The NEM is a mess – so who will clean it up?

The management of the NEM sucks. COAG is a committee without a CEO. The SCO, AEMC, AER, AEMO are the prime bodies entrusted with delivering electricity and gas to the NEM and collectively they have done a very poor job.

It’s almost impossible for them to do a good job because there is no managerial chain of command or overall strategic plan. There are no real metrics for the success of the system and no shared vision of the appropriate direction or how to get there.

As we discuss below 6/8 of the AEMC’s senior management team have a background in law and its chair was originally the economist at the NSW Electricity Commission. The AEMC gets its modelling done by Frontier Economics who’s principal, Danny Price was also economist at the NSW Electricity Commission.  There are only three AEMC commissioners despite a recommendation that this be increased to five.

So in our view the biggest problem is that there is no management team for the NEM. COAG has no executive management team. There is no executive responsible for overseeing the combined role of the AEMC, AER, AEMO.

Each of those organisations has been designed as a silo. The AEMC in particular has little or no accountability. We can see how the AER didn’t do much of a job preventing “gold plating” of NSW networks, we can see the problems of electricity supply in the NEM but there is not much visibility on the AEMC. Our view is that more accountability and performance metrics are strongly needed. And perhaps a fresh direction.

Plenty of blame to share

All parties share the blame. AEMO for instance has, in our opinion,  done a poor job managing South Australia’s electricity supply, failing to ensure that wind farms had the right software and failing to properly use reserve powers to compel Pelican Point to produce when required. The AER for years, in our opinion, let the distribution companies walk all over it and meekly accepted the Australian Competition Tribunal’s overly legalistic decisions as if they were the last word. COAG and the EMC (committee of senior apparatchiks), in our opinion, have turned down various opportunities for reform and produced few, if any, worthwhile policies in recent years. COAG is at war with itself with the Federal and State Govts at ideological loggerheads. The Federal Govt has to accept prime responsibility for this. The reason the Federal Govt makes no progress is that to date its presented no credible plan. The State Govts ban CSG development despite a lack of scientific evidence (other than from fugitive emissions) justifying the ban.

AEMC – a nest of lawyers guided by coal refugees

However in the end, despite some good results, such as introducing competition in metering, it’s the AEMC that, in our view may have to accept prime responsibility for the mess.  The AEMC is is responsible for Rule-making and energy market development at the national level, including in respect of the National Electricity Rules, the National Gas Rules and the National Energy Retail Rules which govern the NEM, elements of natural gas markets and energy retail markets.

An expert panel review of Governance of energy markets in  2016 advised COAG that “governance is fundamentally sound” but also stated “The Panel observed that the Council and SCO appear to lack a focus on strategic direction and are therefore not providing effective and active policy leadership to the energy sector” This latter quote does not directly reflect on the AEMC but the review did call for more accountability for the AEMC.

And we think there seems to be increasing sentiment for reform. Our view and, we think increasingly a view in the industry, is that AEMC is overly process driven, is itself driven by ideology and to put it bluntly the direction is overly conservative and out of touch.

To understand why this might be so we look to the Chair, John Pierce. Mr Pierce was originally Chief Economist of Pacific Power (the State owned monopoly Generator in NSW) before joining NSW Treasury in 1993, and then NSW Treasury Secretary from 1997-2008. He has been Chair of the AEMC since 2010. Arguably no other person is more central in the policy making framework. And IF this is so then it may  seem that no other person is likely to be more responsible for whatever shortcomings there are in that framework.

Its perhaps no coincidence that the prime modelling that the AEMC relies comes from Frontier Economics. The head of Frontier Economics in Australia is Danny Price, who was principal economist at the NSW Electricity Commission which became Pacific Power.

So one view consistent with the history is that much of the policy advice provide to COAG and now underlying the Emissions Intensity Scheme is coming from a pair of old mates with a background in the NSW coal fired generation sector. Frontier Economics has a demonstrably evidenced embarrassing record in forecasting the costs of renewable energy however that doesn’t stop the AEMC regularly using its advice. In our view that alone is sufficient to create a presumption of unfairness.

More broadly though the question must be whether the AEMC isn’t itself due for a process of renewal. The expert panel review recommended it be given more responsibility for policy. Has it demonstrated the track record that would justify this?

The AEMC does have a relatively new chief executive, Anne Pearson. Ms Pearson has been at the AEMC since 2007 and was formerly, regulation manager at Energy Australia and a partner at a leading law firm.

We note that of the eight member of the AEMC management team, 6 have a background in law and none have a background in engineering or science let alone in PV. Of the six with law degrees a couple also have a background in economics. Our view is that this may well be  a recipe for a  bureaucracy.

The story so far:

Over the past year we have spent some time identifying the issues that have lead to gas and electricity price rises in Australia and associated shortages of supply. Although customers complain about high prices, they are a natural part of the market. They are the signal for new supply  and substitution in a well functioning market. That said:

1. The first problem we identified was the RET. This scheme has many disadvantages most of which are discussed at https://reneweconomy.wpengine.com/the-ret-is-a-high-cost-way-to-procure-renewable-energy-50794/ By far the  biggest point to understand from this article is that the RET increases the price of renewable electricity because it relies on uncertain future prices thus increasing the cost of capital. All around the world procurement of renewable energy is moving to reverse auctions with the counterparty able to typically offer a Govt guarantee and a long contract. What we should have added is that Emissions Intensity Scheme [EIS] suffers from many of the same deficiencies that essentially stem from uncertainty about what the future base line for emissions will be. Uncertainty raises the cost of capital and the EIS models simply don’t allow for that.
2. Secondly we noted that one consequence of the RET was that all the renewable energy was being built in South Australia and if more were built in other regions there would be less intermittency. We reviewed important work by UNSW on this topic and looked at regional correlation of wind output. https://reneweconomy.wpengine.com/do-australian-wind-turbines-all-blow-at-the-same-time-27486/ This note was picked up by Peter Martin in the SMH
3. Thirdly we ran a concurrent stream of work looking at battery technology and costs. The key pieces were review of the Argonne model for battery pack costs https://reneweconomy.wpengine.com/need-know-making-ev-battery-packs-13789/ showing how much lower EV packs were compared to household storage and the podcast interview with Marek Kubik, from AES, currently the world’s largest provider of utility scale lithium storage https://soundcloud.com/itk-503826930/aes-marek-kubik-master. Also as part of this stream we pointed out to the advances in modelling battery storage economics made by Alevo, CES and Brattle Group in the USA https://reneweconomy.wpengine.com/battery-storage-bad-advice-about-costs-is-fooling-australian-governments-95310/. In the end the key point is that there is not systematic approach to distributed energy in Australia or how to incorporate it into the total system.
4. Networks and transmission and increasingly distributed energy are the biggest part of the electricity business but are poorly modelled and receive too little attention. We think monopoly regulation doesn’t work and stifles innovation and that ringfencing, although understandable, is the opposite of what’s required. The key note here looked at the legal battle between the AER, the networks and the Australian Competition Tribunal in the context of the current Federal Court case. The Federal Court is expected to hand down its decision in that case by the end of March. https://reneweconomy.wpengine.com/ausgrid-inside-a-utility-soap-opera-and-the-billions-at-stake-27235/.
5. About three years ago now when AGL succeeded with its appeal to the Australian Competition tribunal when I was still at UBS I looked at whether owning lots of coal fired generation was going to be profitable. I  concluded then that eventually new renewable generation and carbon pricing would be a problem but in the meantime every time a coal generator was taken out of the system it was a big lump of supply and would tend to lead to price rises. We summarized the impacts of that three years later https://reneweconomy.wpengine.com/rhetoric-comes-supply-demand-98997/ pointing out that futures prices were significantly above the prices that existed when we had a carbon tax. And of course prices have risen another 20% since then.
6. Finally we recently noted there has been a sharp reduction in competition in the NEM over the past five -seven years. Now no more than two players control 50% of the generation in each State. AGL and ORG very loosely and broadly put control about half of the combined electricity and gas market in NSW, Vic and South Australia. The lack of effective competition has many consequences but certainly it results in lower bargaining power for both rule makers and customers. https://reneweconomy.wpengine.com/too-much-power-the-real-crisis-in-australias-energy-markets-28663/ Because there is so little competiton in the end customers don’t benefit from markets. 50% of the price is determined by monopoly regulation and the other half comes from vertically integrated oligopolies. Essentially the NEM has only succeeded on one front, that is pulling most of the States into the “National” market. However even there the realities of the cost of transmission compared to the benefits mean that individual States are still often islands unto themselves.

Note: To hear Giles Parkinson and David Leitch dissect the week’s events, including the Tesla vs gas, and questions about who is in charge, please click on the Podcast link below.

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.