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. Tasmania has already cornered the market for generation, consoidating all its own generation in Hydro Tasmania, which is also offtaker for the few privately owned wind farms and has the rights to Basslink, the interconnector to the mainland.

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?