What ministers must do to save the National Electricity Market

These present Angus Taylor with the biggest opportunity and challenge he has faced as Federal Minister for Energy and Emissions Reduction.

Australia’s energy ministers created the Energy Security Board (ESB) as recommended by the Finkel Review into the security of the National Electricity Market (NEM) following the South Australian state-wide blackout in 2016.

Sadly, despite widespread support from the electricity industry and its customers, the ministers failed to implement its signature recommendation: a National Energy Guarantee (NEG) that would have integrated emissions reduction and energy policies. One arm of this recommendation, the obligation on retailers to contract for reliability (RRO) did survive, but it had been badly wounded.

In March 2019, the ministers requested the ESB to advise on a long-term, fit-for-purpose market design for the NEM. They were concerned that rapid changes in energy technology, ageing thermal generators, and emerging future challenges were testing the capacity of the NEM to deliver reliable and affordable electricity. Behind these concerns was the need, not then uniformly supported, to reduce greenhouse gas emissions in the most polluting sector of the economy.

The ESB’s work has been burdened by three big problems. The first was widespread disagreement as to whether the ministers’ concern about inadequate future investment in supply was justified. The second was that the ESB’s work was being done even as unilateral government actions to intervene directly in the market were undermining that work. And third, once the NEG was abandoned, the ESB was unable to deal with the impact of emission reduction policies on the NEM.

These problems profoundly influenced two of the ESB’s key recommendations: creating adequate market signals for timely new investment in capacity and developing the transmission system to integrate the rapidly changing generation mix.

The need for the market to value and pay for dispatchable capacity is not in question.

The existing transmission grid was planned and built in an era of big, centralised, fuel-based generators. This meant that things have not gone well in planning, regulating, connecting, and dispatching a tidal wave of largely decentralised wind and solar farms.

Actions by some state governments, to aggressively pursue renewable energy targets without always dealing with the consequences, have not helped.

The ESB recommendations for better decisions on what gets built and what gets connected with what access rights are far from perfect. But there are signs that cooperative efforts between the Australian Energy Market Operator and the project developers are slowly beginning to work.

A central role of the NEM is to match electricity supply and demand instantaneously every hour of every day at the lowest cost. Although hedge contracts between generators and retailers are used to manage exposure to extreme spot-price volatility, it is the present and expected future spot prices that provide signals for new investment.

Concern over the effectiveness of the latter to deal with the growth in renewable technologies with zero marginal cost has driven the ESB’s recommendation for a market mechanism to pay for available capacity separately from generating electricity.

Some market participants have complained that interventions by governments are creating unmanageable risks for new investment. Ministers have been increasingly concerned by extreme weather and supply problems leading to load-shedding over several summers.

Faced with these pressures, the ESB has decided that a form of retailer reliability obligation or capacity mechanism is necessary. They propose that the detailed design should be worked through over the next 12 to 18 months.

Many market participants and consumer groups have expressed differing but deep concerns with the proposed model, ranging from objections to the specific model to whether any big change is justified. The need for the market to value and pay for dispatchable capacity is not in question.

The diversity of concerns suggests there is simply inadequate detail or understanding on how the model will work: whether it will entrench the power of existing thermal generators, whether it will pay for unnecessary capacity or stymie emissions reduction, etc.

When the ministers convene to consider the ESB’s recommendation, Taylor should seek two outcomes: first, endorse the principle of a market-based capacity mechanism and the proposal to fully flesh out the design and likely impact on the market and its participants; and second, agree for this work to proceed without further interventions that would undermine the first.

All governments and market participants support the need for a market that manages the energy transition. This is a big deal. It needs and deserves a big dose of leadership and cooperative federalism.