incentivising more production requires a step up in prices. In the longer term (3 years and beyond), renewables will have to move in to fill the gap.

2. Rising coal and gas costs

High profile shut downs such as Hazelwood dominate the headlines, but a ‘sleeper’ issue for the electricity market has been the rising cost of coal and gas in Australia. Most power stations have locked in the cost of energy either by owning a coal mine or writing long-term, fixed price contracts.


Who is on the front foot?

Rising electricity prices is an undeniable positive for AGL. As the largest power generator in Australia with power generation across coal, gas, wind, solar and hydro, as wholesale prices rise, AGL’s profit rises. With strong management and an excellent balance sheet, we believe AGL is very well positioned to capitalise on higher electricity prices.

At the smaller end of the spectrum, Infigen Energy with their large wind farms in South Australia are also likely to generate strong profits as wholesale prices rise.


Conclusion

Wholesale electricity prices in Australia are set to stay elevated thanks to the shutdown of coal fired power generators such as Northern (SA) and Hazelwood (VIC) as well as rising cost of coal and gas in Australia.

In our opinion, two clear potential winners from these trends are AGL Energy and Infigen Energy – both producers of electricity at low fixed costs. Unfortunately for those of us in the warmer states the users of air conditioners are likely to be the losers.

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