Australia: Energy with honesty: Part 1 of 2 - Time to stop the talk

WHO SHOULD READ THIS

  • People interested in the development and progression of Australia's energy policy.

THINGS YOU NEED TO KNOW

  • Potential alternative policy solutions are being overlooked and not fully explored due to the nature of the National Electricity Market (NEM) and Australian energy politics.

WHAT YOU NEED TO DO

  • Understand how the proposed National Energy Guarantee (NEG) can impact your business and whether the transition period from the Renewable Energy Target to the NEG offers opportunities for your business.
(A two part series on the Australian Energy Market and the polices effecting it)

While the Federal Government has proposed a fix for Australia's energy dilemma, there is still the necessity for more frankness in looking at Australia's electricity system. It's time just to fix it. It will not necessarily be cheap, but there is no such thing as free reliable energy. The question for us all is whether we want to pay a little bit more for reliability and security of supply, or pay out lots more in wider social welfare costs due to an unreliable, insecure system.

The fix should:

  • reduce system and pricing volatility allowing consumers and businesses to plan predictably their energy costs
  • provide appropriate signals to facilitate rational investment in base load and renewables to meet future demand, and
  • stabilise the macro-economic conditions necessary to maintain and attract sustained investment in energy and industry (both traditional and digital economies).

In simple terms, the current NEM – due to its lightly interconnected and sprawling network – permits material regional pricing differences based on regional characteristics, provoking extreme price volatility. The volatility is exacerbated by two distinct characteristics: (a) the States and Territories are sovereign on power; and (b) the NEM is an energy only spot market where generators only get paid for the electricity which the generator is permitted to sell into the NEM - a generator simply does not get paid if its capacity is not despatched. Both go to the heart of the reliability problem Australia now faces.

The NEM was not necessarily designed to deal with an abundance of renewables which are de facto favoured due to a matrix of policy, contractual and factual arrangements, and where consequently the space for conventional base load power becomes limited. A base load generator has no incentive to hang around, as hoping to be despatched is not a viable business plan and not a bankable one either. This encourages the base load generators to exit the market, particularly where utilities have market power in a region across a mix of energy sources, and deters market entry by traditional base load generators, which means that the system lacks the security both for industry needs and the sensible development of renewables.

There are two examples of fixes, one proven and one prospective, but they both have a common feature, a capacity payment mechanism.

I drafted the rules for the Irish Single Electricity Market (SEM). The SEM is like the NEM except that it included capacity payments as well as energy payments for generators. With capacity payments, generators get paid for being available and payments are set at a level to ensure that sufficient generation is available to meet demand; there is an incentive to stay on. As the Northern Ireland Authority for Utility Regulation explained:

"There were a number of reasons for having an explicit capacity mechanism.

Prices avoid the peaks of an energy only pool.

Provides a stable 'bankable' income that would help serve to attract new entrants.

The volatility mentioned above would serve to attract regulatory and political attention that would decrease confidence in the market from an investment perspective."



The result is that the model smoothed out system volatility, reduced the rivalry between renewables and conventional power, silenced any partisan political debate, and made the system resilient and reliable.

Consumers and business could just get on with things knowing the lights would not go out, and also, that renewables could sensibly keep coming onto the system (and not always with a subsidy). In fact, the pricing in the system became so reliable that some renewables operators declined to take advantage of State subsidies that were otherwise available to them. Without capacity payments, Ireland just would not have secured and entrenched the foreign direct investment (for example, 9 out of the top 10 global pharmaceutical companies have material establishments there).

In the all Ireland situation, there were also concerns about generators abusing market power in bidding into the SEM. This was dealt with simply by incorporating express prohibitions in generator authorisations and market rules against gaming or engaging in activity that would be an abuse of market power.

There are solutions, and whilst the Finkel Review looked at this issue of capacity compensation, it recognised that it would require a reworking of the NEM and that was not something that could be done right now. Basically, the question of even engaging in fundamental market redesign was put into the 'too hard' box. This is why we now also have the Australian Energy Market Operator looking to come up with initiatives to ameliorate the current crisis, which focus on responses like demand side management. The National Energy Guarantee (which was proposed last week in Canberra) helps, but really should be viewed through the prism as to whether those remedies can be sustainably accommodated within a system crying out for redesign at its core.

Other jurisdictions have recognised that theoretical approaches to the market, based on political sentiment one way or another, cannot be allowed to get in the way of energy security and reliability. Alberta in Canada is a case in point and all the more salient given its similarities to Australia economically and industrially. Their review last year unexpectedly resulted in the adoption of a capacity market solution (energy payments and capacity payments mechanism) to deal with an orderly transition away from coal generation, although the reasoning for the how and why a capacity market stacks up, regardless of motive. In short, Alberta identified that:

"Alberta's current energy-only market does not:

  • protect consumers from volatile price swings
  • ensure a stable, reliable electricity supply
  • keep pace with the global transition to low-carbon electricity
  • provide the price stability or revenue certainty needed to attract investment...
A capacity market:

  • reduces price volatility and market uncertainty
  • drives efficient use of the existing transmission system rather than building new transmission before it is needed
  • ensures stable, sufficient electricity supply
  • provides investors with a stable revenue stream while preserving key market characteristics such as incentives that drive innovation, cost discipline and investors bearing investment risk
  • enables a smooth transition to cleaner power."

No more really needs to be said.

And yes, while batteries will be important, they can only provide a temporary fix now as the manner in which they operate is not yet a fully contestable unit. So we still need a fix between now and when that technology can become an integral part of the system.

The cost of introduction of capacity payments will not be material when set against the financial and societal cost of the loss of investment that comes with failure to guarantee security of energy supply, or the perception of such. The energy mix is a policy decision, but regardless, what everyone needs is reliability at a reasonable price.

This too is my own experience: system security = investment and jobs.

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.

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