Incomplete markets, pumped hydro storage and the role of policy in Australia's national electricity market

Abstract

All credible scenarios of a decarbonising Australian power system with high levels of renewables rely on a portfolio of flexible, dispatchable storage and firming assets. Given our current understanding of costs and prices, such portfolios are thought to include short-duration batteries, intermediate-duration pumped hydro, and gas turbines acting as a last line of defence against intermittency. Wind and solar output ultimately need to be moved through space (networks) and time (storage). However, the storage asset class with the highest energy density, pumped hydro, appears to be facing structurally high capital costs and face incomplete markets on entry. A generating portfolio that is under-weight pumped hydro may result in rising renewable curtailment rates and a greater reliance on gas-fired generation. In this article, we focus on material reductions in the carrying cost of capital-intensive, ultra-long-lived pumped hydro assets by introducing a ‘semi-regulated’ policy framework to address incomplete markets in Australia's deregulated energy-only power system. When the policy is applied, financing costs are lowered significantly. We find that post-arbitrage carrying costs of pumped hydro can be reduced by almost 40 %, lowering expected prices for consumers. While applied to pumped hydro, the framework may be applied to any storage technology.