Why some of Australia’s energy market conventions should go the way of the dinosaurs

Our electricity market design is based on the assumption that a lot of physical infrastructure is needed to supply variable demand for electricity. 

If we step back, what we are seeing across many areas of our economy and society is a fundamental shift from physical, large-scale infrastructure to virtual, modular, flexible and portable ways of delivering services.

Households and businesses don’t want energy or specific technologies: they want services they value or think they need. Past life experience, available technologies and media influence our perceptions of how services can be delivered. But perceptions can change fast, driving rapid change in demand for specific technologies and energy requirements and change in the nature of infrastructure required. 

The smart mobile phone and the internet have reframed communication, physical travel and business models. Online shopping has shifted physical travel to shops to physical movement of purchased products to consumers. 

For many manufacturing businesses, efficient, flexible electric solutions and modular production mean they can relocate from present sites, chosen because of access to cheap gas, to a wider range of sites.

For example, efficient modular food processors can move close to farms and use renewable energy sources. Microgrids and energy storage can reduce their network costs. They can optimise use of organic wastes for energy and fertiliser and limit impacts of extreme weather events on supply chains. 

Covid transformed demand for transport, office space and electricity and comfort services at homes. While it might be suggested that higher occupancy and activity in homes must increase their energy use, the situation is more complicated.

Initial experience of high energy bills and discomfort can increase investment in building upgrades and more efficient, lower emission and cheaper-to-run reverse cycle air conditioners that deliver net savings. The avoided cost, social impact, family logistics and time of reduced peak hour travel can be very significant.

The design of our energy markets is being disrupted. The poles and wires of local electricity networks and transmission lines have been framed as ‘natural’ regional monopolies, because the costs and other factors such as visual impact of multiple powerlines have been as high.

In theory, competitive markets in energy retailing and generation seemed to make sense to economists and policy makers, despite the duplication of staffing, software, customer churn, advertising and other cost impacts.

These assumptions are now being challenged.

Retailing costs are higher than expected based on simplistic economic theory and changing business models supported by smart, flexible technologies and marketing models.

Poles and wires now compete with end-use energy efficiency and demand management, while ‘virtual’ powerlines out-compete extra powerline capacity as distributed batteries charge during times of low demand, then locally source high demand, reducing need for additional powerline capacity.

Network operators and retailers are beginning to cannibalise each other’s business models. Network operators want energy storage in their networks to capture profits while retailers want behind-meter storage that they can control via Virtual Power Plants, so they can optimise costs and profits.

Third-party businesses compete with energy companies to provide the distributed infrastructure and on-site solar linked to behind-meter batteries and smart energy management solutions that challenge market power of energy retailers.

While regulators call for ‘visibility’ of behind-meter activity, they must face the reality that a lot of that activity is actually driven by appliance and equipment selection, building design and occupancy factors and smart management of energy use. Much of this activity in appliance and building markets at the individual consumer level will never be ‘visible’ to the conventional energy supply system.     

Some market players and consumer groups now argue for network operators to be confined to ‘poles and wires’ so they can’t use their potentially enormous market power to distort markets away from innovative competitors.

On the other hand, network operators are setting up ‘ring-fenced’ subsidiaries that can offer services beyond their regulated boundaries. They are also seeking exemptions to ‘sandbox’ activities outside present regulated boundaries.

If network operators are blocked from broadening the range of services they can offer, they are doomed to a death spiral as behind meter and virtual alternatives steal demand and profit from poles and wires.

The Australian Energy Market Commission’s recent proposals to gradually increase fixed supply charges reflects their recognition that network utilisation is in decline and present infrastructure charges are based on assumptions of long physical asset life and high utilisation. 

A policy assumption that network operators are entitled to a guaranteed level of profit means fixed charges must increase. But do network operators who have exploited weak regulation and poor market design to capture ‘super profits’, as documented by IEEFA, deserve to be protected? Competitors and many consumers don’t think so.

Generators supposedly compete, but the poor design of our spot market rewards incumbent businesses with mixed generation portfolios and retailing businesses, so-called ‘gentailers’.

All generators bidding electricity into the spot market receive the price bid by the highest priced generator needed to maintain reliable supply, regardless of what their actual operating and capital amortisation costs are. The spot market has failed to drive optimal investment in generation, as shown by increasing intervention by state governments, who are blamed by consumers if electricity prices are high.

I am not arguing against the use of a spot market: the problem is the design detail of our present spot market. If incumbents whose capital costs have been covered had their bid prices capped, they could get a reasonable profit while consumers would see lower and less volatile prices.

Energy efficiency, demand management and energy storage compete with generation capacity to manage supply to satisfy demand that peaks in extreme weather, mainly due to thermally inefficient buildings and inefficient space conditioning equipment. But these markets are outside the official energy markets, as they should be. Our electricity market design does not recognise this.

Remaining coal-fired generation complicates the picture. Its limited flexibility is a key driver of very low and negative prices in sunny weather. If coal generation was more flexible, electricity prices in sunny weather would not be so likely to go negative and the ‘need’ to curtail renewables at those times would be reduced.

When a big coal generation shuts down, it creates a shock price impact. If we haven’t driven energy efficiency and construction of additional renewable electricity capacity, consumer prices will increase and state governments will be blamed. 

We face some big challenges. To what extent should the financial viability of businesses designed to operate in a failing energy market design be protected while we support emerging disruptive innovators that are essential to our future and protecting and empowering consumers?