Originally published November 2006
The Energy Reform Implementation Group (ERIG), established by the Council of Australian Governments (COAG), released discussion papers that foreshadow substantial changes to the National Energy Market last Friday. In particular, they contemplate substantial changes to transmission planning mechanisms and financial markets, and provide a thorough critique of impediments to new entrants in the generation and transmission sector and the likelihood of vertical integration within the sector.
Further submissions and comments on the discussion papers are sought from stakeholders by close of business on 8 December 2006. A public Stakeholder Forum is scheduled on 7 December 2006 in Sydney. ERIG is then expected to identify firm recommendations for consideration by COAG by the end of this year. This report identifies some of the more important issues discussed.
COAG agreed to establish ERIG in February 2006 to develop detailed implementation arrangements for the reform of the energy market. Specifically, ERIG was asked to develop proposals for:
(a) measures that may be necessary to address NEM structural issues;
(b) achieving a fully national transmission grid; and
(c) measures that may be necessary to enhance the effectiveness of financial markets.
The discussion papers are the product of considerable research and many submissions from industry, users, regulators and advisers. In some cases, the discussion papers expand on matters that have been the subject of debate since the Parer Report of 2002. But in other cases, particularly on aspects of transmission planning and financial markets, some significant innovations are proposed. Though the papers are intended to form the basis of debate, the comparatively limited consultation time for further submissions means that one can expect at least some of the findings and recommendations in the discussion paper to form the basis of ERIG's final report.
2. Market structures
2.1 State ownership
It is clear that ERIG wants to encourage debate about the desirability of continued state ownership of electricity assets. It noted that assumption by the states of both a regulatory and ownership role created an inherent conflict of interest.
However, it was more concerned about the potential for private investors to be deterred from investing in the sector because of the continued presence of government as an asset owner and developer.
'if governments wish to focus their financial resources on investments in areas other than energy assets, the private sector could ….adequately fill the investment gap, given clear signals from governments.'
ERIG revisited the recommendation in the Parer Report to further disaggregate the NSW Generation entities and noted with concern the submissions it had received over an apparent lack of competitive neutrality on the part of State Owned Generators. It noted:
'even if all of the issues identified [in the submissions] are only perceptions, if these are firmly held, they can have a significant impact on investment decisions'.
In the absence of full privatisation, ERIG recommended seven initiatives for government businesses operating in the sector. Perhaps the most important of these are the establishment of independent mechanisms for board appointments, a requirement that the level of dividends be independently determined by the board, and that GOCs report on the basis of ASX listing rules.
2.2 Confusion over Greenhouse policy
ERIG noted the concerns raised by market participants over greenhouse abatement measures and renewables policies. These concerns were primarily over a lack of regulatory certainty and also reflect a level of frustration at the presence of competing state based initiatives. Investors are factoring premia into investment proposals that reflect this uncertainty.
2.3 Vertical integration and industry consolidation
ERIG noted concerns raised by consumers about the increasing trend to vertical mergers between generators and retailers in the electricity sector. It found that the primary concern was in fact excessive horizontal aggregation. It noted the ACCC/AER submission that the majority of future proposals that only involve generator/retailer integration are unlikely to substantially lessen competition.
It considered the question of whether, in addition to the general prohibition on anticompetitive mergers provided by S50 of the Trade Practices Act, there was a need for industry specific cross ownership rules. It concluded that, except in the case of cross ownership between generators and transmission entities, there was no need for a special set of cross ownership rules for the electricity sector.
2.4 Market governance
ERIG revisited the issues surrounding market governance and the functions of the AEMC and NEMMCO. It signalled that it intends to further investigate the division between policy and rule making functions of the Ministerial Council on Energy and the AEMC, and it foreshadowed a further review of whether the AEMC should be allowed at least some discretion as to its rule making priorities.
2.5 Retail price cap
The discussion paper noted that the presence of price caps can deter new entrants and thus limit competition in the longer term. Although the current MCE process provides for the removal of retail price caps when competition is deemed to be sufficiently strong, such price caps themselves impede competition. ERIG considers that this potential contradiction is worth investigating in further detail.
ERIG proposes the gradual lifting of retail price caps to levels where they are less binding and the shifting of some or all community service obligations to budget transfer payments.
3.1 The level of interconnection
ERIG assessed that the current level of transmission and interconnection investment is reasonably appropriate for the installed generation capacity and peak demand.
However, ERIG expressed the view that the divergence between transmission operation and the needs of transmission users has increased the cost of inter-regional trade, possibly leading to an inefficient under-utilisation of transmission assets.
ERIG identified three critical shortcomings to achieving an efficient mix of generation and transmission investment:
(a) the need for commercial incentives on generators to locate efficiently in respect to the transmission grid;
(b) improved incentives for both efficient operation of the existing transmission system and efficient investment in a market context; and
(c) a requirement for coordination of investment in the transmission system on a national basis.
However, the risk in changing existing rules is always that it will penalise those who have made investment decisions based on the existing regime.
3.2 The regulatory test
Currently, network service providers must ensure any proposed augmentation passes the 'Regulatory Test', which is broken into two limbs:
(a) the reliability limb, used for considering network augmentations determined to be necessary to meet customer reliability standards; and
(b) the market benefits limb, which is applied to other proposed network investment.
ERIG suggests that there is merit in replacing the Regulatory Test with a two step process to guide efficient transmission investment. The first step would involve the establishment of a National Transmission Network Development Plan (the Plan) aimed at delivering an integrated, national plan for the longer term efficient development of the grid. The Plan would then inform the setting of the revenue allowance provided for Transmission Network Service Providers (TNSPs) for a regulatory period. Within that period, each project would be subject to a Project Assessment and Consultation process prior to being constructed.
3.3 Transmission planning
ERIG revisited the need for a national transmission planning mechanism. It noted that:
'a project by project assessment cannot be expected to deliver efficient long term development of the National Network',
It outlined three broad options for national planning:
(a) Modified status quo– involving the establishment of a national planner to disseminate information;
(b) Strategic national planner and co-ordinator – involving a national planner to disseminate information, deliver strong and well informed independent advice on efficient investment across the NEM as a strategic national plan and undertake consultation processes; and
(c) National Transmission Service procurer – involving the establishment of a NEM-wide, not-for-profit corporate entity responsible for making decisions on transmission augmentations.
3.4 Who would be the planning authority?
Three options are also being considered for the location of the national planning function in the NEM:
(a) the creation of an independent new entity;
(b) placement of the national planning function under the Australian Energy Market Commission, in a structure similar to that of the Reliability Panel; and
(c) placement of the planning function within NEMMCO, subject to acceptable changes to the governance of NEMMCO itself.
In Minter Ellison's view, the key question is not so much who should be the planning authority but whether and in what circumstances an authority should have the power to direct augmentation.
4. Financial markets
This discussion paper addresses issues associated with the financial markets (capital, spot and contract) relevant to the energy sector (gas and electricity).
4.2 Phasing out ETEF and LEP
ERIG suggests the phasing out of the Electricity Tariff Equalisation Fund (ETEF) and long-term energy procurement (LEP) hedging programs, due to their negative impact on the efficient operation of the financial market in electricity. The timetabling of the phase-out arrangements for ETEF by the NSW Government is also supported.
4.3 FSR disclosure
ERIG notes industry uncertainties surrounding disclosure requirements under the Financial Services Reform Act 2001 (Cth) (the FSRA). ERIG suggests that it may be useful for ASIC to clarify energy market participants' obligations under the FSRA. ERIG also recognises market concerns regarding the impact of AASB 139 in light of the gross pool character of the NEM.
4.4 Inter-regional trade
ERIG has noted the potential for the improvement of the existing settlements Residue Section Auction (SRA) process. In particular, it suggests:
(a) settling a nominal capacity for each link;
(b) possibly only triggering the SRA when the price difference exceeds a threshold;
(c) pooling auction payments across the regions and using the collected auction premiums to support spot payments; and
(d) longer dating of SRA.
ERIG noted that there may be a case for providing generators with incentives to support flows across interconnectors, but that nodal pricing should not be considered as a solution.
4.5 A single spot and contract settlement mechanism.
Credit inefficiencies in the NEM are discussed. Options for resolving the issues include:
(a) maintaining current separation of spot and financial settlements and addressing inefficiencies as they arise; and
(b) establishing a national settlements and clearing facility to handle both forward and spot market settlement and clearance in the NEM.
4.6 Short term forward/market
There is interest among some NEM participants in the introduction of a short-term forward market (STFM). Industry views are sought as to whether the trial of a STFM would add value and, in the case that it would, evidence of the benefits it would deliver. Although it is not clear who would run the trial, it is suggested that any identified credible party should have the opportunity to compete on an equal footing to run the trial.
Please click here for a full copy of the ERIG Discussion papers. It is expected that ERIG will release a final report on implementation arrangements by the end of 2006.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.