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NEG will replace electricity markets with Soviet-style state planning

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Screen Shot 2017-10-25 at 10.09.50 AM copyWhen the reliability and emission guarantee policy (the “NEG”) was announced recently, my immediate reaction was that the thrust of this policy was to secure the continued production from “dispatchable” generation.

Thermal (coal) generation accounts for the vast bulk of such generation. In the context in which this generation is imperilled by technology change, age and emission reduction priorities, the policy amounted, primarily, to a scheme for the protection of coal generation.

President Trump’s Energy Secretary came up with much the same thing a month ago.

This is Type 1 – immediate, visceral – thinking. It reflects judgment on many things, not least the political imperatives and consideration of the factors that impeded the progress of every other form of emission reduction policy debated in Australia over the last decade.

Now with the passage of time it is possible, for me at least, to engage in a little Type 2 (contemplative, inquiring) thinking.

The document that explains the Government’s NEG is an “advice” letter to the Minister from the Energy Security Board, dated 13 October 2017. The meat of this 8-page letter occupies about 4 pages, with the rest given to niceties and explaining that this new policy is little more than the implementation of Dr Finkel’s report (which it most definitely is not).

At the core is the idea that retailers will be required to demonstrate to the Australian Energy Regulator (AER) that they have firstly purchased a defined amount of “dispatchable” electricity and secondly that the emission intensity of the electricity they buy (or produce) will be better than a defined level.

Both of these obligations are about as clear as mud, but that does not matter too much yet in the early task of properly characterising this scheme.

The letter implies that this new scheme is merely a slight extension of the existing arrangements where retailers enter into contracts to hedge their spot prices.

But this is also not true.

Existing contracts, most of which are traded through the ASX and some are bi-literally negotiated or traded through brokers, are financial contracts.

They hedge spot prices but they do not specify which generator is used. They are just financial transactions – it matters not a jot how the entity that enters into this contract meets it, as long as they are good for the money.

Meeting the dispatch and emission reduction guarantees described in the letter will require physical contracts.

In other words, the contracts will require the delivery of electricity from specific generators whose dispatchability and emission intensity properties will need be defined (by the AER) so that in aggregate the retailer meets the defined dispatchability and emission intensity targets that the AEMC sets and AER administrates.

The AER’s administrative task will be to keep the numbers by checking that the electricity that the retailers buy (and then sell) meets the required targets.

The letter says there is no financial penalty if the retailers do not comply with these obligations. But there is some sort of threat that if they repeatedly do not comply with whatever the requirements for dispatchability and emission reduction are, they will be banned from the market.

In reply to questions, John Pierce, ostensibly the designer of this arrangement (and chair of the AEMC), said that with this scheme there is no emission price.

That is also not correct.

It is true that if there is no defined penalty for not complying (besides a vague threat that the government will ban you from the market) then there is no transparent price either for “dispatchability” (whatever that is) or emission reduction.

But if you are required to buy something that you otherwise would not then of course there is a price even if it not visible.

The letter suggests that retailers can buy international emission permits to meet their emission reduction targets. If this stops the AER from breathing down their neck, they might bother, but if there is no financial penalty for not complying why bother if you can keep the regulator at bay in some other way.

This proposal is a drastic change from the current arrangements. It is the end of the electricity market as we know it. Effectively it puts the regulators (Australian Energy Markets Commission for design and AER for enforcement) at the centre of the industry.

This is the Australian energy equivalent of “Gosplan” (the State Planning Committee) who decided who produced how much in Soviet Russia from 1921 until the dissolution of the Soviet Union in 1991.

The whole thing brings to mind, the edict issue by the All-Russian Central Executive shortly after the 1917 Leninist revolution, that ordered the Commissariat of Finance “to endeavour to establish moneyless settlements with a view to the total abolition of money.”

In revolutionary Soviet Russia, “prices” were the root of all evil. Ditto in Australia in emission reduction policy.

The government has been unable to convince its members to establish a price on emissions. So faced with investment strikes, ageing and increasingly uncompetitive coal generation and international emission reduction commitments, the Government is resorting to command and control to achieve whatever it is that it wants to achieve (which I understand to be the mutually inconsistent objectives of keeping the coal generators going and reducing emissions).

The deceit with this, as with the Commissariat’s attempts to ban money, is that you think by hiding a price there is no price.

The price is there and it will be baked into the instructions arising from the legion of accountants, engineers and lawyers that the AER will need to employ to check over the retailers’ contracts to make sure they tick whatever dispatchibility and emission intensity boxes the AEMC determines.

If the emission reduction obligation is slight the price will be low and all you will have done, besides trashing international commitments, is wasted money on unnecessary bureaucracy (who would like to wager the first draft of the “rules” on this will be more than 200 pages?).

But if the emission reduction obligation is meaningful the price to be paid by emission-intensive plant will not be slight.

To the Machiavellian in our midst that might be the elegance of this approach: here is a way to be all things to all people. It is so ambiguous and internally inconsistent you can read whatever you like into it.

In his marvellous Nobel Peace Prize speech explaining the origin of Perestroika, President Gorbechev explained that Russia’s leadership tired of deceiving themselves and their people. We should avoid getting ourselves into this sort of position in the first place.

So to my mind this NEG should be given a wide berth. But evidently the Government, some market participants (Powershop and Infigen), unnamed other retailers who say they like it the more they look at it, influential analysts (Kobad Bavnagri) and some newspaper editors think this approach is great.

In the popularity contest that is Australia’s energy policy development process today, we might well find that the NEG (whatever it really is) will be our new policy.

In the Socratic tradition, I put this note up for dissection and discussion. If you think I have it all or even partly wrong, please shoot it down and set it right. As balmy as this whole process is, at least it is open and therein lies some hope of maybe arriving, ultimately, at something sensible.

Bruce Mountain is director of CME, Carbon Markets and Economics, an energy consultancy.  

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  • trackdaze

    The Presumed Architect of the scheme is in charge of the networks that have been responsible for the largest majority of price increase.

  • Simon Mathis

    Thanks Bruce I think this is generally right … either an army of auditor’s, accountants, lawyers and traded market specialists to review each liable retailer’s/market customer’s hedge portfolio to ensure the “NET” positions meet the targets and there is no double counting OR there will be a couple of new tradable commodities created (a Reliability Guarantee Right & and Emissions Guarantee Right) by a new regulator to increase efficiency?

    • bruce mountain

      Simon. Yeah, it is possible to easily create a tradeable commodity in electricity – the deliverable is easy to specify. How do you specify a Reliable Guarantee Right or an Emissions Guarantee Right. These are political commodities not financial or physical commodities. There is a really really easy solution to this: price emissions, the externality. From Coase onwards this is the accepted approach. It “just” needs political institutions able to stand straight with steel in their collective spines. Been done many times in many places. Will happen here, eventually, I suspect. And when it does, I suspect many will wonder what all the fuss was about. ‘Twas ever thus.

  • Jack Gilding

    I don’t think there is any doubt that this is at best a fourth best option, not nearly as effective as a carbon tax, an ETS or a CET in meeting affordability and emissions reduction. The important question (and it is largely a question of political tactics) is whether supporting (at least conditionally) the NEG in order to get an end to investment uncertainty is better than trying to block it.

    • bruce mountain

      Investment uncertainty for whom? Renewables developers or coal generators?

      • RobertO

        HI All, one good point about the NEG, it will support new power of any sort and it also likely to help solar households with a new demand management requirement (but there is no plan for new power of any sort, and household may have their solar switch off in the middle of the day to protect coal power losses, a ripple control feature to inverters telling them to shut down). NEG will not float at all. States have too much to lose and no plus side at all!

  • RobertO

    Hi All, I have a problem with all of this idea of a NEG (The other day somebody suggested that the NEG are the equal of CDO in the money world, extremely valueable to the seller (Coal Gas and Hydro) but worhless to us consumers. If I shut down my coal peower station there may no rules to stop me selling my NEG paperwork (on the grounds that I can restart my dispatchable (NOT) coal power station). Given that QLD got such a large responce to the state Gov tender, the NEG will not survive the next fed election (General , not the Barneeeee court forced election decision due tomorrow). If we change I would expect a large RE action shortly after they take power.

  • Mark Byrne

    Agreed re central planning. Plus the power it gives gentailers as well as regulators. But to me the oddest thing about it is the reliability guarantee. Genuine reliability favours some gas, hydro and batteries, not coal – and not only because it is slow to ramp up and down. Liddell is the most unreliable generator in the NEM, as was proven during last summer’s heatwave. If you’ve bought contracts with a coal plant and it blows up on a hot day, who is liable? Even wind and solar are more reliable; they may be intermittent but are largely predictable.
    The only upside I can see is that the emissions guarantee could be ramped up by a more responsible future government, right before it turns it back into a genuine market carbon price (rather than a price hidden in opaque hedging contracts) and abandons the reliability guarantee as superfluous thanks to other existing mechanisms to achieve this end courtesy of AEMO doing its job.

    • bruce mountain

      Hi Mark. I suspect the fact that coal is less flexible than alternatives will be batted away – its dispatchable and that ticks the boxes in making a market for it – just as in recent U.S. policy under Trump. Same idea.

      On your second comment, I would caution against looking for way to make a purse from a sow’s ear. This bizarre idea is shockingly poor economics and reflects no meaningful knowledge of power system engineering. Better to avoid such a dog’s breakfast altogether.

  • Andy Saunders

    It does depend overall on the emissions intensity requirements (which could vary all the way from being no constraint at all therefore basically ignored) through to being the only real constraint and therefore dominating; and the definition and degree of “dispatchable” – does battery storage fit, for instance. Could be a huge boom in battery installs/pumped hydro if so. In the same vein, do virtual generators (with or without storage) and demand management count as dispatchable?

  • John Herbst

    Hypothetically, if the REG put proportionally larger and stricter burdens on larger retailers, I could imagine it being somewhat fair. But of course that’s not what will happen. No one would have the power to actually revoke AGL’s license or that of any large incumbent retailer. That would cause chaos.

    • Ian Porter

      All part of the risk/reward balancing equation for the vested interest/incumbent groups who not only want certainty of which RE (in an open market) robs them of as demand shrinks when the sun shines and the wind blows, but these same groups will want a govt bailout at when the latter is faced with untenable system black scenarios. Hence ‘run the regulator” to give you the pension fund blue-chip five star credit rating your stakeholders require. Never mind the peasant electricity consumer taxpayers: their only purpose in life is to provide the revenue streams either side of the balance sheet – sky high network costs impacting world leading power unit prices (revenue stream 1) and when it all goes sour, the pollies run to the taxpayer and commit them to bailout by way of a debt obligation to keep the lights on (revenue stream 2). Its perfect storm in the making that absolutely doesn’t have to happen if we look to nature to save us. Unfortunately nature includes human beings and how sad is that?

  • Ian Porter

    Good information in the article Bruce, I just don’t see the connection to Soviet/Leninist policy. What we can see here is clearly a political stunt to provide certainty of supply and a bogey ‘mechanism’ (in name only) to link generation contracts with supply certainty and low emissions ‘possibilities’. The devil is also in the detail: installation of John Pearce as the head of AEMC is a clear case of conflict of interest. He has made so many statements clearly that he is not for RE and definitely pro-incumbents fossil generators. As a consequence, we are moving toward a phenomenon popularly referred to as “regulatory capture” (See https://en.wikipedia.org/wiki/Regulatory_capture) where the (FF) industry, either directly or through proxies run the regulators and influence policy to put profits on their own balance sheets and if things go wrong, the risk is going to be with the consumer and/or taxpayer bail outs (Snowy Hydro 2.0 will come from the public purse). We’ve seen also the sell off of many supposedly loss making assets of the state flogged off to private interests who then turn them around and make super profits from them. Vales Point power station is a classic example. This kind of activity is an extension in large part of neo-liberalism and capitalism gone wrong. It’s definitely not communist era practice.

  • MG

    “Effectively it puts the regulators (Australian Energy Markets Commission for design and AER for enforcement) at the centre of the industry.”

    Yep, but you’ve forgotten one regulator: AEMO, who would be newly tasked with determining the “operating requirement” for each region. AEMO would be making (presumably time-bound) decisions about whether the Reliability Guarantee binds in a jurisdiction (or not), and thus retailers are obliged to procure contracts for dispatchable power for a period of time (or not), and what level of contracting is required for any time period.