How to fix the electricity market

Yet, mounting evidence suggests the current NEM may not deliver enough investment in low-emissions generation, storage and transmission, when and where it will be needed. A major review is needed – it must be credible, and it must start now.

From its creation in 1998, the NEM was fine for more than a decade, and then it was not. The imperative to address climate change in the absence of bipartisan support for clear climate change policy created a mess of industry development policies and subsidies to support renewable electricity.

And there was little attempt to deal with the closure of fossil-fuel generators and the building of transmission infrastructure to support renewables.

Previous attempts at major market reforms, most recently by the Energy Security Board, failed. In 2019, the federal and state energy ministers asked the ESB to review the NEM and report on what the energy market should look like beyond 2025.

Despite multiple working groups, a new secretariat, and extended industry consultation, almost every policy option the ESB put forward was opposed by vested interest groups, and some by ministers. No major reform was achieved, and the ESB was abolished in May 2023.

We must learn from this failure.

An effective NEM review must look beyond the focus on closing and replacing coal generation, transmission delays, and government interventions in the market, the latter including various forms of nationalisation.

The good news is that we probably have enough Band-Aids, partial solutions, and government funding to muddle through until most coal-fired plants have closed.

The NEM review will inevitably go to matters of policy and politics, and ideally would result in a new Australian Energy Market Agreement. If ministers want to impose any constraints on the review, they should make that clear from the start. If they can’t do that, they shouldn’t waste their time, or ours, on a review.

The review should be co-designed with consumers, industry, and politicians, drawing on the deep expertise of the market bodies, but without them leading the process.

Rather, the review should be led by an independent body. The Productivity Commission may be given the task, but will require a wide consultation mandate and additional resources because many of the key issues are outside its experience.

The first step should be a cross-jurisdictional review to identify the respective roles for markets, consumers, and governments, and decide what rights and responsibilities each of these bodies should have.

The current context of federal and state governments underwriting generation and, in some cases, moving towards nationalisation suggests difficult decisions and compromises. Yet, any new market design or principles will surely fail spectacularly without addressing these issues.

These decisions must be accompanied by a major review of the governance structure. The new governance structure needs a better way of dealing with the split between state and federal responsibilities, and with derogation. While the states have clear decision-making powers under the federal system, the ultimate goal must be to achieve an effective market that delivers for all consumers.

There are three policy priorities for planning the future market that the review should address. First, develop the case for, and design of, a market structure that will help ensure adequate energy resources in a high-renewables system dominated by fixed-cost infrastructure.

Second, signal the introduction of a clear and enduring carbon price for the energy sector. Without it, the market will continue to struggle to guide investment decisions, including gas plant entries and exits.

Federal Labor’s adoption of the Coalition’s Safeguard Mechanism shows that carefully crafted carbon signals can be implemented without climate policy skirmishes.

Finally, tackle the challenge of better integrating and orchestrating all forms of distributed energy resources (such as rooftop solar and batteries), including but not limited to those that will be considered in the federal government’s National Consumer Energy Resources Roadmap.

Once the policies and the core structure of the market have been decided, the technical detail of designing rules and operating procedures that reflect these decisions should be passed to the market bodies to develop.

The first-best outcome would be a well-regulated, optimised energy market that meets the long-term needs of consumers.

An effective NEM review should provide ministers, consumers, and market participants with confidence that Australia can make the transition beyond coal and towards net zero while keeping the lights on and consumer bills affordable.