Is it time for a full review of WA’s Reserve Capacity Mechanism?

Reform has been a consistent feature of Western Australia’s Wholesale Electricity Market (WEM) in recent years. The Energy Transformation Strategy was established by the WA Government in 2019 to ensure the reliability and security of the power system. It was seen as an urgent action to keep the lights on and address the increasing risks in the South West Interconnected System (SWIS).

Fast forward a few years, and the same issues that led to the Energy Transformation Strategy being set up have been amplified with more than double the amount of large-scale renewable generation connected to the grid and a sharp increase in rooftop solar PV.

The challenges posed by the ongoing changes in the WEM saw the Western Australian Government launch the Energy Transformation Strategy Stage 2 in July 2021. One of the initiatives under the ‘keeping the lights on’ section is a review of the Reserve Capacity Mechanism (RCM). The Market Advisory Committee (MAC), a committee of industry and consumer representatives convened under the WEM Rules, has just taken the first steps towards starting this RCM review.

Here we look at how the WEM has changed and what that means for the RCM and generators in the South West Interconnected System (SWIS).

Predicting the future

The RCM was initially designed to encourage investment in enough generation to provide security of electricity supply and ensure that the optimal mix of generating capacity was available to meet peak demand in the SWIS. When the RCM was established, peak demand would occur for a brief period only on a hot summer day and typically after a series of hot days. If this peak demand situation was adequately covered then it meant that there should be sufficient capacity available to meet any other demand situation.

This was a simple deterministic, non-energy limited problem: did we have enough “megawatts on the ground” to supply that extreme peak plus some reserve to cover the loss of the biggest generator? Tough questions like “will the wind be blowing?” or “how long can those megawatts last?” never arose when the RCM was designed.

The most recent examples of peak demand show that capacity stress events still occur after a number of hot days. The 2020-21 summer peak demand period took place on 8 January 2021 (see figure 1). It was 3,789 MW, 130 MW lower than last year’s peak of 3,919 MW, and coincided with a succession of three hot days exceeding 36°C. The below figure shows the cumulative impact of prior hot days on the 2020-21 peak demand event.

Figure 1: Demand and temperature profiles for peak demand day and preceding two days (6, 7 and 8 January 2021

Source:  WEM 2021 ESOO

While peak demand in the WEM still occurs after a series of hot days, the proliferation of rooftop solar and intermittent generation is threatening to change when capacity stress events will occur. Since the Energy Transformation Strategy was established only two years ago, the amount of large-scale renewable capacity connected to the SWIS has increased by 144 per cent while rooftop solar PV generation has increased by 51 per cent. Depending on the day, rooftop solar is sometimes the second largest generator in the WEM.

The Australian Energy Market Operator (AEMO) ran simulations as part of its 2021 WEM ESOO and it concluded that in the short term the combined impact of rooftop solar and batteries will cause daily peak demand to occur later in the day.

Figure 2: Distribution of forecast time of 10% POE peak demand, expected demand growth scenario

Source: WEM 2021 ESOO

The longer-term impact is harder to predict. With no sign of new rooftop solar and intermittent generation slowing down and the expected reduction in dispatchable capacity with the planned closure of the coal-fired Muja C, questions can be raised about what high supply-demand stress situation the RCM will need to address as the market continues to evolve: will capacity stress events still be in the late afternoon after a series of hot days in summer, or when there is moderate demand but intermittent generation is low, or on high demand days in winter when solar generation is low, or will it be some other time?

Unexpected variations in supply/demand will be another stressor. Such a scenario took place on 16 March 2021 when a fast-moving cloudbank quickly reduced rooftop solar generation. It resulted in a huge increase in load of approximately 300 MW within 30 minutes and grid frequency reducing to 49.50 hertz, a drop generally associated with the trip of a large generation unit.

And maybe it won’t really be a capacity stress event at all? It might be a winter Dunkelflaute event, when there is plenty of accredited capacity to meet demand, but due to an extended lack of sun and wind, that capacity exhausts its energy supply, be it contracted gas, liquid fuel or battery storage.

What should be in the RCM review?

Tucked away in the launch document for the Energy Transformation Strategy Stage 2 is a paragraph signalling a review of the RCM:

“The RCM ensures there is sufficient generation capacity to meet peak demand levels in the SWIS. Energy Policy WA will review the RCM to ensure it remains fit-for-purpose and supports the transition to a lower-emissions generation mix. The RCM review will be completed, in consultation with stakeholders, by mid-2022 followed by implementation of any identified actions.”

It's a brief reference for what should be a major undertaking. Nonetheless, the review is timely given that the changing demand and generation profiles in the SWIS make it unclear whether the RCM still targets the correct situations for capacity stress events, suggesting that the current RCM design may no longer be fit for purpose.

Taking the lead on the RCM review is the MAC, which is a group of industry and consumer representatives that provide advice on rule change proposals and WEM Rules. The objective of the review is to develop an RCM that:

• achieves the system reliability that underpins the current RCM at the most efficient cost for consumers for the current and the anticipated future system demand profiles;
• addresses the issues associated with the transformation of the energy sector; and
• accounts for any transitional issues associated with any changes to the RCM.

This limited review of the RCM is a positive step. However, the pace of change in the SWIS suggests that it’s timely for a more thorough, ground-up review of the RCM that also considers the relationship between the RCM and energy price limits: i.e. the totality of the investment signals. This is particularly the case for capacity sources with energy limitations, such as battery storage and demand-side action, which we will need to rely on more for capacity stress events in the future. The challenge created by the current WEM market design is how to correctly recognise the value of these and operate them effectively.

The current WEM design uses a fixed allocation of reserve capacity credits that ignore energy limits. While this suits a more traditional power system, it creates two key challenges in a twenty-first century power system with battery storage and demand-side activity.

Firstly, there is no capacity mechanism to support investment in technologies like battery storage. As a result, there may be no avenue for these providers to recover their fixed capital costs, disadvantaging them compared to conventional capacity providers.

Secondly, a low energy price limit does not encourage the efficient allocation of limited energy. Rather, the energy price limit discourages participants from conservatively building energy stocks and retaining it for the time when it has most value – that is, when the system is facing load-shedding. Instead, these providers are incentivised to exhaust the energy as soon as the energy price rises which may be before non-energy limited, such as diesel generators, are operating. . The result is that energy limited capacity unnecessarily exhausts prior to the period of most stress.

The new essential system services (ESS) market may provide opportunities for dispatchable capacity to develop a third revenue stream (in addition to the RCM and energy price limits) and encourage investors. However, there is concern that the ESS price limit, and the ongoing revenue stream, may not be sufficient and that it doesn’t appropriately incentivise capacity sources with energy limitations. There is also uncertainty with this market because the rules require the Economic Regulation Authority (ERA) to monitor prices and intervene in the markets to reduce prices if the ERA considers they are too high.

Future-proofing the WEM

The RCM review is a welcomed announcement and comes at a timely point with the SWIS facing ongoing pressure from the changing way that electricity is demanded and supplied. The objectives of the review are positive but there is a now a need for the entire RCM to be fully considered to ensure it is a functioning part of the WEM.

A key part of any RCM review is understanding the type, duration and frequency of peak demand events that the RCM is addressing and the likelihood of capacity stress events changing over the coming 5-10 years. This will then determine the type of plant and technologies that can assist with meeting potential future supply shortfalls.

The other important part of any meaningful and comprehensive review of the RCM is an assessment of how the RCM interacts with the energy and ESS price limits. It’s feasible that capacity stress events in the future will be more random and influenced by weather patterns, requiring fast responses that don’t suit the current generation fleet featuring units with limited ability to quickly ramp up. The lack of a capacity mechanism to support investment in technologies like battery storage and the failure to incentivise energy limited capacity to store capacity for peak demand events is a major gap in the current market.

The RCM review is a huge undertaking for the MAC. It needs to be comprehensive and thorough, and it can’t be a rushed exercise if the RCM is going to be rebuilt for the next 5-10 years to give investors sufficient confidence.