From NEM to NEP

The Clean Energy Investor Group (CEIG) represents institutional investors with a combined generation portfolio of 11GW across more than 70 power stations. The NEM is going to need plenty of investment over the next few decades, so when investors speak up, governments tend to listen. The CEIG has spoken – it has set out its manifesto for the NEM, based around five “investor principles”.We take a look at this report to see whether it’s common sense or merely self-interest. The principles are as follows:

  1. Align NEM development with global markets
  2. Redesign governance for transformation
  3. Improve revenue certainty
  4. Allocate risk effectively
  5. Build investable and innovative markets

The first principle is a bit oblique but turns out to have three components. The first is committing to net zero, which technically all Australian governments have, even if the Commonwealth government are somewhat cagey about when.

The second is to “choose” an AEMO ISP scenario, specifically the Step Change scenario. This is a curious proposal – the scenarios are not meant to be a menu from which governments choose their favourite, they are forecasts of how to efficiently configure the future NEM if a particular set of assumptions hold. These assumptions are on factors like demand patterns, fuel prices and technology costs. If those assumptions don’t hold over the next few decades, then that scenario won’t represent a lowest cost NEM.

Presumably the point of this recommendation is to ensure a guaranteed pipeline of renewable developments for the CEIG members to make money from. To be clear, this represents a firm shift towards central planning and away from allowing market signals to determine the timing and mix of generation and storage investment. This may be on the cards anyway, with the largest NEM states all developing a range of procurement options to drive investment in their own jurisdictions. At least the CEIG’s proposal would be a NEM-wide plan, which would be better co-ordinated and thus more efficient.

Having set up the need for massive swathes of renewables investment (over $100bn on wind and solar farms, plus an indefinite amount on storage), the CEIG then appeals for reforms to make the NEM “attractive” to investors. These are largely consistent with what the other main renewables lobby group the CEC has been calling for; namely faster transmission deployment, reform of marginal loss factors (MLFs),  abandonment of the proposal to introduce location marginal pricing, and reforms to the connection process, which is blowing out lead times for renewables development.

The value of these reforms is that greater revenue certainty can drive down the cost of capital. Which if you’re going to drop a lazy hundred billion on wind and solar is a big deal. Based on surveying their members, the CEIG reckon that their shopping list of reforms could drive down their cost of equity by 100-250 basis points. If this is true – and of course it’s not an independently verifiable figure – and if it was all passed to consumers in the form of lower prices, then this could save them $7bn in total.

What the report doesn’t consider is the flip side – if policy and regulation is oriented around derisking investors, where does the risk go? Where risk arises due to government intervention or vacillating around emissions targets, then it can be genuinely reduced. But most of the NEM features the CEIG is pushing back on are there because of real physical challenges on the grid. Some of them have always existed, others are a factor of the rapid energy transition.

If investors don’t bear the risks associated with their investment decisions – what to build, where to build, what sort of inverter to use, whether to add storage or some other form of dispatchability to their project, then consumers wear the risk. And this risk has costs too. A report for the Energy Security Board estimates that if left unaddressed, network congestion (where too much energy is trying to travel along the same transmission line) could cost consumers $1bn by 2030. This is a conservative estimate and is just one example of the inefficiencies that can arise if risk is misallocated. So, it’s far from clear that the CEIG’s reform package would cost consumers less in the long run.

These are the kinds of unanticipated consequences that can arise from a centrally planned approach. While markets can have their own efficiencies they are typically much better at self-correcting. This is why planning regimes like the Soviet Union and its National Economic Plan (NEP) were ultimately unsustainable. Curiously, other elements of the CEIG’s reforms have a flavour of the old Soviet Union. They would like to put a “climate expert” on each of the energy market bodies’ boards, rewrite the national electricity objective and create the Orwellian sounding Investors and Innovators Council to add to the mix of energy agencies. Enforcing a dominant orthodoxy is another hallmark of moribund societies. And innovation – one of their other key goals – doesn’t thrive in the kind of comfortable, cushioned environment the CEIG are seeking, it is driven by adversity and constraint.

Admittedly it’s drawing a longish goal to compare a group of private capital providers to Marx, Lenin and co, but a lot of the same afflictions apply to both. Before we succumb to the siren song of planning and risk reduction, we need to think through the consequences and potential pitfalls.