Briefing Note | November 2021

Energy-only vs capacity markets

Key Points

The Energy Security Board (ESB) has been exploring major changes to how the National Electricity Market should be redesigned for the 21st century.
A key considerations of the post-2025 market design project has been whether the existing energy-only wholesale market introduced in the 1990s is worth retaining, augmenting, or whether other variants, typically involving some sort of payment for capacity, will be added to it or replace it entirely.
The current wholesale market works hand-in-hand with a financial contracts market that acts as a form of decentralised capacity market. However the contracts market is opaque and poorly understood whereas an explicit capacity market managed by AEMO would entail clearer signals about how much capacity had been procured and what the costs were. Such optics do not matter in economic theory, but they do in political reality.
In July 2021 the ESB issued its recommendations that included provision of a capacity mechanism, designed to enable the provision of 19 gigawatts of fast start, dispatch able generation needed to firm the expanding fleet of renewable generators.
Such capacity payments are essentially a payment for availability. In an energy-only market generators are paid only for the electricity they dispatch. Increased renewables generation reduces the frequency and scale of electricity provided by firming generators. But they are still critical to reliability at times of low or no renewable generation. A capacity mechanism ensures there is sufficient fast start, firming capacity by augmenting their revenue stream. Fast start, firming capacity includes batteries, pumped hydro and gas peakers.
In October 2021 the National Cabinet approved the post-2025 ESB recommendations, including capacity payments. Further design work will continue and states have the ability to opt out of the scheme.

You are unauthorized to view this page.