17 October 2017

Keeping the lights on: Australia’s new energy plan throws a lifeline to ‘reliable’ coal and gas fired power plants

This article was written by Louis Chiam and Vishal Ahuja.

In the midst of a politically charged debate over electricity blackouts and steep price rises, the Australian Government has announced a new energy policy that forces electricity retailers in the Eastern States to ensure they purchase wholesale electricity from a portfolio of sources, including both ‘reliable’ coal and gas fired power, as well as low emission sources such as wind and solar.

The Australian Government has released its eagerly anticipated energy plan, announcing a new National Energy Guarantee, under which electricity retailers will be obliged to source electricity from both renewable generators (the “emissions guarantee”) and more reliable generators (the “reliability guarantee”).

The energy plan, which has been recommended by the new independent Energy Security Board, caps off the government’s response to this year’s Finkel Review and represents a major new policy direction, which rejects the Finkel Review’s call for a new Clean Energy Target.

Wholesale buying guidelines

Under the new plan, electricity retailers (and large users who directly acquire power from the National Electricity Market) will have new obligations as to how they source their wholesale power. The retailers will need a portfolio that includes both:

  • reliable sources of supply, which can be dispatched centrally by the market operator – this would include traditional sources such as coal or gas fired generation, as well as hydro and batteries (unlike intermittent sources such as standalone wind and solar) and flexible dispatchable demand; and
  • renewable energy sources (including hydro, solar and wind) which will assist Australia to meet its emissions targets, such as its Paris Agreement commitments to reduce emissions by 26% to 28% of its 2005 emission levels by 2030.

Retailers will be given significant flexibility to decide how they choose to meet each of these requirements, although the reliability obligation will be regionally based; South Australian retailers will need to source South Australian generation, and so on. 

It appears that the reliability guarantee will apply to retailers and large users who purchase direct from the national electricity market, but will not apply in Western Australia or the Northern Territory. The emissions guarantee would be applied nationally but there would be flexibility for a different approach and target for Western Australia and the Northern Territory.

The ESB recommends the reliability guarantee start in 2019 and the emissions guarantee start in 2020.

Tracing power in a ‘blind’ market

A major challenge for the policy will be how to audit the wholesale power purchasing by electricity retailers. In Australia, most wholesale electricity is purchased through a combination of:

  • physical market: a mandatory ‘blind’ auction process – all generation is pooled and sold into the National Electricity Market operated by Australian Energy Market Operator and in turn sold to electricity retailers. No individual transactions can be traced through the NEM and a retailer cannot tell which generator provided its electricity; and
  • financial market: a secondary financial market where generators, retailers and other buy and sell hedges and other risk management products.

Options to deal with the tracing issue include:

  • tracing via contractual commitments given directly by a generator to a retailer, for example tied to a wholesale market hedge;
  • creating ‘energy security certificates’, which to date has been the preferred mechanism to attribute generation sources through the market (for example in the RET). However, the government had flagged it will not require retailers to purchase new certificates; and
  • restructuring the NEM from the current ‘energy only’ into a capacity + energy market, in which ‘reliable’ generators would be paid a market price for their available capacity.

The ESB has recommended option 1 proposing that retailers be required “to hold forward contracts with dispatchable resources that cover a predetermined percentage of their forecast peak loadCompliance with the guarantee is then based on the actual output and availability of the dispatchable capacity and the cost of any non-compliance is based on the real time spot price… This operating requirement would set the minimum level and type of dispatchable capability the system requires. This could include fast start or slow starting but longer running resources, and would be determined given the expected load requirements of market customers in each region, the level of dispatchable and various resources and the interconnector capacity”.

At the beginning of each compliance period, retailers would need to provide the Australian Energy Regulator with evidence that their contract position meets the reliability guarantee. However, it appears the guarantee would be applied in real time. Failure to comply would expose the retailer to adverse spot price outcomes and potential deregistration from the market.

This would encourage ‘reliable’ generation to remain in (or enter) the market by potentially opening up a more stable revenue stream for generators (and potentially a new cost for retailers).

The emissions guarantee and RET

The ESB suggests that the Commonwealth Government would set the emissions guarantee at a level to meet Australia’s emission reduction commitments such that retailers would need to meet their load requirements at a certain average emissions level. Generators and retailers would enter into contracts for supply of energy at certain emissions levels. There could be secondary trading to allow balancing of portfolios. To show compliance, retailers would provide evidence to the AER that the mix of electricity has met the emissions guarantee. Retailers could also meet their obligation by using Australian and international carbon units.

The Government will not extend the RET, instead allowing it to run its course under current legislation – with the target peaking at 33,000 GWh in 2020 and the scheme expiring in 2030. The much maligned renewables scheme, which requires retailers to buy green certificates from new renewable generators, has been criticised for attracting too much ‘unreliable’ renewable generation.

The emissions guarantee is not intended to change the RET. The policy could determine whether retailers could use existing RET generators to meet their emissions guarantee.

Navigating the cross-bench

With the government’s choices constrained by the politics of a tight Parliament (including a hung Senate and a Labor opposition indicating it requires at least the CET as part of any bipartisan deal on energy policy), the new policy is in many ways about the art of the possible.

  • Any major legislative changes (notably repealing the RET) would have required approval by a potentially hostile Senate. By simply allowing the RET to lapse, the government avoids this battle.
  • Much of the remainder could be implemented by regulation, which was the mechanism used for the gas reservation policy targeting LNG exports. But this runs the risk of disallowance by the Senate.
  • The third course, is the COAG Energy Council / AEMC rule change process, where energy market rule changes progress through a cooperative bureaucratic process, but where the (mostly Labor) State Governments hold considerable sway.

The ESB is recommending the third option with COAG considering the package in its November 2017 meeting with a view to engaging with subsequent detailed design consultation thereafter.

For those with energy reform fatigue, there is no time to rest.

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