INSIGHTS 2018 13generation. Like in Ireland, Alberta found that a capacity market for electricity would:
- reduce price volatility and market uncertainty;
- drive efficient use of the existing transmission system rather than building new transmis-
sion before it is needed; - ensure secure, sufficient electricity supply and provide investors with a stable revenue
stream while preserving key market characteristics such as incentives that drive innova-
tion and cost discipline.
The Finkel Review recognised the need to modernise the NEM to ensure an orderly transi-
tion to a reliable and low emissions electricity system and investigated capacity compensation.
However, the review put a fundamental market redesign in the ‘too hard’ box as it was not
within its remit to be so wide-reaching.
This is why we now have the Australian Energy Market Operator (AEMO) looking at ways to
ameliorate the current crisis, largely focusing on responses such as demand side management.
And while the NEG helps too, it’s important to consider whether those remedies can be
sustainably accommodated within a system crying out for a redesign.
What sort of redesign? Well, when we compare the justifications for introducing a capac-
ity mechanism as referenced and Prime Minister Malcolm Turnbull’s recent statements, the
similarities are stark. “The National Electricity Guarantee will lower electricity prices, make the
system more reliable, encourage the right investment and reduce emissions without subsidies,
taxes or trading scheme. It is truly technology-neutral, offering a future for investment in
whatever technology the market needs — solar, wind, coal, gas, batteries or pumped storage.”
So, the NEG will do all the things that capacity mechanisms do, and electricity genera-
tors, through imposing purchasing pattern requirements on retailers, will remain available for
dispatch based on regional demand. This goes beyond an energy-only market and begins to
suspiciously look like a capacity payment mechanism. In net terms, more baseload power will
be guaranteed across the country but some states will undoubtedly face a requirement to
source more emissions guaranteed power, ie, renewables. We won’t know until the regional
numbers are crunched. Guarantees like these always carry a cost though — the question is
who will bear the cost and where in the market will it be borne. Even though these guarantees
are designed to shield against market failure, there are costs involved.
The next question is whether it will get through a NEM rule change process given the
negative sentiment historically attached to such mechanisms in Australia? Or will it lead
COAG to consider asserting more direct control by regulators instead of effectively being
outsourced to the retailers?
Either way, the retailers must feel like the meat in the sandwich, between the NEM and
the generators. There is no detail on how these guarantee requirements will be executed —
via an auction, through bilateral contracting or a contract for difference?
Further, the ESB’s initial advice appears to be based on a normal, functioning competitive
market in a relative state of equilibrium. This point is made as the ESB’s advice is based on
a regionalised outcome with outsourced execution to retailers but pays no attention to the
state of competition in each of those markets. For example, how will the scheme work in
markets of high concentration and low contestability as against highly competitive markets?
Is market behaviour so predictable so as to point unilaterally to a lower cost outcome in
concentrated markets? Was the Australian Competition and Consumer Commission given the
opportunity to review this advice?
Ultimately, the cost involved in introducing a capacity payment mechanism to the Austral-
ian market certainly seems less material when one considers the social and economic costs
resulting from our failure, perceived or otherwise, to guarantee energy supply.
While our energy mix is a policy decision, what everyone really needs is reliability at a
reasonable price.
McCullough Robertson
http://www.mccullough.com.au