Reliability Guarantee: It’s just a flesh wound

On 20 August the Federal Government abandoned the emissions component of the National Energy Guarantee (NEG) since it was not confident it could have the necessary legislation pass the House of Representatives.[i] But what does that mean for the other half of the NEG, the Reliability Guarantee? We take a look.

Can the Reliability Guarantee stand alone?

The week after the COAG Energy Council’s 10 August meeting, the Energy Security Board (ESB) released draft legislation for comment, and also a consultation paper outlining alternative policy options for activating the reliability option.[ii]

The draft legislation is the National Electricity (South Australia) (National Energy Guarantee) Amendment Bill 2018.  In common with all National Electricity Market (NEM) legislation, South Australia would enact the lead legislation, which would then take effect in the other NEM jurisdictions.

The draft legislation would insert a new Part 2A “National Energy Guarantee” into the National Electricity Law. There are two divisions to the amendments:

• Division 1: Emissions Reduction Requirement; and
• Division 2: Reliability Requirements.

In addition there are consequential amendments, such as extending the Australian Energy Regulator’s (AER) ability to monitor compliance of the new requirements.

It is clear from the way that the ESB has drafted the legislation that the components are separable, i.e. the Reliability Guarantee can be implemented by itself, without the need for the Emissions Guarantee to accompany it.

What about the new Reliability Requirement Pre-Condition Options?

At the COAG Energy Council meeting the South Australian minister expressed concern that a reliability gap could emerge at any time across the 10 year forecast period and asked the ESB to consult on legislative options to address the issue.[iii] In response the ESB quickly issued a consultation paper outlining three further options.[iv] Unfortunately unlike its previous final design paper, the options paper was prepared without extensive industry consultation and collaboration, and this is clear from the detrimental market effects contained in each of the options proposed.

The final design paper which the ESB presented to the COAG Energy Council meeting proposed that if a material reliability gap was forecast three years out (T‑3), then the reliability obligation would be triggered, and liable entities would need to put in place qualifying contracts to cover their share of system peak demand (and hence address the reliability gap) in the forecast period.[v] (In addition, the reliability gap would be assessed at T‑1, and a reliability obligation could be triggered then.)

The new options paper proposed three alternative triggers for the reliability obligation (apart from the T‑1 trigger), and these are discussed in turn below.

1. Addition of a T‑5 Determination

Although the Australian Energy Market Operator (AEMO) produces its Electricity Statement of Opportunities (ESoO) annually, which would show impending reliability shortfalls, the addition of a T‑5 trigger would put liable entities on notice that they would need to have arrangements in place, whether that be qualifying contracts or necessary plant built, so that they could meet the reliability obligation in five years’ time. In addition, the presence of a T‑5 determination would empower AEMO to commence a voluntary book-build from that year, and every year until T‑1.

From the Energy Council’s perspective a T‑5 determination provides no additional comfort that the reliability obligation will met in Year T.  Forecasts of shortfalls five years in advance of them possibly occurring will necessarily be vague and uncertain given likely and possible changes in supply and demand over the intervening period. The ESoO already telegraphs coming shortfalls to market participants and prospective generation plant builders, therefore there is no need for a reliability obligation to be imposed on the market so far out.  In addition, from a financial markets’ contractual perspective, there is next to no liquidity so far in advance of the year in question, therefore market participants would be unable to act on the trigger anyway.

2. Removal of T‑3 Determination

At face value removing the T‑3 Determination appears sensible, since responsible market participants will be monitoring the ESoO and planning responses when reliability gaps are forecast, however this leaves an element of surprise for liable entities, since a T‑1 determination can be called at any time. Although liable entities will be monitoring the ESoO’s forecasts as they become closer and closer to the reliability gap year, Year T, the entities may not have entered into the required qualifying contracts when a T‑1 determination is sprung upon them, since their internal forecasts may have indicated no likely reliability shortfall.

The paper has also proposed that despite the removal of the T‑3 Determination, a market liquidity test would be conducted by the AER at T‑3, and if necessary, a Market Liquidity Obligation imposed upon large, vertically integrated retailers. In addition, AEMO would have the ability to commence a voluntary book-build from that year, and every year until T‑1.

To the Energy Council’s mind the removal of the T‑3 Determination would therefore be of little value, since it would introduce additional risk to market participants due to the possibility of a T‑1 determination being called with little warning, introduce a market obligation on a limited number of market participants, and not allow the market as a whole to address the problem of correcting the foreshadowed reliability gap in good time.

3. Ministerial Powers to activate the Reliability Obligation

Under the final option proposed, Ministers for each NEM jurisdiction would be able to trigger a T‑1 Determination with a minimum of three months’ notice. No material reliability gap would need to be present for a Minister to make a determination, and there would be no limit to how far in advance of Year T a determination could be made. As in the other proposed options, AEMO would have the authority to conduct a book-build every year from the Minister’s determination until T‑1.

Although the ESB suggests that this should be a transitional arrangement to be reassessed five years after implementation, the interventionist nature of the proposal is absolutely inappropriate, and would seriously distort the physical and contractual basis for the NEM.  With unfettered powers to call a reliability determination with as little as three months’ notice, market participants will be on tenterhooks, awaiting the ministerial determination which may never come. This will affect their planning, purchasing, building and contracting strategies, and will lead to businesses inefficiently allocating capital and expending money to address risks which may never materialise.

Each of the options proposed also includes the ability for AEMO to conduct a voluntary book-build.  The Energy Council would argue that AEMO’s role is to operate the market rather than facilitate the market. Conducting book-builds, even though they will be voluntary, will divert opportunities, and hinder the market from developing the most efficient solutions necessary to addressing the forecast reliability gap.

Conclusion

Although there is some merit in progressing the Reliability Guarantee (despite the lack of evidence there will be any reliability shortfall in the immediate future), industry continues to seek investment confidence by having a robust emissions framework put in place. To this end it would be preferable if the development of both parts of the National Energy Guarantee was continued, despite the political squabbling about what the ultimate emissions target should be.

In respect of the Reliability Guarantee, the Energy Council notes that the final market design was agreed with stakeholders and industry with significant consultation conducted by the ESB, and it is important that this is the design progressed, rather than alternatives which provide no additional comfort that any reliability gap will be addressed, and in doing so distort the market.

[i] Press Conference with the Hon. Malcolm Turnbull MP, Prime Minister, the Hon. Scott Morrison MP, Treasurer and the Hon. Josh Frydenberg MP, Minister for the Environment and Energy, 20^th August 2018

[ii] http://www.coagenergycouncil.gov.au/publications/consultation-national-energy-guarantee-legislative-amendments

[iii] COAG Energy Council, Meeting Communique, 10^th August 2018, p.1

[iv] Energy Security Board, National Energy Guarantee Reliability Requirement Pre-condition Options, August 2018

[v] Energy Security Board, National Energy Guarantee Final Detailed Design, 1^st August 2018