McCullough Robertson has always had a finger on the pulse when it comes to the discussion surrounding the development and progression of Australia's energy policy. A topic which is certainly nothing new to Australians. For years, there has been concern and debate surrounding price volatility, reliability of supply and how to ensure future sustained investment in energy and industry. 

While the Federal Government has previously proposed a fix for Australia's energy dilemma, there has been an obvious necessity for more frankness in looking at Australia's electricity system. The opportunity cost has been discussed time and time again, with the cost of the fix on one end of the scale, and the reality that there is no such thing as free reliable energy on the other. The question we have been facing 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.

By way of background, the National Electricity Market (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. This ultimately 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.

McCullough Robertson Partner, John Kettle was integral in drafting the rules for Ireland's Single Electricity Market (SEM). The SEM is like the NEM except that it includes 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."

Yesterday, Australia's Federal Minister for Energy and Emission Reductions, Angus Taylor and his fellow ministers, released a long-anticipated Energy Security Board (ESB) report arguing that the explosion in low-cost renewable energy production must be matched with "sufficient investment in reliable generation". 

The board is proposing a capacity mechanism for Australia's energy market, which mirrors that seen in Ireland with the SEM. In capacity markets, power generators are paid when they can guarantee they can dispatch power at specific times. Some players in the renewables sector believe these payments will artificially prolong the life of coal generators.

In Ireland, the model saw smoothed out system volatility, reduced rivalry between renewables and conventional power, silenced partisan political debate, and a more resilient and reliable system.

The board's recommendations for the Australian energy market provide incentives to retain existing power generation for as long as it is needed to keep the system affordable and reliable. The introduction of the capacity mechanism would maintain reliability while the transition to renewable energy continues.

The Energy Security Board has promised to work with industry players and governments about how the mechanism would look, with concerns over funding fossil fuel generators to stay in business already flagged by renewable energy investors as impacting on new supply.

The old saying seems to ring true, "slow and steady wins the race" as Minister Taylor also spoke to the importance of avoiding a rushed transition to avoid price hikes such as those seen in 2017 Victoria's Hazelwood coal-fired power station was closed.

Although significant investment in renewable capacity has been seen in the past year, there is still not enough capacity to ensure a reliable and affordable grid said the minister. Energy ministers will meet in September to agree the final package of reforms which will be provided to national cabinet in October.

For further insights continuing the conversation on this topic please view our articles here:

Energy with Honesty Part 1 of 2 - Time to Stop the Talk

Energy with Honesty Part 2 of 2

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