Energy Security Board makes big concessions on NEG

The Energy Security Board appears to have made several significant concessions in the design of the proposed and hotly debated National Energy Guarantee, that will be discussed by COAG energy ministers at their summit in a week’s time.

The biggest concessions is removing the need for “physical” rather than financial contracts, proposing government “emissions intensity” targets to manage the emissions obligation, and a “light touch” reliability obligation that will only be triggered if a shortfall arises. And there are none in view.

The shift is included in a 50-page “high level design document” for the NEG, circulated to state energy ministers ahead of the COAG meeting next Friday, where the ESB will be seeking an “amber light” to do further design before presenting a finalised version for a vote in August.

However, while the technical details of the proposed NEG are improved, key policy decisions such as the emissions reduction ambition, the use of offset, and “additionality” of state-based schemes are addressed in a separate, yet to be released document from the federal government.

The ESB, chaired by Kerrie Schott, and representing the country’s three key energy institutions – rule-maker, operator and regulator – still insists the NEG is the best opportunity to resolve 15 years of political impasse, and is needed to ensure a shift to a “cleaner, cheaper and more reliable grid”.

The new document makes particular mention of the role of consumers in generating and storing their own energy, of demand response, and the substantial change from the days when “supply-side solutions” were considered the answer to all energy challenges.

RenewEconomy has obtained a copy of the document, and a potted highlights of it can be found here.

The NEG is now likely to move into a phase of rapid evolution as it seeks a path through the political minefield, represented by right-wing conservatives defending coal on one side, and the need to get Labor states and territories across the line on the other.

In the meantime, it needs to design a scheme that provides a platform for something that actually works, and it appears to be shifting to a model of “do no harm” that addresses reliability and security issues, at the same time as leaving flexibility on emissions.

The removal of the need for physical contracts – in favour of financial swaps and caps and over the counter contracts – will be seen as a major step towards addressing issues of competition, and therefore prices, and could be enough to bring some states already faced with limited competitions, such as South Australia, across the line.

But there is still work to be done to win over those states with higher renewable energy targets, and emissions reduction targets. The ACT, Queensland and Victoria, for instance, are pushing hard for “additionality” – in other words, to ensure that their efforts are not used an excuse for others to do less.

One of the major stumbling blocks for the general acceptance of the NEG is the overall emissions reduction target, which at 26 per cent for the electricity sector by 2030 is seen as hopelessly inadequate, and imposing more effort on other sectors of the economy where reductions could be more expensive.

These policy questions are not addressed in the ESB paper, but apparently are addressed in a separate Commonwealth paper which is yet to be distributed to the states and territories, or even to the ESB (as of yesterday).

“The ESB paper starts to address the technical issues, but in the absence of significant policy issues, it is hard to draw a conclusion because it is the way they interact that will ensure the design is right,” said ACT energy minister Shane Rattenbury.

“We hope to see the Commonwealth paper before the COAG meeting.”

A spokesman for energy and environment minister Josh Frydenberg said the Commonwealth paper would be forwarded to the states “shortly”.

The removal of the physical contracting requirement is significant, however, given criticism was near unanimous – from regulators, consumer groups, retailers and network operators, and others – and which begs the question of why it was suggested in the first place.

The emissions guarantee will be based around an emissions intensity target to be set by the government, in line with its own long-term targets, meaning that it could well end up looking more like an EIS that the government had previously rejected.

This time, rather than having its own certificates, it would operate within the National Electricity Market, using NGERS and AEMO dispatch data, and allowing retailers to enter into caps and swaps and other contracts to meet that target.

The graph above illustrates the general principle. Emissions intensity will be decided by the emissions generated and contracted, and retailers will be required to meet those standards through financial contracts (existing ones and old ones) in any way the retailer deems appropriate.

A further illustration is included below.

Interestingly, all “behind the meter” generation – which means rooftop solar and storage on households and businesses – will be included in the retailer emissions calculations.

It will be interesting to see what the industry reaction is to that. Will households give the bigger retailers an easier ride. Shouldn’t they deserve some compensation for doing so?

The ESB appears to be resisting the push by some to shift the burden to generators, rather than retailers, and also leaves the question of offsets, and particularly international ones, to the government, at least at this stage.

It has also resisted a push to exempt small retailers from the scheme, possibly justifying this through the shift from burdensome and impractical “physical” contracts, to the financial ones.

The reliability mechanism, on the other hand, would only be triggered if the market failed to respond, three years out, to an identified “market gap”.

This will be decided by AEMO 10-year forecast contained in its annual Electricity State of Opportunities. So there will be time for the market to react, once the gap is identified. And the ESB sees no forecast gap now.

This will be subject to increase transparency, and annual review, and will also be updated in the case of sudden change, such as the closure of a major demand centre (factory or refinery), or the proposed closure of a major coal or gas generator.

Once triggered, all retailers will need to ensure they have sufficient contracts to ensure they can meet their share of the anticipated system peak. Those contracts will be underpinned by “dispatchable capacity”, although the exact nature is yet to be defined.

AEMO will assist the process by conducting a “book build” that can offer valid contracts, and it says that demand response will be “central to this process.”

If the market gap is still not met one year out, then AEMO will access an emergency reserve. The cost of that will be paid for by retailers who fail to meet their reliability obligations.

There is growing confidence that the reliability obligation will be very light-touch – a reflection of the fact that there is no fundamental reliability issue in the grid at the moment, although one could arise if there was a sudden rush to the exit of more major coal-fired generators.

Two reasons back this view: one, is that the contracts will not relate to individual generation, but system wide. This is a major advance from early last week when the government, even Alan Finkel, were seeking to burden individual wind and solar farms with their own battery storage. That doesn’t actually make much engineering sense.

However, there is a strong indication that the definition of a market gap may well be reviewed.

The ESB wants the reliability standard to reflect the “peakiness” of the grid from increased penetration of variable renewables, and changes in demand, reflecting the increase in heat waves. So it will be more focused on system peaks, than annual averages.

There also appears to be a recognition that AEMO must be left to decide on the system security issues, which are the sort of problems that can arise in the two to three hours a year when thing get really tight.

AEMO wants to address this through mechanisms that are outside of – but importantly linked to – the NEG. Think of day-ahead markets and reserve capacity.

The latest “high level document” also seems to represent a middle ground between the head of the Australian Energy Market Commission, John Pierce, and the head of the Australian Energy Market Operator, Audrey Zibelman, because it leaves the nature of the NEM more or less in-tact (happily for Pierce), but leaves special mechanisms in place for the AEMO (happily for  Zibelman).

Indeed, it is interesting to note the speed with which the AEMC has introduced more demand management options into the market – at the request of AEMO – and is now looking for feedback on AEMO’s favoured renewable energy zones.

This, though, reflects a potentially more interventionist role by AEMO, both in setting the criteria and technical requirements of new generation, but also where it is built. That would be an end to the free-for all that has existed till now.

Altogether, the NEG is now looking a little less scary, and could well get the amber light from the states and territories, although the devil for the industry and consumers will be in the detail, and subject to further analysis by those who know better.

The devil could also be in the Coalition party room, whose support will be needed to approve a few minor legislative changes to various acts. And on this point, it was interesting to note the intervention yesterday of Innes Willox, the head of the Australian Industry Group, in a speech in Adelaide.