Lake Liddell with power stations
What would you expect to find in a reliability frameworks review?
On December 19, the energy market rule-maker, the Australian Energy Markets Commission (AEMC) published its interim reliability frameworks review and is seeking comment by February 6.
We read the review in the hope of finding some good ideas. Unfortunately, we were largely disappointed.
Anyone looking for a framework that outlines a decent set of guidelines for what is actually going to happen will see that if this document is the best the AEMC can offer, then change at the AEMC is required.
The AEMC’s basic philosophy has always been that the market provides the answer.
Your author made a good living analysing markets for more than 30 years and I agree that markets and price will get you a result. But it’s not a painless result.
Prices set solely by market participants notoriously over and under shoot. Markets routinely produce periods of over and under investment if the structure of the market is less than perfect (i.e., if there are not lots of buyers, lots of sellers, few barriers to entry and exit, then the market will not necessarily provide a perfect or even satisfactory outcome).
Rather than some incredibly petty picking on the AEMO’s forecasting record it seems to us the AEMC could have done a bit of work on how well the actual electricity industry fits in with the definition of a well functioning market.
Or, it could have simply looked at the known problems of markets and seen what could be done about them.
There are not just general problems of vertical and horizontal concentration, although these are bad enough, but also quite obvious specific problems. For example ,the normal industry supply curve is set by equating short run marginal cost with short run marginal revenue.
However in a world of zero marginal cost renewables, how does this alter the theoretical, never mind the practical, outcome?
In this review, as in so many others, the AEMC opines using its 100% perfect market assumption, about the costs and benefits of various rule changes in the context of assessing reliabilty.
Quite often little if any data or evidence is provided to support what explicitly largely ideological driven conclusions. However, the real problem is the lack of accountability.
Let’s say the AEMC makes an inefficient rule. The outcome is that one way or another there is a problem, either prices are too high or too low for the level of demand, or reliability is too high or too low, or decarbonization proceeds too slowly.
Does the AEMC bear any consequences of this bad rule making? It does not.
It will probably take time to even work out the rule is bad, and in fact all that will happen is the AEMC will get more work to make a new rule.
Even if the AEMC did proper cost/benefit analysis of its rules, as it bears no costs for bad decisions, the analysis will always be suspect. What we have is a bureaucracy subject to all the flaws of Government which the AEMC is so anxious to protect everyone else from.
The AEMC has an Executive Chairman and a Chief Executive. Well, in the private sector that would be a nonsense to start with.
By design the AEMC is supposed to be reactionary. And much of the time it succeeds in looking very reactionary.
In our view the AEMC is at its best when its explaining how the current system works. If you want to learn about different types of day ahead markets, or how the current RERT originated and what it does, then this review is for you.
Specifically if you want to know how the current reliability standard is operationalized via:
Then appendix C in the reliability frameworks review is great.
On these measures Australia’s relative performance deteriorated mildly in 2017, although to be sure, less than we expected and at 33rd in the world there has been no improvement in the past four years.
Australia is underperforming on electricity and we believe the AEMC is a significant part of the reason for that, and that the Energy Trilemma index provides one objective measure on which to assess the AEMC’s performance.
Readers may recall that the Energy Trilemma is essentially the balance between energy security, equity (or electricity price) and environmental performance. It is measured each year for 125 global countries
See www.trilemma.worldenergy.org.
As we noted last year this provides an objective measure of how Australia compares with the world on electricity and decarbonization.
Our 2017 ranking was 33, broadly consistent with rankings from previous years, but it showed a deterioriation on reliability and price and no improvement in environment where we still rank 95/125 countries.
China is at position no 86, the USA is up at 15, the UK at 5 and Canada at 21.
Does the AEMC consider Australia’s relative performance? Of course it doesn’t.
According to this review the contracts market is working, a strategic reserve would result in excess costs to consumers by distorting investment markets and a day ahead market, Texas style, would take longer to implement than Snowy 2.
Yet in the real world it’s quite clear that there are all sorts of problems. We don’t want to go through these again but lets just observe.
What follows is a brief review of a more than 266 page document.
Chapter 4, the first substantive chapter deals with whether the AEMO has a good forecasting record. I mean for heavens sake. Is this a joke?
Everyone knows that the AEMO had a poor forecast record (like almost everyone else) some years ago, when demand fell sharply, and for the most part unexpectedly, that the AEMO is essentially incentivized to over forecast demand, that in recent years the AEMO has put a lot more science and resources into its forecasting, and partly because demand has been flat its forecasts have improved.
Is it really the job or a high priority of the AEMC to be sitting around opining on the forecasting ability of the AEMO?
These days there is quite a bit of cognitive science research on forecasting and forecasting biases but that isn’t much discussed in this report. Is the AEMC going to make a rule requiring the AEMO to improve its forecasts?
Chapter 5 discusses trends in the contract market. It’s clear from a reading of the chapter that the assumption is that contracts are a good thing and the purpose of the chapter is to conclude that there aren’t any substantial problems with either the concept of the contract market or how it works in practice.
To me it seems clear that as the level of horizontal (that is fewer retailers and fewer generators) and vertical (retailers owning generators and gas supply) increases, then the need for hedging contracts reduces.
This impact could, I guess, be masked by an increase in speculative trading. The AEMC looks at ASX contract liquidity, notes a decline in 2016, but perhaps correctly does not take this as definitive. Other measures of liquidity like bid-ask spreads, and price impact measures are not tested.
The fact is that most ASX contract trading takes place in the near term years and that out year prices most reflect trends in the near term (next two years) of futures.
As such the price signals tend to come too late, and the NEM is increasingly under or over invested or invested in the wrong areas.
In our view, though, the AEMC ignores other drawbacks of using price, either in the spot market, or through the contract market as an investment signal for the provision of an essential service.
For instance the delay between receiving the price signal and the time in which new generation can be brought on. Secondly the public and political intolerance for “high” electricity prices.
Chapter 6 deals with demand response. We leave demand response and the AEMC’s role to a separate note.
Chapter 7 deals with strategic reserves. The Finkel panel recommended that the AEMO and AEMC consider the need for an additional reserve separate to the Reliability and Emergency Reserve Trader [RERT].
The AEMO wants to have a 1 GW reserve but the AEMC is worried it might cause a market distortion. In essence the conclusion in Chapter 7 is to do nothing but just to think about it some more.
The AEMC showed that the total costs of procuring RERT reserves was just $5 m prior to 2017. We regard this cost as trivial in the context of the NEM. RERT reserves can under existing rules only be contracted at most 10 weeks ahead of a projected supply short fall.
As usual the AEMC’s discussion of the need for a strategic reserve is couched in terms of how it might interfere with the “perfect market” that the AEMC is working in the case of the NEM.
Retailers and generators are still discussed as if they are separate entities. However the AEMC does agree the market cannot guarantee that a reliability standard will always be met and that therefore some reserve may be necessary.
The AEMC advocates a short time for procuring a reserve on the grounds that a reserve contracted long in advance will crowd out new investment.
It assumes that a market solution will be cheaper than a contracted solution The AEMC explicitly states “A market response is a more economically efficient outcome than reserve contracting.” Page 277.
We don’t think that this is as self evident as it is made out. In our view the AEMC has stood on its ideological high horse for far too long and needs to demonstrate some evidence that the above statement is true.
The AEMC frequently discusses the costs of the reserves but provides no data on what those costs would actually be. How can the AEMC go about making these rules without doing the appropriate cost benefit analysis?
David Leitch is principal of ITK. He was formerly a Utility Analyst for leading investment banks over the past 30 years. The views expressed are his own. Please note our new section, Energy Markets, which will include analysis from Leitch on the energy markets and broader energy issues. And also note our live generation widget, and the APVI solar contribution.
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