The NEM – last chance saloon
Why do renewables hate a capacity mechanism?
Chart of the week: Minimum demand
If the Energy Security Board is successful in introducing capacity payments for some generators, then it marks the beginning of the end for the National Electricity Market. The unanswered question is where will this reform end? The NEM mechanisms could end up retreating to a simple dispatch engine, with all investment and dis-investment managed outside the market.
That throws up questions about the usefulness of current boundary markets like ringfencing provisions, which assets are regulated and how they are approved, and how a more hands on system retains competition and commercial risk to retain some modicum of efficiency. We take a detailed look at the historic ESB announcement this week. Will it work with the states? Why does the renewables sector hate it so much? What is the likely fate of other reforms in the package?
Elsewhere the billionaire boys club of Twiggy Forrest and Mike Cannon-Brookes have been talking up their multi-billion dollar Sun Cable vanity project, promising to make it bigger, even though they don’t have a customer, the cable will cost billions, take months or years to repair if it fails, run in some of the world’s deepest oceans and be stranded by low cost hydrogen. Apart from that it’s a shoe-in.
Spark Infrastructure has accepted a $5.2 billion takeover bid from investors KKR, highlighting the difference in how the market values regulated energy companies from merchant, coal owning ones. The politics to re-route and add cost to the Western Victorian Transmission Network project is gaining steam, with the Victorian Opposition backing the shift.
Twiggy watch: While Andrew “Twiggy” Forrest was talking up his Sun Cable project, his CEO of Squadron Energy Stuart Johnston quit this week, just as he was supposed to be building a new gas import terminal at Port Kembla. Despite a stream of bullish promises on construction by the now departed Mr Johnston, the Forrest-owned Squadron Energy hasn’t managed to secure enough supply contracts. Good thing this wouldn’t happen to Sun Cable!
The NEM – last chance saloon
Like any big package of reform proposals, the Energy Security Board (ESB’s) post 2025 market design (P2025) recommendations is trying to be many things to many people. One of the most important things is that it is trying to rescue the NEM from collapsing into individual state-based systems, each with their own rules and schemes. This is a trend that has been steadily developing for some years, led by Victoria, but that has been gathering pace in the last year or two.
A few years ago, policy reform proposals would have barely mentioned the states – unless they were explicitly consolidating old state-based regulations into harmonised NEM-wide rules, such as the National Energy Customer Framework (NECF) process a decade or so ago. Now, the P2025 papers are littered with references to jurisdictions: what they are doing; what their needs and concerns are, and how the ESB’s reforms can help address these.
In particular, the short term goal resource adequacy reform package appears to be to get jurisdictions, including the Commonwealth, to refrain from panicking about reliability (or even just high prices) and throwing money at new entrants and/or browbeating anyone with the temerity to close an unprofitable generator. The package consists of a menu of options for jurisdictions to at least get a broadly consistent set of mechanisms in place rather than divergent schemes or ad hoc interventions.
It includes a Ministerial RRO trigger that allows the local energy minister to force retailers to buy certain level of qualifying contracts regardless of whether AEMO expects a reliability issue. There is also a new strategic reserve, which will have a single design, but which jurisdictions can choose whether to use it and how big they want it to be. Whatever the capacity mechanism looks like, the ESB signals that jurisdiction can choose their own targets if they want to, given they appear to have a lower tolerance for reliability issues than other parties. The ESB also accepts that jurisdictions may still have their own investment schemes on top of all these other levers and includes some principles for such schemes in an attempt to corral jurisdictions into some sort of consistent approach.
Will it work? History is not on the ESB’s side. The creation of the NEM itself aside, there are few success stories here. It’s true that the NECF did, over several painful years result in a set of NEM-wide retail regulations, but Victoria opted out and other states implemented some derogations to maintain a handful of state-specific rules. More recently, a plan to harmonise state-based energy efficiency schemes petered out without any real progress being made. States may also be wary of devolving their newly-revived powers back up to a national framework, given that when they wound down their various climate schemes on the premise that the national carbon price would do its job, the carbon price was promptly abolished by an incoming Coalition government.
Additionally, state governments are not hanging around waiting to see how the ESB reforms turn out. NSW is busy designing the tools it will use to deliver its Electricity Roadmap while Victoria is gearing up for its next renewable energy auction and ways to procure new transmission infrastructure that bypass the NEM’s Regulatory Investment Test.
It’s a little different for the two states that still own most of the electricity infrastructure in their state: Queensland and Tasmania. Queensland didn’t need to design a procurement scheme to achieve its state-based renewable energy target, it just created a government owned business, CleanCo, funded it, and told it to go out and build or buy enough renewables.
If the ESB reforms don’t get passed, jurisdictional exceptionalism is only likely to continue. At some point in the next few years this will lead to the collapse of the NEM architecture as a harmonised set of rules and regulations across the eastern states’ shared grid. Some vestiges of the NEM will remain; duplication of all AEMO’s functions would be very expensive and technically challenging, so states will likely subcontract market operations and procurement of essential system services to it (much as WA has done). But states all still have their own regulatory bodies and Victoria in particular is beefing up their departmental policy capabilities, so AEMC and AER could become supernumerary. There would be little reason for energy ministers to meet regularly if they were doing their own thing, or at least there would be less they’d have to try to agree on.
Does it matter? Well for many years the NEM was demonstrably one of the success stories of the wave of deregulation and competition reform that swept through many Australian industries. And as the ESB points out, jurisdictional schemes actually introduce more uncertainty rather than less. Due to the physical interconnection of the states, which is scheduled to grown significantly according to the ISP, schemes in one jurisdiction may fail to consider NEM wide impacts and may drive increased risks of unexpected or early closures of plant including in neighbouring regions. This may then necessitate further interventions. Realistically state governments can keep the lights on, but probably at greater cost. Meanwhile at retail level, balkanisation of regulation will hamper providers of new energy products and services, who will have to deal with selling into five diverse and relatively small markets with different standards and rules rather than one.
The NEM is drinking in the last chance saloon. The ESB just tried to buy everyone a round, but who will end up picking up the tab?
Why do renewables advocates hate a capacity mechanism?
Big renewables investors have written to energy ministers and posted full pages ads in newspapers opposing the capacity mechanism reforms proposed by the Energy Security Board. The question is, why?
The proponents of a mechanism to pay for capacity are not the owners of coal fired generators, right-wing think tanks or even the Morrison Government. They are the coalition of agencies responsible for running the grid, the A-Team (or the AEMC, AEMO and AER) and operating under the auspices of the Energy Security Board.
Agencies like AEMO want the grid to be able to cope with 100 per cent renewables by 2025. That doesn’t sound like a cohort vested in coal fired generation, as has been painted by some renewables players.
Capacity payments for some types of fast responding generation or dispatch – batteries, gas, pumped hydro – appears to be a good idea to make sure there is enough capacity to jump in at time when volatile big renewables jump out.
Big lumbering coal generators can’t do the job, their output inching up and down. The remaining role of coal generators this century will be to provide stability and system strength, and to frame the stage for renewables, gradually receding over time like some men’s hair until you can hardly see them at all.
As this transplant evolves, we are going to need a growing amount of capacity that is highly responsive and can work nimbly in concert with big renewable generators. Now it will be gas and batteries, one day it could be green hydrogen.
You would think renewables advocates would support such an approach. But they are furiously opposed, preferring no reform, a retention of the status quo. On current form that appears likely to deliver them deteriorating returns on solar and wind all generating at much the same time, resulting in slowing investment.
Bearing in mind that the details of a capacity mechanism are still to be worked out, you would think a rational pro-renewables approach might be to steer the design in favour of supporting more renewable investment.
There are four broad arguments being put against the possible reasons for renewable opposition interest to a capacity mechanism.
First, the market purists argue you can fix the current market by increasing the maximum price of wholesale electricity. Some academic suggest this might need to increase up to $80,000 per MWh for it to work under advanced renewables generation. That’s politically unlikely.
Second is the populist messaging that capacity mechanism will fund coal fired generators, using the term CoalKeeper to describe it (even though the actual design hasn’t been decided).
Third is self-interest, in the hope that left to their own devices coal generators will exit quickly, sending prices skyrocketing and driving another renewables boom like the one experienced after the closure of Northern and Hazelwood in 2016 and 2017. This might also smash reliability, but renewables have never taken any responsibility for that. After all, they’re primarily a building industry. This argument is implicit, and not talked about much, for obvious reasons.
Finally the fourth reason is political, that some in the renewables sector oppose Energy Minister Angus Taylor and anything he is associated with, and won’t support any policy mechanism that has his backing.
The ambiguity of the renewables opposition is reflected by the media statement put out this week by the Clean Energy Council. It expressed concern about the mechanism because it could “distort the energy market and price signals for new investment”. “The case for such a profound change has not been made” said CEC CEO Kane Thornton. But obversely, the CEC hasn’t actually made a case for its opposition.
The ESB’s post-2025 market design (P2025) final report contains a panoply of recommendations. Some are novel, many are actually already under way anyway, but there are a few familiar old friends. It’s not unusual for policy proposals to come around again. The wholesale demand response mechanism was rejected once before it found favour again and starts in earnest later this year. Veterans of AEMC processes will recognize the old multiple trading relationships proposal in the ESB’s plans for flexible trading arrangements, but there are two reform ideas that just never seem to die, but can never really get implemented either: transmission access reform, and network tariff reform.
Transmission access reform
In April 2010, energy ministers directed the AEMC to conduct a review of the arrangements for the provision and utilisation of electricity transmission services in the NEM. A fundamental concern was the lack of clear locational signals for new generators of where they should be sited. Generators don’t pay for transmission services, consumers do, so generators don’t suffer a direct penalty if their location results in additional congestion (though they are at some risk of having their output constrained). Conversely, generators don’t have the right to firm access, which means existing generators could find their output constrained, if new competitors connect to the same part of the transmission grid. Following extensive analysis and consultation, in 2013 the AEMC decided to introduce a reform model called Optional Firm Access (OFA). Generators would be able to pay for being assured that their output would not be constrained off (or rather, since the laws of physics can’t be changed, they’d get paid as if they hadn’t been constrained).
The model had little support from industry. Incumbent generators were mostly unaffected by congestion and had little interest in paying for a level of access they were largely getting for free. New and prospective generators were concerned they’d end up at a disadvantage to the incumbents if they paid (especially as the incumbents were lobbying hard to have a certain level of access “grandfathered” for free).
The OFA model ended up being highly complex and it was quietly shelved in 2015. Generators breathed a sigh of relief. But not for long. In 2016, the AEMC embarked on a review of ways to achieve the co-ordination of generation and transmission investment (COGATI). This resulted in a final report in 2018 which recommended a model called Locational Marginal Pricing with Financial Transmission Rights (LMP/FTR). LMP is used in several other electricity markets around the world. Again, it met strong resistance from the industry. Renewable developers, by this point, found strong allies in state governments who were keen to accelerate the rollout of wind and solar farms in their jurisdiction. Throughout the P2025 review, the ESB has held out LMP as the desired end state and had proposed a series of progressive reforms to get to this point. The final report, however, has clearly prioritised a new congestion management model and declared that “it would be disruptive to introduce successive access models to move to an LMP/FTR regime. To provide stability and clarity to the market, the ESB’s view is that implementing the congestion management model should be the priority reform at the current time to address congestion”. In other words, LMP/FTR has been booted into the long grass.
Network tariff reform
At the other end of the grid, network tariff reform has been on the agenda for even longer. Network tariff reform is broadly about reforming the way that households are charged for use of the network that recognises that the network is busier at some times than others. This is broadly known as cost-reflective charging. The simplest approach is Time of Use (TOU) charging where the day is separated into peak and off-peak times. But to be able to do this requires a better meter than the old accumulation meters that many households still have. So, in 2007 energy ministers endorsed a staged approach for the national mandated rollout of electricity smart meters, providing the costs outweighed the benefits. Modelling suggested national benefits of up to $4bn over 20 years, but each jurisdiction was supposed to decide for itself if it was worth it. Victoria was first to jump and instructed its distribution businesses to begin rolling out smart meters from 2010. The high standards Victoria chose and the accelerate rollout plan made the process expensive, and consumers noticed the large jump in their bills, which happened whether or not they had their new meter installed yet. A new government reviewed the scheme and decided it had gone too far to cancel, despite community opposition, but had no interest in following through to ensure the benefits. Following another change in government and a rule change designed to require distributors to implement cost-reflective tariffs, the Victorian energy minster (the current incumbent, Minister D’Ambrosio) vetoed the tariff reform plans. Remarkably, the government passed a law to ban mandatory cost reflective tariffs.
Meanwhile, the fallout from the Victorian smart meter rollout meant no other state was willing to order a mandated rollout. So, the AEMC switched responsibility for the rollout to retailers. Unlike networks, no-one was going to pay the retailers to rollout smart meters. So, they mostly adopted a policy of only upgrading to minimum functionality smart meters when they had to, i.e., for new connections and if an old meter broke.
As a result, the incidence of cost-reflective tariffs remains low. By 2020, only two distributors in the NEM had a quarter of their customers on such tariffs. The AER, who has responsibility for approving network tariffs, runs a forum to monitor the uptake of tariffs and address issues arising, but does not drive the policy forward. While it is ostensibly already a current policy to encourage network tariff reform, in the final P2025 report it is relegated to the third priority of reforms, those that will happen “later”.
What are the links between these two ill-fated reform programs? Both are ways of divvying up the costs of networks. The networks themselves are largely unaffected as they are on regulated revenues. So, they are not strongly motivated to drive reforms. And like any method of cutting up a pie, some gain and some lose out. So those who would pay more under these reforms oppose them, but those who benefit are typically less well-organised. They are also quite technical reforms, which are likely to produce net benefits eventually as they should result in more efficient future network investment, but complexity and jam tomorrow are hard sells politically. So, energy ministers have shown little appetite for driving them forward.
In theory, the AEMC as rule maker has the power to implement any reform it chooses. In practice, it cannot do so without the support of at least some other stakeholders. Tough reforms like these require a coalition of the willing to push them forward. Who knows when, if ever, these two reforms will become so compelling that a coalition can be built around them?
Chart of the week: Minimum demand
When new AEMO CEO Daniel Westerman spoke to CEDA a few weeks ago he highlighted the importance of the grid being ready for 100 per cent renewables by 2025. Maybe he should have focussed on the grid being ready for minimum demand events by 2025. On AEMO’s own projections, the growth of rooftop solar PV will deliver critical minimum demand events by 2025, where on sunny Sunday afternoons the scale of solar PV generation (which is hard to curtail) will push remaining firm generation below the thresholds for secure operation.
Chart 1: NEM Minimum demand projections (excluding Tasmania)