The Australian Government announced on 17 October 2017 its new energy policy in which it proposes to adopt the recommendation of the Energy Security Board (ESB) to implement a National Energy Guarantee (NEG). The new energy policy confirms the Turnbull Coalition Government’s anticipated rejection of the Finkel Review’s key recommendation of a Clean Energy Target (CET). In particular, the ‘technology-neutral’ nature of the NEG presents a departure from the priorities of the formerly proposed CET, which would have favoured investment in renewable energy sources such as wind and solar.

Broadly, the NEG recommended by the ESB comprises:

1. a reliability guarantee, under which electricity retailers and large users who purchase directly from the National Electricity Market (NEM) must meet a certain percentage of their electricity load requirements with ‘flexible and dispatchable resources’; and
2. an emissions guarantee, under which electricity retailers and large users registered in the NEM will be required to meet individual emissions profiles in order to meet a nationwide emissions target to be set by the Australian Government.

Early indications suggest that while the reliability guarantee will be assessed at state level, the emissions guarantee will be uniform across the country.

The ESB has recommended that the Turnbull Government’s proposed NEG scheme be put to the Council of Australian Governments (COAG) for consideration when it is expected to next meet in November 2017, with detailed consultation on the design of the NEG scheme to follow. In its advice to the Commonwealth Minister for the Environment and Energy, the ESB proposed that final approval of a change to the National Electricity Rules (NER) to facilitate the NEG occur by the end of 2018, implementation of the reliability guarantee by no later than 2019 and implementation of the emissions guarantee in 2020. It is worthwhile noting that the next federal election is due before the end of 2019.

Few details have been published by the Turnbull Government at the time of writing this Insight and so it remains to be seen how, and if, the final NEG scheme will be implemented and its implications for Australia’s energy industry and electricity consumers.

Reliability Guarantee

The reliability guarantee is proposed to apply to electricity retailers (as opposed to electricity generators) and large electricity customers who purchase directly from the NEM, by requiring them to guarantee that a pre-determined percentage of their forecast peak electricity load will be sourced from dispatchable energy resources. Retailers and customers can meet their obligations under the reliability guarantee by holding and entering into forward contracts with, or investing directly in (that is, owning), dispatchable resources in each region of the NEM.

While the precise scope of dispatchable resources is still to be determined, it is envisaged that it will cover traditional sources such as coal and gas fired generation, as well as pumped hydro and battery installations, that can be controlled by the Australian Energy Market Operator (AEMO) to respond in real time to electricity demand in each region of the NEM. At the time of writing this Insight, the method for calculating the proportion of a retailer’s or large customer’s peak electricity load for a particular NEM region is yet to be determined.

The reliability guarantee is proposed to be calculated based on the system-wide reliability standard set by the Australian Energy Market Commission (AEMC), translated into a minimum level and type of dispatchable capacity for each region of the NEM.

Retailers and large customers will be subject to compliance action if it does not have sufficient dispatchable capacity available to meet the pre-determined percentage of the electricity they sell to customers in the NEM. The ESB’s recommended approach for compliance with the reliability guarantee is for retailers and large customers to regularly provide evidence to the Australian Energy Regulator (AER) that their contract positions meet the reliability guarantee. The ESB’s advice to the Australian Government suggests that compliance with the reliability guarantee will be based on the actual output and availability of the dispatchable capacity and the cost of any non-compliance will be based on the real time spot price. Deregistration of a retailer or large customer from the NEM would be the ultimate consequence for consistent non-compliance.

In essence, the reliability guarantee appears to be aimed at ensuring that generation supply can always meet consumer demand in each region of the NEM.

The application of the reliability guarantee to large customers who purchase directly from the NEM excludes Western Australia and the Northern Territory, regions that are not part of the NEM.

Emissions Guarantee

The emissions guarantee will involve an emissions target that replaces Australia’s existing Renewable Energy Target (RET). It is proposed to be implemented in 2020, the target date for ensuring that at least 33,000 GWh of electricity comes from renewable sources under the RET. Projects financed under the RET will be grandfathered from 2020, and will continue to earn certificates until 2030 as currently legislated.

The new target is yet to be set by the Australian Government. The ESB has recommended that it be decided as soon as practical, according to a ‘trajectory [that] would recognise both the current emissions position and the least cost trajectory towards the Paris agreement undertakings’.

In order to meet the target, an emissions guarantee will be imposed upon retailers, who will be required to provide evidence to the AER that the mix of electricity they supply has met the emissions guarantee for their served load over the designated compliance period. Generators and retailers will enter into contracts that will specify an emissions level at which energy is to be delivered. When retailers purchase from the spot market, the average emissions level of the uncontracted generation capacity available to the market will be assigned to the purchase.

Retailers who would otherwise fail to meet their required emissions profile directly through their contracts with generators will be able to balance their portfolios by purchasing other retailers’ excess compliance and by trading Australian and international carbon credits. The ESB has proposed that any retailer who repeatedly fails to fulfil its guarantee be deregistered as a wholesale market customer under the NER.

The ESB has proposed that the guarantee could be designed such that electricity used to conduct emissions-intensive trade-exposed activities are exempt from emissions liability, as is currently the case. The Australian Government is yet to indicate whether this will remain in place.

The ESB has also indicated that while the target would be national, it may be apportioned unevenly among the states and territories so that a different emissions target approach could be established for Western Australia and the Northern Territory, which are not connected to the east coast market, if required.

A stable transition towards renewable energy

The NEG seeks to put in place an effective framework for managing a measured transition to lower emission power generation while maintaining base load power and grid stability with minimal price pressure and disruption along the way. Whether the NEG can actually achieve these objectives will depend on the detail of that framework, much of which is yet to be developed or released.

Focusing the reliability guarantee mechanism on retailers should assist to do so by motivating retailers to appropriately prioritise dispatchable power. Over time, as power storage technologies and dispatchable renewable power generation technologies become more available and affordable, the emissions guarantee should complement the reliability guarantee by motivating retailers to contract with generators that use these technologies – thus providing a smoother transition to a lower carbon power generation sector within a market framework.

In the meantime, the effectiveness of the emissions guarantee will depend on the strength of retailers’ incentive to comply with their obligations.

In practice, strict compliance with the reliability standard could prove challenging for retailers. Retailers who ensure that the required percentage of their forecast peak load is covered by dispatchable resources should not necessarily be penalised if their actual output does not meet the required standard because, for instance, actual demand is materially higher than the forecast peak.

For the regulator, balancing the two guarantees will involve a trade-off between requiring retailers to guarantee enough dispatchable capacity to meet peaks, and leaving enough room for non-dispatchable capacity, which may be required to meet the emissions guarantee. If the reliability standard is set too low, shortfall will still occur in the event that non-dispatchable capacity is not available during a period of peak demand.

Where to from here?

The ESB has recommended that the Turnbull Government put forward its proposed NEG scheme at the next COAG meeting, which is expected to be in November 2017. Agreement between the Commonwealth and the state and territory governments is not certain given the partisan approach to energy policy between Australia’s political parties and where most state governments are Labor controlled. A response from the federal opposition Labor party will be crucial to whether the policy proceeds in the Turnbull Government’s proposed form, however several Labor state premiers have already criticised the policy, setting the scene for contentious deliberations in the months ahead. So far, federal Opposition Leader Bill Shorten has criticised the policy for its lack of detail, while other senior Labor MPs have signalled openness to it in some cases, and reluctant support for it in others. Alternatively, any major legislative changes proposed by the Turnbull Government would need to navigate through a potentially hostile Senate. Greens MPs have criticised the policy for the risks of a low emissions target and that some states will be directed to use less renewable energy.

Industry response has been mixed – whilst some have warned that failure to reach a national consensus on energy policy may stifle the growth of the renewable sector, others have signalled their support.

Although the proposed NEG may be a positive step in addressing energy supply, reliability and emissions issues, the full details and implications of the NEG remain to be seen. Until then, uncertainty for market participants and electricity consumers and the so-called political climate wars carry on.

We will continue to monitor the debate and implementation of the NEG and update readers of new developments as they occur.