Analysis: AEMC road map ignores advice, and could make things worse

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New AEMC blueprint ignores bulk of expert submissions and overseas experience, and may make Australia’s transmission problems worse for new generation rather than better.

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“While Australia is not alone among the world’s electricity markets in seeking to address the challenge of improved coordination between transmission and generation investment, the AEMC appears to be alone among its global peers in considering the introduction of LMP and transmission hedges as the key solution to the challenge.

“We conclude the AEMC has misinterpreted the lessons from other jurisdictions. While LMP may provide some operational benefits, a careful reading of international experience indicates LMP and transmission hedges will not help in solving the coordination problem correctly identified by AEMC. Given the complexity of introducing LMP, the diversion of effort into the reform program proposed by AEMC would likely mean that the fundamental problem of coordination will remain unaddressed “ 

Castalia Report to Origin Energy on COGATI reforms

AEMC’s new plan

The Australian Energy Market Commission has released two new papers pushing on with the largest change to the National Electricity Market since it was created some two decades ago.

Under these new draft proposals, from July 2022 the market will have to deal with locational marginal prices settled every 5 minutes and a vastly more complicated system of financial transmission rights.

This is despite problems in New Zealand, the only other jurisdiction in the world to have introduced such a system in an “energy gross pool” market, and despite countries like the UK explicitly considering and rejecting the system.

What rankles most in some ways is that the AEMC is not considering a single alternative to its approach. Despite very significant negative feedback in its consultation process, it is forcing the majority of its solution on the market.

This is a poor approach to policy design. And it’s a solution to what is at best a minor, secondary problem.

The AEMC and AEMO have made a mess of transmission investment, and now the AEMC is likely to make things worse.

As the Snowy submission to the COGATI reform process states”

“Today, the fundamental problem in the transmission network is not one of co-ordination but a pressing need for increased transmission capacity.“

AAP Image/Lukas Coch
Transmission planning failure

There isn’t enough transmission because (1) AEMO’s planning processes didn’t identify the need for new transmission early enough and (2) The AEMC’s RIT test is a hopeless way to develop new transmission. It should never take 2-3 years of planning and regulatory approval to get up a preferred option for each new transmission line.

I would go further and argue that an underlying reason for the problems is that the AEMC particularly has approached the problem with the wrong culture.

It was slow to understand the carbon issue and has a rigid, ideological view that markets are the answer to every problem, or to put it conversely it’s strongly opposed to solutions that involve centralised planning.

As a result it’s made bad rules that violate its own core market philosophy. For instance the “do no harm rule” obviously violates the principle of “putting risk where  it can best be priced”.

As a result of the mess, stakeholders are being forced to play catchup. Specifically, the AEMC is trying to rush through a massive reform of the market ahead of the Energy  Security Board process for wider reform.

We  think it’s solving a problem that doesn’t exist and potentially creating massive new problems. There is widespread concern about the reform from well-informed stakeholders. I will evidence those concerns below:

It is curious why the AEMC is in such a rush for what will be the biggest reform in the NEM since it was started, and such a contrast with  the 5 minute settlement rule. Your analyst strives to be analytic and not cynical, but in my cynical moments I can’t help thinking it’s something that the AEMC chair wants to get done before retiring.

In writing this note, I’ve read probably more than 40/60 submissions to the ESB market reform paper and parts of all  of the 37 submission to the AEMC COGATI submissions.

Do yourself a favour and read the Castalia report

I highly, highly  recommend reading the Castalia Report appended to  the Origin Energy submission (from where the quotes at the start of this analysis were sourced). This report is the best piece of writing on the topic of electricity transmission I have ever read.

It expresses exactly the way I think about the topic, but far more authoritatively.

It seems to me an unbiased report from an organization with no skin in the game. It goes to the problems in New Zealand, and discusses the plan by Professor William Hogan who developed the concept of transmission rights.

It also points out that the UK has been through a similar situation to the NEM and in two separate reviews – but particularly in the 2008 review looked at, and explicitly rejected, location pricing in favour of Option A:

“Model A was to ‘connect and manage’. Generators would be offered connection in line with their development schedules and the transmission owners and SO would manage the consequences with supporting measures by the regulator “

This is the simple model. Never mind the even more forward-looking ERCOT model in Texas.

Finally, the Castalia report has some recommendations. It would be easy to support them.

“Transmission access reform requires improved central planning”

“Transmission access reform requires improved transmission pricing”

“Contractual coordination between generation and transmission investors could further improve outcomes,”

and

“Independent planning combined with competitive auctions for new transmission capacity could also improve outcomes “

This is a planned transmission system (inevitable) with competition via reverse auction for supply of the service. It is a way simpler and better model.

Finally, the Castalia report concludes:

“In our view, the AEMC approach is not supported by international experience, and at best would be a marginal bolt-on to the necessary comprehensive reform. It is also a very complex and high-cost marginal bolt on. The proposed approach risks significantly complicating, and potentially even replacing, necessary market-wide reforms.

“We therefore strongly advise against proceeding with transmission access reform as proposed in the AEMC’s Directions Paper. In fact, the additional regulatory complexity from pursuing the model as outlined in that paper would likely add to consumer costs.”

We turn now to issues raised in the 37 formal responses to the previous Directions Report. These are the formal responses, and your analyst has been told that much more “tell me what you really think” views were expressed at stakeholder forums.

Submissions in summary

(1) Doesn’t identify or solve the actual  problem which is not enough transmission. Its like arguing over how to divide the cake instead of growing it.  Does nothing to identify what is the optimal amount of transmission even if, as the AEMC says, system optimal doesn’t guarantee 100% access for everyone.

(2) Bad methodology. Locational pricing and transmission rights appear to be the only model considered. The advantages and disadvantages of other models of  firm transmission access weren’t presented. Only one form of location pricing is considered (AEMO’s point). The AEMC states that it is now doing a Literature Review, to be completed by December 2019.  Better late than never I suppose buts it more common academic practice to start with the literature review.

(3) Bad timing. COGATI should come after and not before the ESB market design reform. Many submissions to the ESB process made this point.

(4) Major reform is being rushed. Almost all submissions said this.

(5) Introduces large level of complexity without corresponding benefit. EG Hydro Tasmania points out that 12,000 nodes have to be transformed into access rights. (ITK adds, together with  5 minute pricing). Simplicity is a virtue long forgotten at the AEMC.

(6) Adds system wide costs (5 minute settlement costs for AEMO alone now estimated to exceed $120 million, arguably implies more than $1 billion for NEM participants as a group, maybe more).

(7) Firm access rights won’t be firm because of network topology issues. An example would be the recent changes in network stability in NSW. Apparently“Kirchoff’s Law” is the reading here but it didn’t help me. Essentially changes in generation or load can impact the way electricity flows around the network creating stability or other issues, some of which are very complex and difficult to model.

(8) Likely to have a significant negative impact on market liquidity (this point made by several submissions). Snowy states “Market Liquidity Obligation cannot effectively operate under nodal pricing.” Even AFMA –  normally the last organisation to be critical of new contract markets – noted the liquidity issue. In the latest iteration there will still be a regional reference price which may help with the liquidity issue but it comes at the expense of increased basis risk.

(9) Major increase in “basis risk”, the risk between the region(State) price and the location price. Basis risk increases costs for  all participants. This is the risk that the expected differential is not the actual differential between the local price and the region price.

(10) Will introduce the possibility of market concentration over transmission rights, something the ACCC has tried unsuccessfully for years to deal with in gas transmission. Again as Snowy puts it, and seems obvious, the possibility of “Local market power” is much higher than for “Regional Market Power”. Actual experience in New Zealand confirms this is a real issue.

(11) Flies in the face of actual experience in the NEM where the Snowy node was abolished to improve competition and liquidity.

(12) Likely to lead to far greater responsibilities for AEMO in terms of the auction and power flow control process. This means a big increase in bureaucracy. Again to be sceptical it’s not like AEMO hasn’t got any other jobs.

(13) Despite what the AEMC paper says several submissions note it hasn’t worked that well in New Zealand as evidenced by Mercury in presentation to AEMC and considered in detail in the Castalia Report.

(14) There are issues around grandfathering existing rights. AEMO stated “intractable issues in determining the price for long term access rights and deciding how to grandfather existing rights.” This must be the case as right now there isn’t enough transmission for all generators, so they can’t all get rights, never mind age priority etc.

(15) There is academic consensus the revenues from sale of transmission hedges are less than the efficient costs of expanding the network. This model does not solve the financing problem (Castalia Report).

(16) Almost no one else around the world is trying to do it the way the AEMC is approaching it. Maybe there is a reason for that. Maybe the AEMC doesn’t always have the best answer.

A 50% increase in transmission investment would add around 2% to household bills

The AER and much of the AEMC wording is about avoiding over investment in transmission as occurred in distribution. But this is fighting the last war rather than dealing with today’s problem.

Transmission costs are much lower than distribution costs and in any event the need is much more obvious. I used Transgrid as an example but similar results would result across the NEM. This example is simplistic but gets the point across.

Prior to the current discussion paper, the AEMC released a “Directions Paper” in June.

There were 37 submissions to the Directions Paper.

ITK read enough of each submission in order to force rank them into either Yes supports the reform despite reservations, or No on balance didn’t support.

In some cases there was a neutral of soft support or soft negative. Virtually every submission said the timetable was rushed and that there wasn’t enough information in the Directions paper for fully informed comment.

The authors of many of these submissions may disagree with my forced ranking, but it was my best, if hurried view.

Notwithstanding the count we give more weight to some submissions than others. For instance network (last mile) companies basically just don’t want locational pricing applied to them. And it won’t be. Politicians would never allow it as rural customers would have to pay more.

I was influenced by Delta, Snowy, Hydro Tasmania, Infigen and Tilt, all of which are generators and all of which were negative, some vehemently so. Tilt has NZ experience.

On the yes side the Lighthouse submission provided some excellent worked examples from a financial perspective.  However, my view would be that those theoretical examples didn’t take into account the bureaucracy and complexity and liquidity issues.

The Background

The AEMC has published two discussion papers, one dealing with the intention to introduction Locational Marginal Pricing [LMP] and Financial Transmission Rights [FTR] and the other developing some long overdue ideas around Renewable Energy Zones [REZ]. The changes are scheduled to come into action in July 2022.

LMRs are supposed to sum to a volume weighted average regional price.

LMRs are calculated including dynamic los factors.

FTRs can pay out either 24/7 or can be for specific times.

FTRs can be for any combination of quarterly periods up to 4 years in advance.

The FTRs would be auctioned by the AEMO but can be traded in a secondary market.

Only “large” generators retailers and physical market participants can participate in the auction. Other products can be purchased by other including by traders.

The AEMC proposes to model the changes and undertake paper trials.

What the latest version does better than the Directions Paper

The newest version of locational pricing has dropped the idea of using the FTRs as the main way to organize new transmission. Not one single stakeholder was in support of using FTRs that way.

It could be argued that providing a regional price will improve contract liquidity risk although I have my doubts and

It’s probably true that locational pricing may be of assistance to battery and pumped hydro location and help with demand response decisions.

The latest paper notes it will do quite a bit of modelling on the various claimed  costs and benefits. Again it would be more normal to do the modelling first.

And, guess what, modelling is very complex and time consuming, as the AEMC itself says:

“However, internal assessment by the Commission and consultation with a number of economic consulting firms indicates that such a model would be computationally challenging as a result of the need to model the bidding behaviour of individual agents in every five minute settlement period over several years.”

Please also read the response of the AEMC’s Tim Nelson to this article: A few thoughts on COGATI: We’ve taken the feedback on board

 

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