Australia: Energy with honesty: Part 2 of 2

Part 1 of Energy with Honesty can be accessed here.

WHO SHOULD READ THIS

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

THINGS YOU NEED TO KNOW

  • Potential 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 policies effecting it)

If it walks and quacks like a duck...

The Federal Government decision to adopt the advice of the Energy Security Board (ESB) concerning the introduction of reliability and emissions guarantees is striking in several ways. Whilst the instant debate quite properly has focused on its workability with the reaction being quite benign from many stakeholders, what really is it?

The NEM is a steadfastly energy only trading market. For many, this energy only component is this precise attribute which has led to the current energy crisis. This is even recognised by the Australian Electricity Market Operator (AEMO) in its letter dated 4 September 2017 to Minister Frydenberg when it stated:

"Based upon the changes we see in the system, we are concerned that the current energy only market design is not sufficiently valuing resource flexibility and dispatchability, and that in the absence of a market design change, sufficient investments in new resources or existing resources that provide dispatchable capability are unlikely to occur."

The obvious and proven way to deal with this was to reform the NEM to introduce a capacity payment mechanism so that base load generators are incentivised for being available, so there is sufficient dispatchable base load when required.

But there was no real advocacy for this by the main stakeholders and Finkel effectively put such a market reform in the 'too hard' box.

Yet when we compare what the justifications are for introducing a capacity mechanism in Ireland and Prime Minister Turnbull's recent statements, the similarities are stark. Here is how the Northern Irish regulator justified its introduction into the Irish Single Electricity Market:

"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."

Malcolm Turnbull's statement on Tuesday:

"The National Electricity Guarantee will lower electricity prices, make the system more reliable, encourage the right investment and reduce emissions without subsidies, taxes or trading scheme. It is truly technology-neutral, offering a future for investment in whatever technology the market needs – solar, wind, coal, gas, batteries or pumped storage."

So the guarantees will do all the things capacity mechanisms do, and generators, through imposing purchasing pattern requirements on retailers, will remain available for dispatch according to regional demand. This is going beyond an energy only market and begins to look suspiciously like a capacity payment mechanism, howsoever called. More base load will be guaranteed in net terms across the country but no doubt some states will face a requirement to source more emissions guaranteed power, i.e. renewables. This will only be determined when the regional numbers are crunched and determined. Guarantees like this always carry a cost, it is just identifying who and where in the market that is borne. Even though these guarantees are cast as a shield against market failure, there is still that cost.

The follow on question is will this get through a NEM rule change process if it is actually perceived as a capacity mechanism given the negative sentiment historically about such mechanisms in Australia? Or will it cause Council of Australian Governments to actually seek to introduce a streamlined capacity mechanism which is controlled more directly by regulators rather than an outsourcing to the retailers to execute?

The retailers may feel like the meat in the sandwich here between the NEM and the generators. There is no detail as to how they are to execute on these guarantee requirements. Is it by way of auction, bilateral contracting, Contract For Differences or whatever.

Further, the ESB's initial advice (as there may very well be a need for the ESB to provide a much more comprehensive follow up) appears predicated on a normal functioning competitive market in a relative state of equilibrium. I make this point as the ESB advice is based on a regionalised outcome with outsourced execution to retailers but pays no attention to the state of competition in each of those markets. How will the scheme work in markets of high concentration and low contestability against very competitive markets? Is market behaviour so predictable so as to point unilaterally to a lower cost outcome in concentrated markets? Did the Australian Competition and Consumer Commission get to give this advice the once over?

And did everyone miss the fact that we saw the final piece of legislation implementing the Harper Review competition law changes pass into law on the very day we were distracted by the new energy policy? Perhaps the new concerted practices provisions and section 46 introducing the effects based test for abuse of market power may have something to say about all of this! Well, when one controversy ends, another one always opens.

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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