Will the NEG provide relief from high costs in the Reliability and Emergency Reserve Trader mechanism?

Author Alister Alford

Date June 2018

In recent weeks as large electricity users have been receiving their bills, many were surprised by charges that relate to the unexpectedly high cost of maintaining supply security in Victoria and South Australia over summer using the Will (RERT) mechanism. The measures employed by the Australian Energy Market Operator (AEMO) certainly kept the lights on and the air conditioners running. We also know had large-scale blackouts occurred, the cost impact on business and the broader economy would have been far higher. However, what these unexpected charges highlight is the fact that as our energy market transitions, there will be challenges along the way. The withdrawal of old generators and their replacement with intermittent, distributed energy sources will take place against the backdrop of national expectations that energy supply is reliable and low cost.

In this article Energetics considers the impacts and what the National Energy Guarantee (NEG) and its Reliability Guarantee may provide.

Recovering the costs

AEMO is responsible for maintaining power system reliability and system security. Reliability and Emergency Reserve (RERT) contracts are a mechanism by which AEMO can draw upon non-market committed resources such as aggregated demand response and embedded generation to avoid blackouts, typically during summer when the demand and supply balance is tight.

AEMO's cost of utilising RERT contracts is recovered on a state by state basis from electricity retailers (‘Market Customers’) as ancillary services charges in proportion to their energy usage during business hours, regardless whether the retailer had taken steps to ensure adequate generation capacity would be available to cover its load.

As electricity retailers have sought to recover the costs associated with AEMO’s use of the RERT during the 2017/18 summer period, medium to large businesses in Victoria and South Australia have experienced significant increases in market ancillary service charges.

Scrutinizing AEMO’s data, Energetics calculates that the costs associated with the RERT are in the order of $37m in Victoria and $0.9m in South Australia.

An energy market in transition

The need to exercise RERT contracts is a recent consequence of the greater utilisation of intermittent renewable generation coincident with the withdrawal of ageing coal fired power stations such as Hazelwood (Vic) and Northern (SA). This transformation places greater challenges on operating the power system in real-time. AEMO has advised that “without this additional reserve procurement, there is a risk that the reliability standard may not be met under certain scenarios, such as during a particularly hot summer with extreme demand conditions.1”

However, RERT cost recovery is indifferent to good contracting practices.

Unbundled large retailer contracts typically pass market operational charges through to end users. The hedges put in place by retailers have no bearing on allocation of RERT costs which are proportionally recovered across the market.

As AEMO does not publish a forward-looking estimate of RERT activation or availability charges, end users have no measure to assess the balance of costs and benefits of changing business operations in response to a RERT event. Furthermore, efficient price discovery in demand side response is limited by the time frames associated with procuring the necessary reserve contracts. While demand side aggregators have made significant inroads in facilitating end user demand response, large customers typically need more time than the current RERT ten-week procurement process to identify and integrate a demand side capability in their business processes.

What has been AEMO’s response?

1. AEMO has requested an urgent rule change to reinstate Long Notice RERT

AEMO are concerned that 10 weeks does not provide enough time to procure reserves in the most competitive way and at the lowest cost. An urgent rule change to reinstate the Long Notice RERT has been submitted to the AEMC seeking authority for AEMO to procure RERT up to nine months ahead of a projected shortfall.

2. Enhanced RERT and steps towards the Reliability Guarantee

AEMO have also sought a rule change from the AEMC seeking an enhanced RERT as a stronger safety net to mitigate against the risks associated with unanticipated shortfalls. An enhanced RERT would incorporate procurement over a longer period with standard terms and conditions rather than highly bespoke contracts.

Incorporating the enhanced RERT mechanism, the Reliability Guarantee design replaces the whole of market load allocation principle with a targeted application of costs on those retailers and large energy users not adequately seeking physical sources of supply (or demand response) to support power system security. While the ability of the Reliability Guarantee to generate appropriate price signals to drive behaviour is untested, placing clear expectations on retailers opens a path for them to be held accountable and take mitigating actions rather than passing on costs to end users.

Charting a path forward

The Reliability Guarantee and the enhanced RERT seek to add much needed transparency. The presence of clear price signals, standardised instruments and targeted obligations are hopefully sufficient to drive the commercial responses needed to avoid the application of arbitrary costs devoid of true competition.

The high cost of the RERT over the 2017/18 summer highlights the potential for the energy transformation currently underway to produce adverse outcomes. In times of rapid change, the value of actions aimed at enhancing the awareness of market dynamics to better inform strategies to manage emerging risks, shouldn’t be undervalued.

Energetics will continue to monitor developments in the design of the NEG, and provide commentary on the implications for large energy users. 

Please contact the author or any one of our energy markets experts if you have any questions or comments.

 

1.  Australian Energy Market Commission: Consultation on reinstatement of the long-notice RERT, https://www.aemc.gov.au/sites/default/files/2018-04/Information%20sheet_3.pdf. 

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