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A steady hand on the tiller of energy policy

A recent report by KPMG for the Australian Energy Council advised on the principles for successful wholesale electricity market design. The principles developed allow for a robust assessment of market design changes under consideration by Energy Council and market institutions.

Cassandra Hogan
Cassandra Hogan
29 June 2018

This article was written by Cassandra Hogan and Daniel Hamel from KPMG.

Why are market design principles important?

Decreasing wind and solar costs, along with government emissions reduction policies, are driving the transformation of the Australian electricity sector. This is well-known. However, what is sometimes taken for granted is that the investment required to facilitate such a change – estimated to be $23 billion to 2030 for the NEM – will be provided by capital markets1.

Investors require certainty in the energy policy framework. Change in any market is inevitable. What is important is this occurs in a way that is well understood and provides both investors and customers with confidence to make long-term decisions. Markets may not deliver if this certainty is lacking or regulatory change is not somewhat predictable.

In our view, policy certainty requires the following:

  1. A single, unambiguous policy objective against which all reforms are tested. For the electricity sector this is the National Electricity Objective (NEO).
  2. Established and accepted market design principles to support the assessment of reform proposals against the NEO. Table 1 sets out the market design principles that were developed by KPMG for the Australian Energy Council.
  3. An objective regulator that assesses proposals on their merits, against the overarching objective and using a consistent set of principles. This is the role played by the Australian Energy Market Commission.

While the first and third points are on track, we believe there is merit for the Energy Council to work with industry to agree upon a set of market design principles to promote greater certainty and discipline in how electricity market reforms are assessed.

Table 1: KPMG Market Design Principles


KPMG's ELECTRICITY MARKET DESIGN PRINCIPLES
Principle 1 Competition and market signals Participants responding to market signals in a competitive environment tends to promote better outcomes for consumers than centralised planning.
Principle 2 Risk allocation Markets that allocate risk, costs and accountability for decisions to those best placed to manage them, promotes efficient outcomes.
Principle 3 Competitive neutrality Markets that are technology neutral and do not favour one technology or business model over another encourage consumer needs to be met at the lowest cost and promote innovation.
Principle 4 Clear and durable rules Markets that are durable across a range of credible future scenarios, and establish a clear and consistent set of rules, provide participants with the confidence to make decisions.
Principle 5 Information asymmetries For competitive markets to work as intended, market participants need accurate and timely information to make decisions. Without this, they will not be confident they are competing on a level playing field.
Principle 6 Cross-market integration Costs to consumers will be minimised when markets complementary to energy, such as ancillary services and emissions, are designed in a way that is consistent with the price discovery mechanism for electricity.

What happens if it all goes wrong?

Looking to the future, failure to provide policy certainty will result in a lack of the ‘right’ type of investment in the market. As variable renewable energy continues to form a greater proportion of the energy mix, investment in dispatchable generation is required to firm variable output from renewables. If this investment is not forthcoming, the market will face a greater risk of reliability shortfalls.

Recent events in NSW illustrate the impact a lack of investment could have. Figure 1 shows output from the NSW coal generators overlaid with price for the week of 4 June 2018. The average capacity factor of the coal fleet was 58% during this period, resulting in a number of high price periods, AEMO issuing Lack of Reserve notices and Tomago aluminium smelter engaging in demand response.

The reduction in capacity was roughly equivalent to the retirement of the Liddell and Vales Point power stations, both of which are due to close within the next 10 years. Further, solar output was zero during the peak periods in the evenings, while wind was running at an average capacity factor of 23%.

Without a consistent and well-understood set of principles underpinning changes to the NEM policy framework and providing investors with policy certainty, investment from capital markets will not be forthcoming.

Figure 1: NSW coal-fired generation capacity overlaid with price, week of 4 June 2018


figure-1-kpmg-article

Source: AEMO data and KPMG analysis.

Wrapping up

Electricity is a vital input to the Australian economy. Electricity market design can have a material impact on the cost of the electricity sector given they are the ‘goal-posts’ within which market participants make investment and operational decisions.

Substantial investment in new capacity is required as we transition to a lower emissions economy. Capital markets should not be taken for granted. Policy makers need to ensure that market design changes occur in a way that continue to meet well-established objectives and principles, and are therefore predictable.

KPMG’s recommended market design principles are set out in our report, with both the executive summary and full report published on the Australian Energy Council’s website.

This article was written by  KPMG's Cassandra Hogan, National Sector Leader, Power & Utilities and Daniel Hamel, Associate Director, Power & Utilities. The opinions expressed here are their own and don't necessarily represent AGL Energy's positions, strategies or opinions.




1 See Australian Energy Council website.