The National Energy Guarantee

Many questions, few answers

Author Alister Alford, John Bartlett

Date October 2017

With the announcement of the Federal Government’s National Energy Guarantee (NEG), the headlines in the media focussed on the dumping of the recommended Clean Energy Target and in turn, any formal scheme to subsidise renewable energy. At the centre of the announcement is the promise to restore confidence in the reliable supply of electricity and support sufficient emissions reductions to meet our national 2030 climate target. How these goals will be achieved and the ways in which the electricity market will change, is still very much unknown. 

In this article, Energetics’ energy markets and policy experts share their early observations.

What has been the market’s response? 

Some market participants have expressed in-principle support for the NEG.  However further detail is required on the proposed implementation models and expected energy price outcomes, as mandating specific levels of dispatchable and low emissions generation is a significant departure from the current merit based system.  Furthermore, extensive consultation with market participants and affected industries will be required to avoid inefficient risk allocation, further concentration of market power and wealth transfers.

Also, as the current market has supported an increasing diversity of retailer commercial models driven by the falling cost of renewable energy, storage technologies and access to technology agnostic electricity futures markets, policy makers are now challenged to increase obligations on retailers without eroding the appetite for innovation in the sector.

Following the announcement of the NEG, ASXE Futures electricity prices were up, reportedly due to increased demand for gas power generation contracts.

A new level of Government intervention

One of the most striking features of the NEG is that it is set up as a form of central planning, by mandating both emissions reductions requirements and dispatch characteristics, rather than letting the market respond to developments as they arise.

Currently, wholesale hedging arrangements (such as Contracts for Difference) are agnostic about the type of energy sourced. It could be black, green, hedge fund, financial institution, retailer trading book etc. Therefore creating obligations to contract with sources of readily dispatchable or low emissions energy implies the use of instruments of a more ‘physical’ delivery nature such as a sales agreements or power purchase agreements. A little more like you would see in a capacity market or a balancing (net) pool design.  Assigning spot purchases with an emissions intensity for uncontracted generation capacity suggests the creation of a centralised repository of contract quantities. 

Furthermore, when the theory translates into real world scenarios, how this obligation is managed in times of unplanned outages, which themselves may often be the trigger for lack of reserve scenarios, needs to be understood. While the parties may hold contractual agreements for the energy fuel source, the reality is that dispatchable generation may not always deliver energy in real time.

Our Energy Markets team also question the idea of a ‘single energy price’ when there are three contract classes being created, all of which have different supply/demand, credit quality characteristics and potentially trading at different spreads to a pure financial hedge (i.e. the price spread is the investment signal for that type of generation).  The three types of contracts are:

  • Sales agreements that are dispatchable and emissions-intensity specific
  • Sales agreements that are non-dispatchable, emissions-intensity specific (largely renewables)
  • Financial derivatives which are technology and emissions agnostic.

We also question whether this spread of prices across these three classes of contract will be stable and long enough to support investment. 

What could be the impact on competition?

Retailers of all sizes buy baseload energy and renewables when required. However, some small retailers or end users directly hedging do not have the credit quality to deal directly with generators and often source their cover from the Futures Exchange. 

The implied need in the NEG’s announcement to contract directly could become a significant barrier to entry for smaller participants.  The large vertically integrated energy companies would be in the best position to meet the new obligations.  That said, the ACCC has previously flagged concerns about the power of the three largest.  In a media release Chairman Rod Sims stated: 

“The ‘big three’ vertically integrated retailers or “gentailers”, AGL, Origin, and EnergyAustralia, continue to hold large retail market shares in most regions, and control in excess of 60 per cent of generation capacity in NSW, South Australia, and Victoria making it difficult for smaller retailers to compete[1].”

The behaviour of the gentailers is therefore likely to be subject to considerable ACCC scrutiny, while at the same time trying to deliver a policy that promises savings for consumers.

To support smaller retailers, if a central repository of bilateral contracts operates, could we see centralised clearing to reduce the need for prudential requirements for market participants?

Other questions include, does a retailer risk deregistration for the failure of a generator to contractually perform? What is the impact on the Retailer of Last Resort (ROLR) framework? This scheme is designed to ensure that in the event of retailer failure, arrangements are in place to ensure that customers continue to receive electricity and/or gas supply.  How could the NEG align with this and other existing requirements under law. Will they work against each other? How will this be policed and/or audited in real time?

Also, with a requirement to fulfil emissions reduction obligations, retailers which do not comply may need to make-good, possibly with retailers who achieve deeper cuts to emissions or through the acquisition of ACCUs.  Could we therefore see carbon traded?

Will households see $100-$115 per year in electricity bill savings?

Another aspect which is unclear is how the compliance obligations change the nature and type of investment in generation capacity.  There is concern that the new mechanisms could drive economically inefficient development to address artificial constraints, which in turn could lead to higher costs that would need to be recovered through higher energy user charges. 

It would appear that the modelling underpinning the projected reduction in residential energy bills and wholesale market prices has not yet been released.  The forecast $100 - $115 savings may have worked on paper but in reality time is needed for the market to adjust. With any piece of analysis however it is the inputs that drive the results. Over recent years we have seen single factors contribute to material price rises, and while modelling may suggest a saving, the real measurement is how sensitive that result is to a single material change in market conditions such as the unaccounted closure of a power station.

Further, is the fact that the Prime Minister placed such focus on the cost saving suggest that the political objective was to be seen to be addressing reliability and cost pressures while not abandoning climate objectives. Can a single policy deliver all three objectives, especially when it involves an additional level of regulation? Rarely has additional regulation led to lower costs.

Will environmental charges come down?

Some may have presumed that in not proposing any new certificate-based charges as the RET will not be expanded beyond 2020, environmental charges will come down.  However this is not the case.  Retailers are obliged to buy certificates out to 2030.  The pass through costs of state-based certificate schemes are still likely to apply.

The NEM is five loosely connected markets. It’s hard to see the NEG getting up within three years.

The announcement indicates that the new requirements will be written into the rules and in effect by 2020.  However, the detailed development and implementation of the NEG needs the support of State Governments coordinated through the Council of Australian Government’s (COAG) Energy Council to implement changes to the energy markets regulatory framework. 

This support is not guaranteed in an environment where State Governments are already progressing overlapping energy and emissions policies in their own jurisdictions.

Energetics monitors the NEM on a daily basis and will be evaluating, in detail, the information as it is released on the features of the NEG.  We help large energy users understand and develop strategies to mitigate their energy cost risks and carbon liabilities.  Please contact any one of our experts for further insights and advice.

 

[1] https://www.accc.gov.au/media-release/electricity-report-details-affordability-competition-issues