The papers set out a framework for a new energy system that accommodates and facilitates the fundamental changes that we are seeing in our energy market. These include the rapid and widespread uptake of rooftop solar systems – more recently accompanied by battery systems and sophisticated energy management software – and the bi-directional energy flows driven by these systems exporting increasing quantities of excess power into the grid.

We see the ESB papers as a significant step forward towards a market that can maximise the benefits from the technological changes we are seeing. In this note we identify key features of the framework proposed by the ESB, and include our observations on how these changes will drive new business models and new types of market players.

The framework considered in Moving to a Two-Sided Market will allow consumers to schedule their intentions and participate in the market, and more appropriately allocate variable and fixed costs.  In System Services and Ahead Markets, the ESB looks at the creation of new markets for reserve capacity, essential system services and demand response, including ahead markets. 

These are important changes that will not only enable the market operator and DNSPs to better understand the impact of large quantities of distributed energy resources on the system, but will also allow these and other resources to contribute to system security and reliability.

The ESB notes that consumers may participate in the market through retailers or aggregators acting on their behalf. We would go one step further. As we identified in our recent paper Data, Dollars and Electrons: A vision for the 2030 energy system, retailers or aggregators acting as virtual power plant (VPP) operators are likely to be major players in the future market with their ability to aggregate and orchestrate distributed energy resources.

Notably, the ESB recognises that there is a trade-off between higher levels of visibility for the system operator and the cost of technical requirements it might impose on scheduled participants. There is some distribution level data that would not be shared, and it follows that VPP operators with access to the most data and with the most sophisticated energy management software will have a competitive advantage in being able to predict and respond to consumer behaviour and run the more cost-effective VPPs. As we are seeing through the trialling of VPPs by retailers such as AGL and Simply Energy, and the entry of newer market players such as Reposit Power (who provide smart technology software solutions that maximise the value of battery systems), the race is on.

The ESB papers do not address what we see as an important question – who will manage the complex flows of data and electricity at distribution level? We expect that there will be an important role for local system operators – for example DNSPs or an independent body – in operating these systems and interfacing with the wholesale market operator.

The ESB envisages a two-sided market that facilitates the integration of end users with controllable demand and supply to reduce imbalances and system costs. In this market:

• Participants can ‘schedule’ their intentions, eliminating the need for central forecasts (though forecasting may still be required for those participants that choose not to participate in scheduling, and for long-term processes).
• Consumers can choose if and how they participate in the market, whether directly or through a retailer or aggregator.  The ESB sets out three models of participation in a two-sided market: voluntary participation, selective participation and full participation. Ultimately, the ESB’s view is that the full participation model is the goal of a two-sided market as it provides the most information to a market operator and elicits the most value from responsive capabilities. The table below sets out the benefits and drawbacks of each model considered.

Importantly, the ESB recognises that the technical requirements imposed on current scheduled generators, in particular metering information and providing it to AEMO in real time, should not apply to all scheduled traders in a two-sided model – there is a trade-off between higher levels of visibility for the system operator to operate the power system and the cost of technical requirements it might impose on scheduled participants.

This in our view leaves open an important role to be performed at the local distribution level (including operation of the VPP markets). As we explored in our Data, Dollars and Electrons paper, given that local systems will be increasingly complex, it may be appropriate for local system operation to be managed by separate regional bodies rather than a single national operator. There could be a patchwork of separately operated regional systems, with the local system operator potentially being the DNSP in the relevant region, or an independent body. Under this model, AEMO would continue to have the central role of managing the wholesale market, but it would increasingly need to interface with local system operators, and the regulatory framework would need to accommodate this

The ESB identifies several benefits that a two-sided market will provide. We list these, and some observations, below:

• Consumers: Consumers will have greater control over their electricity, and will have the information available to make cost saving decisions regarding their electricity use.  Consumers could, with the aid of energy management software, participate meaningfully and without too much difficulty on their own. However, as discussed in Data, Dollars and Electrons, we see this participation being undertaken primarily by VPP operators – retailers or aggregators who, for a fee from the consumer, would apply their expertise, sophisticated technology solutions and aggregated portfolio of customers to minimise the power bills of consumers while at the same time participating in market opportunities and in doing so generating a separate stream of revenues.
• Traders: Traders will be able to participate in new market services on the supply and demand side, enhancing market efficiency.
• The market: The two-sided market will provide the market operator with more accurate and up to date information, which will assist in enhancing system security and reliability. It will encourage price responsiveness and demand flexibility, which should in turn reduce the need for AEMO intervention – in short, the market will become more efficient, and costs will be allocated more fairly.
• DNSPs: The ESB notes that the increased demand side information available to AEMO could also be made available to DNSPs to make more accurate demand forecasts for their network and optimise network assets with increased levels of DER. We would add that more nuanced information may be required to operate the complex bi-directional flows of electricity at distribution network level than is needed by AEMO to operate wholesale markets. It may be appropriate for DNSPs, or an alternative independent body, to operate the local systems.

In our Data, Dollars and Electrons paper, we predicted that there will be much greater focus by regulators on the structure and method of charging customers, as distinct from the total volume of revenue to be recovered – in other words, regulatory processes will be less about what can be recovered, and more about how. Ultimately, it will be the method and structure of charging system users which drives incentives for efficient deployment of distributed resources and optimal use of the system as a whole.

There has already been much consideration given to ways of moving to more cost-reflective tariff structures. However the ESB advice brings this issue into sharp focus, highlighting two issues in particular:

• a need to align variable price components with locational and time-based variable costs; and
• a need to ensure that fixed costs are recovered in a way that does not distort usage decisions.  The ESB points to a ‘subscription charge’ model for recovery of fixed costs, as an alternative to the traditional usage-based charging model.

The efficiency rationale for these changes seems clear. Providing sharper price signals and removing any cross subsidies should promote more efficient usage and investment decisions, thereby lowering system costs overall.

It is for this reason that we see it as inevitable that, in future, we will pay for our energy services differently. We have previously speculated that users of the future would purchase ‘energy packs’ for a monthly charge that would include a fixed network access fee. This would be one way of addressing the ESB’s concern regarding inefficient usage bias created by traditional usage-based models.  Given that network costs are largely fixed (i.e. they do not vary significantly with total consumption, but are more related to peaks in demand), a monthly subscription charge model would seem more appropriate.

However, while the efficiency rationale seems clear, the ‘fairness’ of any changes to tariff structures may be a more subjective and debateable proposition. Any change to tariff structures will inevitably create winners and losers, at least in the short term. Those system users who end up facing higher costs, or greater volatility in the charges they pay, may not agree that such changes are necessarily fair. We have seen major disputes flare up over changes to tariff structures in the past – most fervently in the United States around the removal of ‘net metering’ rules (effectively a form of subsidy for power generated behind the meter).

Therefore, the real magic will be in the design of the transition path, and in convincing all stakeholders that changes to tariff structures are necessary and appropriate. The ESB appropriately recognises this challenge and the work already underway to address it.

In System Services and Ahead Markets, the ESB considers the increased need for more essential system services, including operating reserves, frequency management services (such as synchronous inertia) and system strength, to be provided in real time at the lowest overall cost to consumers.

The ESB sees the two key components in achieving this being:

• establishing new frameworks to value all essential system services so that they will be available to the power system when needed; and
• incorporating a mechanism in the NEM’s pre-dispatch and dispatch process that provides visibility and enables efficient co-optimisation of the essential services ahead of time, to ensure these are available without costly and distortionary interventions (such as those regularly seen in South Australia).

The paper considers how the essential system services will be scheduled and priced, forming a preliminary view that, taking into account scheduling complexity and price formation, the level of competition in the market and frequency of services needed:

• operating reserve could be scheduled and priced in dispatch (along with energy and FCAS as is currently the case);
• additional frequency services (such as inertia response), system strength and voltage control could be scheduled in dispatch and priced outside of dispatch (for example based on contracts); and
• less common system restart and load restoration could be scheduled and priced outside of dispatch, through system operator direction if needed and based on contracts or regulated provisions.

For services that can be scheduled in dispatch, the paper also looks at the benefits of an ahead market (such as the typically day-ahead delivery schedules seen in the US) which can be physically or financially settled and adjusted in real time. Potential benefits include:

• facilitating the provision of real time services which are constrained by ramping and start up lead times, for example synchronous inertia and system strength services provided by synchronous units;
• enabling increased demand side participation by consumers that need to plan consumption decisions in advance (for example, a C&I customer scheduling planned downtime the next day to align with high demand response prices);
• creating market liquidity through short term trading opportunities; and
• allowing increased co-ordination with the gas market.

In a client update we prepared last year, we queried whether a short term forward market for energy being contemplated by the AEMC would assist in maintaining system reliability, given limited stakeholder support and voluntary participation.

The ESB recognises the value of compulsory participation in energy and essential system services ahead markets – at least for critical system services – in minimising security and reliability issues. The ESB also recognises that these benefits need to be weighed against the additional costs and operational burdens that would be placed on participants, which will be a focus for the ESB as it continues to develop the market design for new frameworks for system services and ahead market arrangements. As we have previously indicated, we would like to see all options for enhancing reliability remain on the table – for example the possible introduction of some kind of capacity payment mechanism, although this has not been explored in the ESB papers.

The ESB papers do not consider broader regulatory issues relevant to a two-sided, technology driven market, for example in respect of the use of data. The capture and use of data will be a key feature of the two-sided market.

We anticipate that sophisticated algorithms will be used to devise pricing plans which reflect the way in which different customers interact with the energy system. If there are to be accurate price signals sent to customers, this implies some degree of algorithmic price discrimination, albeit based on different patterns of usage and supply. While such algorithmic price discrimination is likely to be efficient, it may be seen as unfair, particularly to those who cannot afford to invest in technologies that could reduce their burden on the system.

Concerns around ‘unfair’ use of data – particularly use of data to facilitate price discrimination – could lead to heavy-handed restrictions on use of data for pricing purposes. In our view, this would be an unfortunate development, if it were to occur. Efficient price discrimination is likely to yield significant benefits for all system users, particularly better targeted deployment and use of distributed resources. Rather than preventing use of data for this purpose, any regulation should be focused on targeted protection of particularly disadvantaged customers.

The ESB is set to provide a more detailed analysis of the issues considered in their papers by the end of 2020, along with the final 2025 report. We will continue to monitor updates closely.