ESB recommendations are dead. What’s next?

ESB recommendations are dead. What’s next?

21 September 2021 By Matt Baumgurtel, David O’Carroll and Rahul Tijoriwala

National Energy ministers will meet this week to consider the ESB’s advice to the Energy National Cabinet Reform Committee – under a month since publicly releasing the advice and two months after energy ministers received the advice, wrote Matt Baumgurtel, David O’Carroll and Rahul Tijoriwala.

Energy ministers now have the opportunity to consider rejecting both the introduction of a capacity market and the imposition of congestion charges – both will prolong the status quo. Policy makers should consider implementing reforms focused on the future. If they don’t, they risk the future passing Australia by.

The Energy Security Board (ESB) has been on an enormous PR campaign since publicly releasing their advice. Not a day has passed where senior members of the ESB have not been briefing ministerial offices, the most senior offices of the gentailors, grid companies, industry associations, and stakeholder groups.

This is not surprising given the sweeping changes to the market recommended by the ESB which will fundamentally change the way the NEM operates – impacting the business of every generator, retailer, and consumer – as well as the role of those that regulate the NEM.

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Behind the scenes, over the last month, the lobbying machines have been in overdrive, and the corridors of power clogged (virtually) with energy politicking at levels not seen since the dark days of the Warburton Review.

However, unlike efforts to oppose the cutting of the RET, politicians appear to have listened first to Matt Kean and last week Lily D’Ambrosio opposing the introduction of a capacity market. Congestion charging also appears off the table as being inconsistent with the promotion of new dispatchable renewable generation.

So, what happens on Friday? Before we look ahead, let’s briefly recap how we got here.

The ESB reforms

The ESB published its final advice to energy ministers on 27 July as the final part of its original task to consider the post-2025 redesign of the National Electricity Market (NEM).

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The ESB recommended a number of major energy market reforms which, if adopted, will have a significant impact on the design and operation of the future NEM. The two most significant of these reforms are also the most controversial – the introduction of a capacity market; and the imposition of congestion charges.

Capacity Market

The ESB has recommended the introduction of a capacity market, which is essentially a strategic reserve for significant events in the NEM to provide backup power to maintain grid reliability. It is proposed to work in the form of a decentralised model which would determine the volume of the required capacity in the market whereby retailers would be obliged to pay generators to have sufficient dispatchable capacity on standby to fill gaps in supply (Physical Retailer Reliability Obligation). The ESB’s concern is that as the old coal generators retire due to no longer being financially viable (in large part due to the rise of dispatchable renewable technologies), there is an imminent risk that there will be unexpected and early closures and this will create gaps in energy supply to the grid.

This capacity mechanism will ultimately require consumers via their retailer to pay these conventional generators not just for the electricity they generate but also for the size of capacity installed at the plant irrespective of how often that capacity is actually needed.

Fundamentally, the impact of a capacity market will be to undermine confidence in future clean energy investment (i.e. energy storage) by propping up (effectively subsidising) existing coal plants that are already nearing their end of life. Financially incentivising these plants to remain operational because of the feared variable nature of renewable technologies in the energy system is not only in direct opposition to Australia’s fossil fuel emissions targets and Australian Energy Market Operator’s (AEMO) goal of 100 per cent renewables by 2025 but is also no longer the solution to a problem that may not actually eventuate.

Sustainability targets aside, it is becoming apparent that the increase in generation and storage projects coming online and improvements to the transmission networks will go a long way (if not all the way) to mitigating this supply reliability risk, and not the unreliable, polluting generators of a bygone era.

There has been significant investment in new renewable generation capacity and energy storage to ensure the continued reliability of the energy system. With the number of new generation and storage projects in development – and hundreds more possible with a little policy certainty – any potential gap in electricity supply can be avoided, with the added benefit of the outcome being a market and network fit for the 21st century.

Congestion Management Model (CMM)

The CMM would introduce a set of congestion charges to be borne by generators (both scheduled and semi-scheduled) in proportion to their impact on congestion caused during a dispatch interval, with a separate rebate mechanism to allow eligible generators to claim congestion rebates.

The ESB has recommended the implementation of the CMM as they say it will deter generators with low operational costs (i.e. wind and solar) from continuing to export energy at locations in the grid that may struggle to accommodate it.

However, incumbent generators and generators fortunate enough to be located in dedicated renewable energy zones (REZ) when these are established may have their congestion fees refunded by generators outside the REZ or by generators added to the REZ post-establishment through a congestion rebate funded from the revenue received from the CMM.

The effect of the CMM if implemented is that the brunt of the charges for congestion on the grid would be forced on new wind and solar generators, thereby increasing costs and reducing revenue certainty and ultimately deterring the development of new solar and wind projects.

By proposing the CMM, the ESB has chosen the stick over the carrot. It missed the opportunity to incentivise investment in transmission infrastructure to promote new electricity generation. In circumstances where new generators are required to replace those retiring, a CMM penalises the solution.

Building transmission to facilitate generation is not a new idea nor is it inefficient or bad policy as some suggest. Let’s remember from the 1960-1990s (well before the NEM was created) the current high voltage network was built to interconnect a dozen or so coal-fired generators located next to coal mines. Those generators (and their private owners) have benefited from the billions of dollars of public money spent building that network. Augmenting and extending that network to facilitate the next generation of power plants is not only logical, but it’s also what will keep the lights on for the next 100 years.

Stakeholder concerns

Both reforms favour, if not directly support, existing coal and gas-fired generation, and hence will slow the transition to renewable electricity generation. The prolonging of reliance on ageing unreliable generators utilising inefficient 30-year-old technology will only delay the new energy future.

However, delaying an orderly transition will mean when the transition does come it will be extremely disruptive to energy markets with the direct flow on effects for the broader economy – including a significant lack of electricity supply resulting in increased frequency and duration of rolling brownouts (load shedding) events.

Investor and developer clients tell us the lack of clarity in the operation and regulation of the market over the medium term is halting investment decisions. This uncertainty actively erodes investor confidence, which delays the investment decisions required to develop and build the wind, solar and battery projects required to ensure energy security for generations to come.

What will happen?

Given the New South Wales and Victorian position, it would appear impossible for energy ministers to progress any redesign of the NEM. This places the federal government in conflict with New South Wales and Victoria on energy policy. And with no alignment in Queensland, the federal government is lacking support and power to find a resolution.

As COVID has brought into clear focus, in our federation when the states dig in they can stop the federal government in its tracks – just as Sir Henry Parkes and Andrew Inglis Clark intended.

Unlike COVID, however, the fracture between states and the Commonwealth in relation to energy policy is deep and long-standing. The ESB was intended to bridge this gap and provide objective non-politised advice. Unfortunately, perception following the ESB recommendations is that it has been significantly influenced by the existing regulators, federal government, and gentailors.

So, what will happen? Most likely not much. However, whether the ESB has a future now that it has delivered on its original brief is unclear, particularly where the centerpieces of its recommendations appear to be non-starters in any future market redesign.

What should happen

A short-term focus now risks the long-term future of the NEM. Now is the moment to encourage investment in the new energy economy and focus on developing an energy system that promotes modern clean technologies to fill the supply gap for decades to come, not merely the next election cycle.

State governments have recognised the potential for an energy transition to lead COVID recovery. New renewable energy zones and associated planning overlays coupled with electricity transmission investment are firmly focused on unlocking the renewable future. State renewable energy programs such as the Second Victorian Renewable Energy Target Auction (VRET2), Long-Term Energy Service Agreement (LTESA), and CleanCo are also focused on unleashing the billions of dollars of private capital waiting for a sign it is welcome. This investment will create thousands of high-skilled inter-generational jobs at the moment in history when they are most needed.

However, these progressive policies focused on the future are held back by mechanisms such as congestion charges and capacity-based market structures which favour market incumbents by imposing costs and risks on new generation assets.

But the opportunity for energy ministers to reset energy policy in Australia should not be missed. It will take courage not to be held hostage by the incumbents, but the only certainty of ignoring the future is that Australia will be left in the past.

Matt Baumgurtel is the head of the New Energy sector team at Hamilton Locke. David O’Carroll is an associate at Hamilton Locke. Rahul Tijoriwala is a paralegal at Hamilton Locke.

ESB recommendations are dead. What’s next?
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