If all else fails, do the conventional thing

Friday, Nov 16, 2018, 01:24 AM | Source: Pursuit

By Michael Brear

If all else fails, do the conventional thing

Tolstoy's famous opening of Anna Karenina reads; "All happy families are alike; each unhappy family is unhappy in its own way."

It's fair to describe our federal and state governments as an unhappy family, at least when it comes to energy. As members of the Council of Australian Governments Energy Council, several are leading bespoke and uncoordinated initiatives that aren't collectively putting forward a strong case in the national interest.

Under-investment in much-needed forms of generation risks system reliability. Picture: Getty Images

For example, Australia's Federal Government is currently considering implementation of one of the recent recommendations from the competition regulator, the Australian Competition and Consumer Commission (ACCC), that it underwrite investment in certain forms of generation that is 'firm'.

When we say 'firm' this means it's controllable by the Australian Energy Market Operator, our Independent System Operator (ISO). This is a bespoke form of government intervention in our wholesale electricity market.

As are the Victorian and Queensland Governments' reverse auctions (or tenders) for renewables; Snowy 2.0; Tasmania's Battery of the Nation; and South Australia's big battery.

Government intervention in our National Electricity Market (NEM) is in vogue.

But these different inventions have different objectives. Some intend to build renewables; others intend firm supply; some also intend to reduce market concentration. Remarkably, none are targeting average electricity prices or carbon emissions explicitly.

And how much of each intervention we get depends on who sets the policy, and not necessarily on what we need.

No 'orderly transition'

The fundamentals of engineering and economics dictate that under-investment in much-needed forms of generation risks system reliability, particularly in summer but increasingly at other times - while also raising average energy prices. Over-investment in any form of generation reduces returns to all investors in the market, making any future investment less attractive.

So these uncoordinated government interventions are inconsistent with 'an orderly transition'.

The situation is potentially even trickier if we also implement another bespoke initiative - the proposed Retailer Reliability Obligation (RRO),which imposes requirements on electricity retailers to contract specified quantities of firm generation.

There are established methods to encourage investment in electricity power generation that are routinely ignored in much of Australia. Picture: Shutterstock

At best, a RRO would be benign, as it shares a similar intent of encouraging investment in firm generation capacity. But this isn't a justification for its implementation.

Capacity markets: part of a conventional approach

There are established methods to encourage investment in electricity power generation that are routinely ignored. Rather than uncoordinated government interventions, we need to seriously consider a capacity market in the National Electricity Market (NEM), alongside a stable, carbon-based environmental policy.

Capacity markets encourage investment in electrical power generation and other resources, including controllable demand, and are a kind of rolling reverse auction.

They are operated by the Independent System Operator (ISO) on behalf of consumers, years in advance of the current day, after the ISO makes an independent assessment of what capacity is needed by the system.

They are widely used in electricity markets world-wide, including in Western Australia, the United Kingdom and the United States. A good example is the capacity market run by the PJM Interconnection, which is the world's largest, liberalised wholesale electricity market and serves about 65 million customers in the US.

The capacity market signals firm resource, and the carbon policy signals cleaner resource. Both are needed in concert with the wholesale market itself. This three-pronged method is the conventional way to approach the tough problem of decarbonising electricity.

After considering what seems like every possible bespoke alternative, it may also end up as the only option that COAG can plausibly agree on.

This is particularly the case if the RRO doesn't adequately address concerns that it lacks transparency and encourages market concentration.

Investors in electricity generation calculate their investment risk and then either charge us or else ask the government to partly cover it. Picture: Shutterstock

We need a carbon price … to reduce electricity prices

A stable, carbon-based environmental policy is also needed for more than environmental reasons. We need it to reduce investment risk and, as a result, reduce electricity prices as the NEM decarbonises.

Investment risk is always present, and is quantified by investors, whether governments acknowledge that or not. That's why my mortgage has a lower interest rate than my credit card.

The likelihood of my not paying either is similar, but the bank gets my home if I don't pay the mortgage and charges less interest accordingly.

Similarly, investors in electricity generation calculate their own investment risk and then either charge us for it through the electricity market, along with other things, or else ask the government to at least partly cover it, as government underwriting of investment intends.

However, we always pay for investment risk in our National Electricity Market since we are both electricity consumers and taxpayers; either through our electricity bills, increased taxes or lower quality government services.

Our electricity bills are more transparent – as we can see it and can act accordingly, by putting solar on our roof or by reducing our electricity consumption, for example.

As carbon risk is arguably the major form of investment risk in the NEM, we need a stable policy that makes this explicit – and also minimises the risk. And, to investors and bill payers, there is nothing more explicit than a price on carbon.

We always pay for investment risk in our National Electricity Market since we are both electricity consumers and taxpayers. Picture: Shutterstock

So, if a government states that it wishes to minimise electricity costs, as it should, implementation of a stable carbon policy should immediately follow. Regardless of the politics, failure to do so means higher electricity prices for all of us as the NEM transitions.

All happy families are alike

Consumers are best served by the COAG Energy Council designing and implementing stable policies and supporting those who run the National Electricity Market to fulfil their mandates independently.

We might call that good, old-fashioned government. Or happy families.

Policies should be good if they are national, built on sound engineering and economics, target the things that we care about and have a track record of actually working.

So, a capacity market for investment and a carbon price for emissions complementing our National Electricity Market.

The time for endless compromise and uncoordinated interventions has passed.

Banner: Getty Images

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