Energy Market Design & Australia’s Low-Carbon Transition: A Case Study of Distributed Gas Power

December 24, 2010

Social Innovation

By Tom Foster and David Hetherington

Executive Summary

There is much debate of the long-term potential of energy technologies in reducing greenhouse gas emissions -“ clean coal, concentrated solar power, geothermal and wave energy. Yet our transition to a low-carbon energy sector must begin now, using readily available technologies. Only two fit the bill: gas-fired power generation and large-scale wind. Since wind cannot provide baseload power, gas must underpin the lion’s share of the effort.

This paper explores the role of distributed gas-fired power generation in Australia’s transition to a low-carbon economy. It uses the framework of market design to consider why a technology which is cost-effective and readily available, has not penetrated the Australian electricity market to the extent it has elsewhere in the world.

We compare the levelised costs of five existing generation technologies, and find that the cost of power from distributed gas generators is approximately 10% lower than power from black and brown coal. Once trigeneration technology is added, which recycles waste heat to provide heating and cooling, the full-cost economics of distributed gas power are around 25% better than coal. In addition, each megawatt hour of coal-power we can substitute with gas trigeneration allows us to reduce greenhouse gas emissions by two-thirds.

Given this, and the widespread availability of gas in south-eastern Australia, why has distributed gas not been adopted more quickly? We identify a range of barriers to entry for distributed gas producers which are the result of poor market design in our energy sector. These barriers include implicit subsidies to coal-fired generators through coal and water inputs which are priced below market value; reluctance from energy retailers to facilitate connections to the grid; the absence of a carbon price; distortionary feed-in tariff regimes; lack of temporal pricing; and poor information amongst consumers and producers.

We propose a set of market design reforms which would level the playing field for distributed gas relative to coal.

The main findings of the paper are as follows:
– Coal-fired power stations in Australia receive implicit subsidies of $5.3 billion p.a. through fuel and water costs that are purchased below true market value
– On a fully costed basis, including a carbon price of $20 per ton, distributed gas-fired power costs 9.8 cents per kWh
– This compares to 10.7 cents for black and brown coal, and 11.5 cents for large-scale combined cycle gas turbine
– Once the impact of tri-generation is included, the cost for distributed gas-fired power falls to 6.6 cents per kWh
– Australia could reduce its greenhouse gas emissions by 10%, or 54 million tons per year, if half the coal-fired power in the National Electricity Market were substituted with distributed gas-fired trigeneration
– This would involve 8,050 new 1.5MW units and would cost approximately $14.1 billion, which could be paid for through private investment

The paper makes the following market design recommendations:
– Price fuel and water inputs to coal-fired power stations at their true market value
– Introduce a national carbon price covering the entire electricity sector
– Offer incentives to distributed network service providers (transmission and distribution companies) for rapid connections to the grid and impose penalties for tardy connections
– Place a cap on the maximum percentage of connection applications the distributed network service
providers are entitled to refuse
– Roll out a national gross feed-in tariff scheme which does not discriminate between generation technologies
– Install distributed gas-fired power generation in the 19,000 new social housing units currently under construction by the Federal Government
– Establish a public/private energy aggregation company to pool savings from energy efficiency measures
– Introduce seasonal variation for retail electricity pricing alongside time-of-day pricing variation
– Roll out smart meters on a national basis building on the Victorian model