Drought conditions in Australia affecting power prices

Published on October 25, 2019

Droughts have impacted eastern Australia leading to rural communities facing significant water shortages, creating stresses on the farming community, and increasing the risk of bushfires as evident by the recent bushfires in Queensland and northern NSW. Did you know that drought conditions also affect summer power prices?

The Bureau of Meteorology studies has shown temperatures in the Indian Ocean are a strong leading indicator for drought conditions in Australia. Data published by the BoM show the Indian Ocean Dipole (IOD), has hit record levels.

* The Indian Ocean Dipole (IOD) is an irregular oscillation of sea-surface temperatures in which the western Indian Ocean becomes alternately warmer and then colder than the eastern part of the ocean.

The outlook for the next few months is for a dry eastern Australia with an increased bushfire risk, especially in Victoria. Such an outlook is also bad news for electricity prices and security of supply over the forthcoming summer.

History has already proven that drought conditions affect power prices. In 2007, due to low water storage levels, hydropower generation was compromised, but also coal-fired power stations were impacted. Most coal-fired power stations use water for cooling, and as a result of the parlous water conditions on the east coast of Australia in 2007, coal-fired power stations were also compromised. Spot prices substantially increased in the first half of 2007, as did the wholesale forward market prices for the next 3-years.

Drought conditions not only have a direct impact on hydropower and most coal-fired power stations but also increase the bush-fire risk which exacerbates the consequential power price risk. This power risk is due not necessarily from the destruction of power generation assets or transmission lines; but rather smoke affecting the transmission line transfer capacity. There are several cases where this risk has manifested itself. In January 2007, a bushfire near Benalla created a significant smoke plume that drifted across the Snowy Mountain Scheme to Victoria transmission line. Due to the risk of ionisation across the lines, the transmission line was taken out of service, leading to Victoria load shedding customers (temporarily disconnecting) for the afternoon. A similar risk emerged in 2009 when bush fires impacted six transmission lines in Victoria.

For the majority of businesses and organisations who have set up their procurement arrangements for the forthcoming summer, they may think that this drought and bushfire fire risk will not impact them; however, they may be mistaken. Any perceived risk and especially those risks would transpire into reality, are factored-into future wholesale market prices.

Therefore, the risks manifesting themselves in the forthcoming summer, have already impacted subsequent summer prices in the wholesale forward market.

As the perceived risk has driven up Q1-2020 prices, the subsequent summer prices have followed with Q1-2021 increasing, and to a lesser extent, Q1-2022.

I guess we will all sit tight, wishing for more rain for multiple reasons, and await to see how the forthcoming summer transpires.

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