Will policy stability really fix the national energy market and boost capacity?

by Tony Wood

Published by the Australian Financial Review, Sunday 10 September

Australia needs affordable, reliable, secure and sustainable power. But last week the Australian Energy Market Operator (AEMO) warned of imminent shortages and longer-term problems. Governments are inclined to intervene even as industry pleads for stable policy. Homes and businesses face a clear and present danger: unaffordable and unreliable power and rising greenhouse gas emissions.

It’s time for cool heads and a pragmatic, planned solution. A new Grattan Institute report, Next Generation: the long-term future of the National Electricity Market, describes this solution.

AEMO’s report is written carefully and it needs to be read equally carefully. For example, it identifies heightened risk of shortages in 2017-18: in Victoria, a 40 per cent possibility of a shortage of up to 750 megawatts for four to five hours. Yet, this would happen only without the actions AEMO and state governments are already taking to avert such a shortage. Some commentators missed this caveat. AEMO’s chief executive, Audrey Zibelman, concluded: “I think we have done enough to get through this summer without load shedding.”

For the following four summers, AEMO recommends the creation of a strategic capacity reserve to cover possible emergencies even as demand is likely to remand flat and more intermittent wind and solar generation is built to meet the 2020 renewable energy target. This is a sensible proposal.

What to do next?

As for the longer term, AEMO observes that “competitive influences on generator profitability could increase the risk of additional thermal capacity exiting the market earlier than projected”. This reflects the impact of increasing amounts of new renewable energy in a market where little, if any, demand growth is expected. Even if this risk is avoided, the inevitable shutdown of ageing coal plants, the first expected to be Liddell in 2022, means additional dispatchable capability will be required. But there is little agreement on what should be done next.

The market design was supposed to provide incentives for new investment to meet growth or cover shutdowns. The NEM delivered this result for most of the past 20 years. But now, an environment of shutdowns and high prices, flat demand and the prospect of further policy-driven additions of intermittent supply, is challenging the operation of the market. Highly volatile prices – very low when the wind is blowing and the sun is shining, and very high otherwise – mean high risks for investors and governments.

The rational government response is to intervene directly in the market. Rational it may be, but the unintended consequence could be the end of the market and the beginning of re-nationalisation.

With clear policy the market will work. Or will it?

The industry and its customers argue that the solution is for government to finally deliver credible climate-change policy – “Give us a Clean Energy Target!”. AGL, Origin and Energy Australia seem confident that, given clear policy, they can fill the gaps: gas, wind and solar, demand response, and storage based on batteries and pumped hydro.

But AEMO thinks differently. It concludes: “The current market design is unlikely to provide adequate and sustained signals to the market to incentivise development of new flexible dispatchable resources at the level required to maintain system reliability over the medium and long-term.” AEMO recommends immediate development of a longer-term approach to deliver dispatchable capacity. Its report is silent on the CET, presumably because AEMO does not expect such a target will address its core concern on future reliability.

Overseas, governments have blinked and introduced mechanisms to pay for capacity to be available. The UK government concluded: “There is a significant risk that the market will no longer deliver an adequate level of security of electricity supply as it has done historically, principally because potential revenues in the energy-only market may no longer incentivise sufficient investment in capacity.”

A three-stage response

Grattan Institute’s report recommends a three-stage response as a better way for Australia. First, the federal government should implement all the Finkel Review recommendations, including a CET or a similar mechanism to reduce emissions.

Second, AEMO’s annual assessment of future supply and demand in the NEM should be extended to include a more robust assessment of the future adequacy of generation supply, given that new generation can require long lead times. The market may yet deliver the necessary investment in dispatchable capacity.

But third, if the Energy Security Board concludes that the NEM will not respond quickly enough to projected shortfalls, the market design will need to change. Work should begin now on the complex task of designing a capacity mechanism that would integrate with the NEM, so such a mechanism can be introduced if needed.

AEMO’s report on dispatchable capacity provides the last piece in the complex jigsaw puzzle of a credible energy and climate change policy for Australia. Malcolm Turnbull and Energy Minister Josh Frydenberg have the opportunity, and now the tools, to craft the compelling narrative that the best leaders use to unite disparate views and interests. They must seize the moment.