AEMC proposes complex new market signals for wind and solar networks

The Australian Energy Market Commission, the principal rule-maker in the local electricity market, has unveiled complex new market designs – including locational pricing and “transmission rights” – that it says will better reflect the true cost of generation at different locations, and the cost of network upgrades and expansions.

The draft rules, released on Monday, come under the so-called COGATI project – Coordination of generation and transmission investment – and is designed to correct the lack of network infrastructure that has failed to keep up with the pace and breadth of the investment in renewable energy.

The AEMC says its theoretical market designs will lower costs, largely by lowering the cost of capital, and prevent some, or even most, network upgrades from having to work through the notoriously slow regulatory investment tests, known as RIT-T.

It sees the work as crucial to implement the Australian Energy Market Operator’s Integrated System Plan, which is a 20-year blue print on the infrastructure needs to facilitate the country’s transition to a renewables-dominated grid.

At stake is the future of some 96GW of wind and solar and storage projects that AEMO has identified in the pipeline.  Around half of this will be needed if Australia is to compensate for the anticipated retirement of ageing coal and gas generators over the next two decades. But only a fraction may get the go-ahead unless the grid bottlenecks can be unblocked.

Not everyone agrees with the AEMC’s market-based approach, and there promises to be a fierce debate over these proposals. As David Leitch writes in his probing analysis, the response of key players in the energy transition was overwhelmingly negative when they were asked to comment on the proposals.

They do not agree that this will be the key to deliver the required network investment, they suggest the AEMC is misunderstanding the lessons learned overseas, and they also question why these rules are being rushed out now, given that the whole design of the electricity market is under review in a process being led by the Energy Security Board.

Others are also concerned that the proposal for “locational pricing” effectively incorporates “dynamic” pricing of what are known as marginal loss factors. Many major investors have said they do not think this is a good idea because of the complexity and uncertainty involved. They fear it could increase the cost of capital, rather than reduce it.AEMC chairman John Pierce says that the proposals are necessary, regardless of the design changes that could be contemplated by the ESB.

“The proposals we are releasing today essentially do two things,” Pierce said in a statement accompanying the bulky documentation accompanying the proposals.

“They create better investment signals for generators to locate in more cost-effective places, and make it possible for them to use the transmission network more efficiently.

“These structural changes to the market framework are an essential element to deliver on AEMO’s integrated system plan (ISP) to keep the lights on at least cost.”

One of the key concerns of the ISP is the timely availability of key infrastructure to avoid bottlenecks on the grid, and the creation of new “renewable energy zones” which can ensure the necessary grid infrastructure is located in regions that have the best wind and solar resources.

The AEMCs response to this is the creation of what it calls “transmission hedges”. This appears to serve two purposes, to act as a way of shifting the costs of new transmission to new generation and to guarantee access to the grid for those new generators.

It is unclear, however, exactly how this will work and guarantee that network spending – currently delayed by the slow and completed RIT-T process – will be sped up, or how it will reduce costs.

The second key part of the AEMC proposal is the creation of “locational pricing”, which combines a new concept known as transmission rights and pricing that depends on where the generator is located.

“Under the proposed generation and transmission coordination blueprint large-scale generators and storage would get paid locational marginal prices for the first time,” the AEMC says.

“The blueprint also introduces a new risk management tool called financial transmission rights which can give all generators more investment certainty and make sure networks are used more efficiently. Money raised from the sale of these rights would be used to offset consumer bills.

“Generators would purchase these rights to stake a claim to use the grid. It protects generators by paying them for some of the revenue lost at times when they can’t access the network.

“Static, annual marginal loss factors would be replaced by loss factors that are determined dynamically through dispatch to better reflect actual conditions on the power system. Generators would have the option of protecting themselves from changes by hedging their marginal loss factors to increase the financial certainty of their investment.”

So this locational pricing will replace the current controversial method of “marginal loss factors” – which has seen the output of many wind and solar farms reduced (and some raised) – because of grid congestion, or the shifting of load.

However, it will likely not please big investors who have recently made clear that the replacement of marginal loss factories should not be with “dynamic” pricing that can change because of the uncertainty involved. The transmission rights will be bought by auction, and the idea is to do this three to four years ahead of time.

Further analysis will be needed to see whether this volatility can be efficiently hedged. If the uncertainty continues, the big investors have warned, then investment in new projects will become more costly because of the added risk, and monies will likely flow overseas.

It also explains why the AEMC delayed its proposed replacement of MLFs at the last moment, until after the COGATI measures were unveiled. It also points to a lot of last-minute decision making and reactions.

Pierce hopes that the COGATI reforms can be finalised by the end of the year, and then approved by the COAG energy council. Such a timeline seems ambitious, given the complexity involved and with the uncertainty over the ESB reforms.

The AEMC says it has not yet quantified what sort of costs this would impose on current or future projects. It needs more modelling to do be able to do that.

“Our proposal is to do modelling by early next year to provide some answers to these questions,” the AEMC said in response to RenewEconomy’s questions. “This would be one of the questions our proposed paper trials would seek to address. The paper trials would also seek to estimate the payouts under both the hedges and rights, so that the benefits as well as the costs can be quantified.”

See David Leitch’s analysis for more detailed responses to the AEMC proposals.

And please also read the response of the AEMC’s Tim Nelson to that analysis here: A few thoughts on COGATI: We’ve taken the feedback on board.