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Hey Reader, the market is still digesting today's supersized draft report of the NEM review, but in this special edition of The Energy we cut through the noise to bring you our first take and some early expert views on the key issues.
We’ll have the full recording of our webinar with Tim Nelson out tomorrow, along with more reaction. Please encourage your colleagues to subscribe.
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Energy giants face new obligations
Power giants will face new “guardrails” on their market share to address competition concerns and be required to make markets in a new set of contracts for medium and long term critical energy services, if the ideas of a landmark draft review of the National Electricity Market (NEM) are adopted.
Previous efforts to reform the NEM have foundered but review chair Tim Nelson told The Energy the panel was confident its package had the right ingredients for success. “It’s really the first time we’ll see a reform proposal put forward that’s trying to make the long term, medium term and short term work consistently within one framework,” Nelson said.
The report proposes a new system, known as the Electricity Services Entry Mechanism (ESEM), introducing yet another acronym to the alphabet soup that is already rich in Australia’s energy landscape. The ESEM would build on an existing market for electricity derivatives and hedges by extending contract terms beyond the few years currently written by market participants to terms of 15 years or more.
It does not include a “capacity market” favoured by owners of gas generation and recommended by the former Energy Security Board in 2022 but rejected by the states. However, gas generators should be able to bid for firming contracts.
The draft report says the ESEM should be reinforced by imposing a “market making obligation” (MMO) on big owners of renewables, batteries and gas generators and forcing them to meet with consumer representatives every few years to define the derivatives contracts needed in a firm renewables future energy market.
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Expert view
“The ESEM is really a recognition of the need to provide that longer-term certainty on financing for the assets that are going to underpin the vast bulk of our energy system in that time frame and beyond. So from an investment perspective, that's obviously incredibly helpful.
When it comes to the ongoing governance, they've not made a call about what that's going to look like. And I think this is a really key part of the second phase of work. We can't have governance arrangements of the energy system look like the last 20 years.
We don't want everything subject to political decision and direct intervention of ministers, because it creates all that uncertainty.
On the other hand, there needs to be an acknowledgement that AEMO has been given a lot to do in the last couple of years. It's responsible for the ISP, it's doing a whole lot of other things, and its governance needs to evolve to meet those challenges.
There's an argument to be made that… the way AEMO’s currently set up, they'd be incentivised to over-procure, and we need to make sure that we see the most efficient investment going into the market into the future. So there needs to be a balance between it being completely out of political hands, versus some accountability over the size of contracting”
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Francesca Muskovic
Executive Director, Policy, Investor Group on Climate Change
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Expert view
“Short-term: Retaining the gross pool design is expected, but disappointing that competition only appears in the context of algorithmic bidding. In reality, market power can be exercised when demand is both high and low, restricting entry. Relying on competition law (CCA) to address this in the wholesale market has proven unrealistic.
Medium-term: The push for a deeper derivative market is spot on — but the devil is in the detail. The process for determining contract needs seems impractical, its link to the DMO is unclear, and there isn’t much on how to properly incentivise supply-side participation.
Long-term: The proposed Electricity Services Entry Mechanism (ESEM) raises big questions. If we need tenders for bulk energy, shaping, and firming to ensure efficient entry, doesn’t that concede the wholesale-only market design can’t do this? That has major implications — including for how price caps are set.
Lots to unpack. I hope the final report teases out these consequences.”
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Flavio Menezes
Professor and Director of the Australian Institute for Business and Economics at the University of Queensland
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Expert view
“Currently, the focus of the NEM review is not on the spot market, as its functioning is assumed to be efficient. However, the spot market is really only efficient in the sense of delivering enough energy supply to match demand. The ACCC, AER and AEMC have all highlighted ways in which insufficient competition and the potential for market manipulation have led to higher prices for all consumers.
If the government takes on risk by holding long-term energy contracts for renewables as the review recommends, generators that participate in the scheme should be required to deliver broad social and economic benefits, as is done today through the Capacity Investment Scheme’s merit criteria.
The panel's recommendations should ensure that costs and risks from transforming the NEM are distributed fairly and that the energy system works for low-income households. For example, the proposed overarching consumer duty to protect consumers with solar and battery systems could be extended to all consumers.”
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Mara Hammerle
Senior Economic Adviser, Centre for Policy Development
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