NEG is supposed to be better than nothing. But is it?

An argument that has been doing the rounds is that even though the National Energy Guarantee (NEG) is not the first best solution (or probably not even the sixth best) it gets past the Coalition’s Back Bench and so we must work from there.

This is a sort utilitarian, lowest common factor argument whose underlying premise is that something is better than nothing. But is it?

In brief, the NEG’s proposes to impose on retailers an emission intensity and a dispatchibility obligation. The emission intensity obligation is clear and will be set, apparently, at a level to match the Commonwealth Government’s policy.

The dispatchibility obligation is another beast altogether. It is not hard to see why the ESB has not been able to define it. In an interconnected power system, generators impose external costs (‘externalities”) by virtue of their failure risk.

Specifically, in a power system with large thermal generating units, power system operators need to procure synchronised “spinning reserves” to keep the power system stable if one of those large generating units trips.

In most power systems including the NEM, it is such generator unplanned outages, not demand changes, that are typically the largest source of instantaneous system perturbation.

At the moment, the vast bulk of such “spinning reserve” is obtained from Automatic Generator Control (AGC) on coal thermal units, which allow them to quickly increase or decrease production within fairly narrow bounds: spilling steam to decrease and sending it to the turbines to increase.

Sometimes system operators also “part-load” plant (ensure they have a head of steam but spill much of that steam) in order to ensure that sufficient fast reacting generation is available should it be needed to quickly pick up production.

In the NEM, some of this reserve and fast response is provided through ancillary markets, and AEMO recovers the cost from retailers.

The cost of this “externality” is not huge. In Australia and in electricity markets around the world, the power system operator typically bears the cost and then recovers it from retailers.

Twenty years ago, in an assignment for the British electricity regulator, I worked on an incentive scheme for the National Grid Company in England to reduce the costs of this externality which at that time was not more than about 0.2% of the value of wholesale electricity.

I suspect the cost would be much the same here, although as we know the exercise of market power in ancillary markets means consumers often pay far more than they should.

In an increasingly renewable electrical system it might be argued that the intermittency of renewables provides an additional source of externality – other generation needs to be found when the wind and sun are not available.

But it is debatable whether the adjustments arising from intermittency should be considered an externality. It is plausible to argue that as technologies change so markets must change and we can not just stick with historic constructs borne of increasingly defunct technologies.

Even if we accepted the proposition that intermittency gives rise to externalities, it is far from clear that these externalities will be large – it depends on many factors most particularly the continued rapid reductions in lithium battery costs.

At any rate Dr Finkel’s review suggested that renewable generators might also be required to offer firm dispatch capability to the market and that AEMO should have an enhanced role in procuring reserves to keep the system robust to renewables’ intermittency.

The Finkel Review’s proposals were properly researched and its recommendations are mainstream – the combinations of supply-side obligations and more often, system operator reserve procurement – is the norm in other countries as well.

The NEG, by contrast, proposes the radical idea that the obligation to procure “dispatchibility” should be imposed on retailers not on generators or the system operator.

This will introduce massive complexity, not least because trying to define “dispatchibility” and then enforce it will make the search for the holy grail look like a walk in the park.

More generally, the NEG joins a number of other arrangements in the NEM that are unique or very unusual. These include:

• The bifurcation of the design and implementation of regulation (this is unique internationally);
• The regulation of government-owned network service providers as if they are privately financed (this is also unique internationally);
• An energy-only electricity market (this is very rare internationally);
• No administrative arrangements for demand-response (this is also rare internationally);
• The most volatile electricity market in the world with the highest Market Price Limit;
• Extraordinarily high levels of market concentration in retail and wholesale markets.

These features – most of which the Australian Energy Markets Commission staunchly defends – account for a large part of the reason why electricity prices in Australia have moved from amongst the lowest in the world when electricity was provided by then much-derided state electricity commissions (so what do you think about them now, huh), to now amongst the highest in the world.

The NEG is yet another case of Australian exceptionalism in energy. At first, it struck me as a bizarre idea, detached from a conventional understanding of power system economics or engineering.

The more I look at it the more clearly I see it fits the toxic mix of muddled thinking and ideology that characterises so much of the regulatory oversight of this industry.

But I doubt the Coalition Back Bench liked it for this reason. Presumably they saw in it a way to sustain demand for coal generators – which is indeed exactly what the ESB’s modelling shows to be the case.

As the list of Australian “firsts” in energy markets attests, never under-estimate our polities’ propensity, when all is said and done, to put the customer second.

A number of supply-side lobby groups but also social welfare and environmental organisations have recently pleaded with state governments to just give the NEG a chance. For the supply-side lobby groups this angle is much to be expected, but for the environmental and welfare NGOs not so.

Bruce Mountain is director of CME