With or without you: Rebutting criticism of AEMC’s demand response proposal

We are the proponents of a rule change request to the Australian Energy Market Commission to allow demand response to compete with generation in the wholesale electricity market.

Under our proposal, participating consumerswould be paid to reduce their demand when prices are high. This undercuts more expensive generators, so all consumers benefit from downward pressure on wholesale prices. It is one of the most substantial reforms of the national electricity market in the two decades of its existence.

On 17 July, the AEMC released its draft determination to introduce a wholesale demand response mechanism in to the NEM. Its proposed design is largely consistent with ours, and is superior in one respect – it does not require retailers to make changes to their billing systems.

However, we will be asking the AEMC to reconsider two aspects of its decision: to defer the mechanism to July 2022 and to delay participation for residential consumers.

The response to the AEMC’s announcement was largely enthusiastic, and it received high profile support from the likes of Energy Minister Angus Taylor, ACCC chair Rod Sims and AEMO CEO Audrey Zibelman. Predictably, it was criticised by generators, retailers and their peak body.

Generators – particularly peaking generators – are the losers from this reform, because demand response eats into their lunch when prices head towards the market cap of $14,700 per megawatt hour.

And if you’re wondering why retailers don’t support demand response – you would think lower wholesale prices would reduce their overheads, right? – it is because most retailers are actually ‘gentailers’: they own the generators.

Last week there were two articles in RenewEconomy, by Bruce Mountain and Simon Camroux, that raised criticisms of the AEMC’s decision. Mountain’s article originally appeared in The Conversation.

The criticism common to both articles concerns the complexity of the proposed mechanism. We agree, it is complex. But the physics of electricity are complex; harnessing it safely, even more so.

Designing any type of market to trade it adds another layer of complexity. Ever been inside a network control room or delved into the world of the financial instruments available to trade electricity? Or, closer to home, tried to wade through the confusopoly of the thousand or so retail offers?

There is nothing in the rule change that is more tricky than existing energy market arrangements. In fact it could be made simpler, but the AEMC has introduced extra measures in order to make life easier and cheaper for retailers.

Camroux notes demand response is not consistent with retailer business models, and that the AEMC’s exclusion of residential consumers should be revisited; both points we agree with.

But he also claims that creating a new market participant, the demand response service provider (DRSP or aggregator), ‘adds to market administration and transaction costs… impacting efficiency [and creating] perverse incentives – which can lead to additional regulatory costs’.

This misses the points that under the AEMC’s design the market administration and transaction costs will be recovered from fees on DRSPs so will not be borne by retailers or their customers; while practices that take advantage of ‘perverse incentives‘ are harder in practice than in theory and unlikely to slip under the radar of the regulator.

Mountain’s main problem with the mechanism is the settlement arrangements – that is, how payments are made between consumers, DRSPs, the market operator and retailers. He believes that retailers will be out of pocket if their customers do demand response with a DRSP.

Mountain’s argument is incorrect. His error arises from a fundamental misunderstanding of how the AEMC’s settlement process works, and an apparent unwillingness to look past the complexity to the outcome. The facts are:

1. Retailers would have the same wholesale market costs – based on their spot price exposure and hedging arrangements – whether or not there is a demand response event

2.  Where retailers recover less retail revenue from the customer, they are compensated for their retail margin by the DRSP.

Thus, as the AEMC states, ‘the retailer is left whole.’ The reimbursement rate – used to compensate the retailer for lost customer revenue, not for their wholesale cost as Mountain mistakenly believes – is calculated by the AER based on load-weighted average wholesale spot price over the previous 12 months, on the assumption that retailers are unlikely to want to disclose their actual wholesale market costs.

If this assumption is incorrect, we would be perfectly happy for retailers to be reimbursed for their actual cost of lost revenue from the customer; they just need to disclose this to the regulator.

While retailers won’t lose a cent from their retail operations under the AEMC’s demand response proposal, the competitive pressure from new demand response in the wholesale market means any generators they own will certainly take a profit hit – lowering wholesale prices to the benefit of all consumers.

Camroux – SIMEC’s Head of Regulatory Affairs – riffs on U2’s hit ‘I Still Haven’t Found What I’m Looking For,’ to suggest that the quest for a two-sided market remains unsatiated by this reform. We would suggest gentailers like SIMEC skip to the next track on the Joshua Tree album. The energy market is transforming and demand response is the only tool that can simultaneously help to reduce emissions, outages and price, and it needs to happen… ‘With Or Without You’.

Mark Byrne is Energy market advocate at the Total Environment Centre

Craig Memery is Team Leader, Energy and Water, Public Interest advocacy Centre