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John Pierce AO

Renewable energy integration in our national electricity market

12 September 2019

The AEMC is Australia’s representative on the World Energy Council which organizes the triennial world energy congress. Chairman John Pierce addressed the 24th Congress on 12 September. This forum has been running since 1924 enabling dialogue between the world’s energy ministers, policy-makers and industry on critical developments in the energy sector.

By John Pierce AO, Chairman

As the World Energy Congress convenes in Abu Dhabi, it is worth reflecting on the Australian experience of the energy trilemma – the desire for affordable energy, reliable and secure supplies of electricity and the need to reduce greenhouse gas emissions to address climate change.

Why is Australia such an important marker in this debate? Australia is one of the largest coal and gas exporters in the world yet it is well advanced down the pathway of renewable energy adoption. The state of South Australia sources around half of its energy from renewables with significant volumes of large scale wind and solar and one of the highest penetrations of household and commercial solar PV of anywhere in the world. Close to a quarter of houses in South Australia and Queensland have solar PV on their rooftops.

South Australia today is one of only three markets in the world to be in the most advanced stage of renewable energy integration, according to the International Energy Agency.

Wholesale electricity prices are now reflecting a much greater diversity of energy supplies.

At times during the middle of the day and night, prices on Australia’s east-coast are zero, with abundant supplies of solar PV and wind respectively. But at other times, prices are much higher to signal the need for fast-start technologies to accompany renewables, such as gas turbines, reciprocating engines, pumped hydro and battery storage. In fact, the world’s largest battery is now installed in South Australia.

It is indeed puzzling for people that despite renewables providing the cheapest form of energy now in Australia, the need for complementary higher-cost capacity is causing overall total system costs to increase.

System security and reliability have come into sharp focus by policy makers because of the unprecedented reliance upon variable renewables (i.e. wind and solar). Reliance upon an ageing incumbent coal-fired generation fleet has resulted in policy makers designing new mechanisms to deliver a reliable system.

Australia’s recently adopted Retailer Reliability Obligation requires electricity retailers to demonstrate they have sufficient contracted capacity, not just energy, to deliver to their customers. In this way, policy is being implemented to deliver capacity and energy when customers require it, not just when the sun is shining and the wind is blowing.

New technologies are fundamentally shifting the market for electricity around the world, not just in Australia. Increased adoption of variable solar and wind has significantly reduced the unit costs of these technologies. The take up of emerging digital technologies may also provide material opportunities for efficient reductions in energy demand.

In this context of technological shifts, innovation in policy design will be critical for the world to successfully address the energy trilemma.

In the Australian context, it is worth remembering that the Retailer Reliability Obligation was designed with the option of also requiring retailers to contract for energy and capacity in a manner that reduced greenhouse gas emissions over time. This broader policy was known as the National Energy Guarantee and may be worth considering by countries interested in pursuing the World Energy Council’s trilemma objectives using competitive markets.

A perspective on Australia's microeconomic reform journey

18 July 2019

John Pierce AO

Presented to the Australian Institute of Energy and Griffith University, 18 July 2019, Brisbane Australia

Download a PDF version of this speech

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In Australia we have a very open and accessible set of arrangements to change regulatory frameworks in response to policy changes or structural change in the energy industry. Any person or organisation can propose a change to the rules – from private citizens, business and government. The Australian Energy Market Commission depends on the insights and views of our stakeholders to help inform our thinking and challenge our proposals for reform. Continuous dialogue is one of our key commitments. We have an obligation to evaluate all rule change requests against statutory objectives which require us to serve the long term interests of consumers.

The energy system is being transformed and we are changing the market from top to bottom. Given the amount of change occurring the Commission has articulated a set of five rule-making priorities which will help make it possible for stakeholders to contribute more effectively to energy market developments and influence our provision of strategic advice to governments. Those five priority areas of reform are generator access and transmission pricing; system security; integrating distributed energy resources; digitalisation of energy supply; and reliability.

Introduction

A proper discussion of this topic, even it was to be confined to the electricity sector, would demand something like an extended essay or a book. Given the time we have today, that’s obviously not going to happen. So I will confine myself to a few key points, sprinkled with some carefully selected historical and personal anecdotes to help keep you interested.

In May 1986, the NSW government was presented with the final report of an inquiry led by Gavan McDonell. The background that gave rise to the inquiry was in some respects the opposite of the concerns that many have today, yet in other respects remarkably similar.

There was an excess supply of generation capacity and the organisation responsible for bulk supply, the Electricity Commission of NSW, wanted to build more. The report’s finding, in a nutshell, was that the Electricity Commission of NSW needed to plan better and it made recommendations about how to go about this. As well as cancelling plans for the construction of an additional four by 660 MW power station that was on the books at the time – a sister station to Eraring and Bayswater.

That excess supply and the possibility of more, was a problem in my view because of the consequences that flowed as a result of the institutional, regulatory and industry structures that existed at the time.

For the economy generally, having a few billion dollars of capital sitting around not doing much was a problem in itself when arguably those resources could well have been of more use doing something that people actually wanted. But the truth is that costs of this nature tend to be not readily observable.

The real motivation for questioning what was going on was that the costs of excess supply were being passed onto consumers in the form of higher prices. We are concerned about high prices today, but in real terms wholesale energy prices at the start of the NEM, at just over $90/MWh, were slightly higher than today’s prices in NSW. The other problem was that the debt used to fund power stations was a drag on the State’s finances, limiting the ability of the government to fund other things. Both outcomes were a consequence of the prevailing institution, regulatory and industry structure.

So in 1987 legislation was passed that required the Electricity Commission of NSW to prepare an Electricity Development and Fuel Sourcing Plan. Each plan was to cover at least 30 years. In 1989 the Electricity Commission of NSW published its first, and as things turned out, its last, 30 year plan.

As someone that played a minor role assisting the inquiry, my first thought when the ink wasn’t yet dry on this plan was “this will never work”. The information requirements were too large, the future far too uncertain and the risks so asymmetric to have really have much confidence that “better planning” would materially reduce the possibility of delivering outcomes much different than what had happened in the past.

One way or another it seemed to me that history was destined to repeat itself. In my mind, if future demands, technology, input costs, policy objectives, and the like were uncertain, asking how to plan better was asking the wrong question – or at least diverting attention from what was the most pertinent question.

Now while the development of more sophisticated and informative analytical techniques that underpin this improved planning is always welcome, the primary question in my mind was how to change the institutional, regulatory and industry structure to deal with what seemed to be really the only certainty – that being, that today’s expectation were bounded to get mugged by tomorrow’s reality – and how do you manage the consequences when that happens?

During this period there was a lot of what some people would refer to as virtue signalling going on. Generally it went along the lines of, private sector – good and efficient, public sector – bad and inefficient.

The proposition that the private sector was necessarily better at foretelling the future than the public sector was it seemed if not preposterous, at least a very shaky foundation for a major structural microeconomic reform.

So the thinking basically went along these lines. What if we can have a competitive wholesale electricity market, which of course had to be designed so that it conformed to the laws of physics but also by definition had to have multiple buyers and sellers?  If you simply have a central authority deciding how much capacity will be required in the future and conducting an auction for who would supply it there would be no reason to expect the outcomes to be any different from when we had with the electricity commissions. “Contracting out”, may be the only option for some non-priced public services, but in the energy sector the outcome would be to efficiently build the wrong things at the wrong time and possibly in the wrong place and for the costs of doing being passed onto consumers.

If we could have a competitive wholesale market – in the proper sense of the word “market” - then while the market participants would have to go through the same forecasting and planning  processes that the people in the electricity commissions had to do, the consequences when the future turned out to vary from what was expected, would be quite different.  For instance, if they over-invested then prices would fall rather than rise.

That is, without having to rely on participants in a competitive market being superior at forecasting the future, by changing the institutional and industry structure, which is really about managing the way in which risks are allocated, the consequences for consumers and the consequences for the economy more generally would be quite different.   

But of course it’s that very thing, the change in the allocation of risk, that changes behaviour and drives different sorts of outcomes. And certainly in the case of successful microeconomic reforms – and I’d be the first to admit that many of the total package of microeconomic reforms that were being considered at the time, failed on implementation – but those that did succeed drove more efficient outcomes and higher productivity growth which is a driver of economic growth in the longer-term more generally.

Which is really where the electricity sector reform story fell in line with the broader microeconomic reform agenda – that longer-term economic prosperity had to be underpinned by productivity growth.

Given that we are coming up to the end of the 30 year time horizon of the Electricity Commission of NSW’s 30 year plan, earlier this year I thought it might be a bit of fun to dig it out and have another read.

Viewed from the perspective of the time it’s a highly credible piece of work particularly with the ways the various scenarios of the future were constructed and in many respects might be regarded as “forward-looking” for its time with somewhat familiar topics being discussed – greenhouse gas emissions, demand response, tariff reform – it’s all there.

And of course it’s totally unfair given what we know today, to judge it in hindsight. And to dismiss it would miss the point I’m trying to make. Which in part, is to question the existence, or utility of putting faith in, an omnipresent all-knowing planning god.

I recently described the tendency in the face of uncertainty to centralise decision making as comforting people with the delusion of control over outcomes. In the face of uncertainty centralising decisions concentrates risk.

To help illustrate the point the 30 year plan considered the options for future power stations that were available in NSW. Not all of them would be needed, but the question was what options were available?  It identified a range of existing and future sites that could accommodate 48 additional 660 MW units.

By 2020, depending on the scenario, it said that NSW would need somewhere between 12 and 34 additional 660 MW generating units. Over and above the two at Mt Piper, which were under construction at the time. And under the scenario considered most likely NSW would need 20 additional 660 MW units. As compared to the actual number, which we know that we’ve had over that period which is zero.

The world we face today of course is vastly different from the one that existed in the late 1980s and early 1990s. We’re almost on a different planet. One thing although that possibly endures is the underlying need to have a set of policy frameworks in place that drives innovation and productivity growth.

In those earlier times there was a consensus between Governments around that as an objective – they argued about how to do it, and how the benefits and costs would be distributed, but there was a sense of common purpose when it came to the objective.

Of course that contrasts with today’s circumstances where the objectives that governments are pursuing are somewhat contested between themselves. Given we have a national framework dependant on a degree of cooperative federalism that has some real impacts on the outcomes we are experiencing.

And while questions around what are the appropriate institutional, regulatory and industry structures for today and into the future are obviously being discussed and debated it seems rather futile to engage too much in those discussions without there being some consensus on objectives beforehand to guide those discussions. Indeed many of today’s discussions about “market design” seem to be a phony war over the inability to build sufficient agreement about objectives.

One of the interesting things that happened recently, and probably the Governor of the Reserve Bank Philip Lowe, has been the one most reported to have articulated it is, against a backdrop of the limitations on monetary policy and fiscal policy, the emphasis on the need for structural reform, -given that microeconomic reform is an unfashionable term these days.  That is the policies and frameworks that will drive innovation and productivity growth.

AEMC key priority areas

In this environment what is it that the AEMC should do, or can do? Given the Commission’s remit, what can we do to address the issues that face the sector, and make our contribution to assisting productivity growth and innovation?

Traditionally the Commission given our statutory role have taken an almost semi-judicial stance.  When people put rule change proposals to the AEMC they need to be confident that they will be evaluated on their merits against the national energy objectives.

Given the changes occurring in the sector and the sheer volume of rule changes that are being put to the Commission we have felt it necessary to articulate a set of priorities. Essentially these are issues that are able to be addressed through the national energy rules. They are the areas that in the AEMC’s view will go a long way to addressing many of the concerns that people have with the sector’s performance in this period of history.

I’ll just touch on some aspects of why they are important. Effectively the Commission is asking people to consider rule change proposals that fall within these five buckets, and if they put forward proposals in these areas, the AEMC will want to get onto them as soon as we can.

If people have other rule changes they want to propose they can, and we are obliged to deal with them, but you might have to convince us that our analysis of what are the major issues affecting the sector’s performance is missing something, or just accept that it is going to take second priority. It’s just a pragmatic response; a queuing criteria if you like.

The first is generator access and transmission pricing. Currently generators primarily get access to the transmission system by the way in which they bid into the spot market. The access arrangements are essentially built on the premise that transmission is built to achieve reliability outcomes for consumers, and therefore consumers pay for transmission and transmission revenues are regulated.

But given that we are moving from a system with a relatively small number of generators in very predictable locations to one more characterised by a larger number of smaller generators that are far more geographically dispersed, there are some people arguing that rather than building transmission for the benefit of customers, we need to build transmission for generators.

It seems reasonable to ask that if that is the case, if that is how you want to construct this, it is reasonable to ask that generators pay at least part of the transmission infrastructure that is required to give them access to the market.

The second priority requires introducing you to a bit of electricity industry speak. In our everyday language security and reliability tends to be seen as meaning the same thing. But in the electricity sector the two are quite different, and accountabilities and responsibilities for managing them are also quite different.

When we talk about system security what we’re talking about is operating the power system within some fairly tightly specified technical variables so the system can be controlled, even when things go wrong, as they do almost daily in a system as large and complex as ours. The responsibility for keeping the system in secure operating state primarily rests with the operator, the Australian Energy Market Operator, but also there’s a role for the transmission network operators.

It’s a very technical set of variables that need to be managed. A power system needs more than MW and MWh to operate successfully and a lot of those technical characteristics effectively used to come for free as a by-product of the energy produced by coal and gas-fired power stations just by the nature of their physics.

The newer technologies don’t have the same physical characteristics and a lot of these services don’t come as a by-product of producing energy. We have what Professor Paul Simshauser once referred to as missing or partial markets problem.

There are things that the power system need that are not explicitly valued at this point in time so we need to find a way of valuing them or regulating for them.

I’m sure you’re very familiar with the phenomenal penetration of distributed energy resources, most notably solar PV on people’s houses. And when you have a small amount of this stuff it’s not a problem for the main power system, but given the levels of penetration, particularly here in Queensland and in South Australia, the way in which they operate has a flow-on effect back to the rest of the network.

There are parts of the South Australian network for instance where at particular times of the day the load is negative, i.e. where the PV in that part of the network is actually producing more than anyone is consuming behind those parts of the system. Knowing what these distributed energy resources are doing is an increasingly important part of maintaining a stable system.

The integration of distributed energy resources is a vital reform so that their owners not only can get the best value for the energy and network services they offer but by utilising them in the most efficient way, everyone benefits from more efficient distribution networks.

The digitalisation of energy supply is where a lot of innovation is happening and can happen at the retail level.  Enabled by this technology, a very different notion of what it means to be in the retail space in the energy sector emerges. We’re starting to refer to it as the retail energy services sector.

The way I think about it is by reference to the ripple controlled hot water systems that I grew up with. I didn’t care when the energy went in, just cared that when I got up in the morning I had a hot shower. The nature of the technology these days enables essentially the same sort of model to be applied to a whole bunch of energy consuming appliances, i.e. the service you get is the service that you want, but how energy is used can be more actively managed.

The final priority is reliability. One of the things that made the energy market work, particularly during those periods of time when people thought it worked well, was a very close alignment between the financial incentives that market participants face and the physical needs of the system at any point in time.

Did a reliable power system need investment in generation that would meet demand for 80 per cent of the day, 40 per cent of the day, five per cent of the day, or for a few hours on a few days during summer? The price signals in the spot and contract markets conveyed that sort of information and market participants responded to it. As much as you can ever judge these sorts of things, market participants basically invested in the right sort of kit at the right time at the right place.

One of the consequences of some mechanisms used by governments to achieve policy objectives related to renewables, which by their nature are usually intermittent, weather dependent sources of supply,  has been delinking of the financial incentives faced by those investing in and operating these resources and physically what the system needs at any point in time.

If you get the same revenue for producing energy at 3 o’clock in the morning in May and at 3 o’clock in the afternoon on a Thursday in February, then the link between what the system needs and the financial incentive to be available when the system needs you the most ends up being broken.

This is of course not a comment on government’s policy objectives, which is entirely for them to decide. Rather it’s simply to point out that the mechanism used to achieve them is important when you are dealing with something with interdependencies like the power system.

One of the premises of what was the National Energy Guarantee and what is the Retailer Reliability Obligation mechanism is to re-establish these links.

The recent deal Infigen did in putting a portfolio together of intermittent sources of generation and a gas turbine is exactly the sort of arrangements that we would hope to incentivise through the Retailer Reliability Obligation.

It provides additional capacity to offer contracts against the portfolio and it’s the nature of those contracts that creates the link between a reliable power system and the financial incentives faced by Infigen. 

Conclusion

I will conclude with what is unashamedly a plug. We have a very unique, not just in Australia but internationally, set of arrangements for changing the regulatory arrangements in response to either changes in policy or real changes happening on the ground.

Traditionally if you’re dealing with a single jurisdiction, or in places like the United States or other federations you have a set of legislation which empowers government itself and/or a government authority to determine the regulations that sit beneath it.

We of course have energy laws, which have been adopted by all the relevant NEM jurisdictions and national electricity, gas and retail rules.

Instead of requiring nine governments to agree to any changes in the rules, that was always seen as being a bit difficult to achieve, its predecessors and the AEMC were established with the delegated authority to make what are effectively regulations.  The then question became who gets to propose changes to the rules?

What was decided was… anybody can – except the AEMC itself.  I sometimes get asked would I like to be able to just change the rules myself? To which my response is, while I would trust myself with that power I wouldn’t trust anybody else.

So anybody, quite literally anybody – and we have had everyone from private citizens through to the Commonwealth Government propose rule changes – can formally propose rule changes as a way of improving how the sector is regulated. The AEMC’s obligation is to evaluate them against statutory objectives which speak to the long term interested of consumers with respect to price, security, reliability, etc.

So the point being, you do not need to look solely to government to come up with ideas about how to improve the way this sector operates or is regulated. The arrangements for changing the rules, while in some respects a by-product of our particular federal structure, have built within them the premise that the people who are directly involved in the sector – be they market participants, be they interested organisations or other market institutions, be they consumers – are probably going to have a much better idea of what the issues on the ground are and ideas for how to address them.

And they have the ability to come forward and put those ideas directly to the Commission and have them evaluated against the statutory objectives set by governments.

We get rule changes quite literally from everybody. You are in just as good a position as anybody else to initiate a process to get them changed.

This process has described this as “open source” regulation making.

As long as the statutory objectives are clear, and as long as the body evaluating them can be held to account through the courts to evaluate then against policy objectives embedded in statutory obligations, we have a structure that welcomes ideas coming forward from people like you.

It means you have a direct path to change how this sector operates.  The opportunity to improve outcomes for consumers through changes in the rules is very much in your hands.

AEMC priority areas of reform

12 June 2019

John Pierce AO

Presented at Australian Energy Week, 12 June 2019, Melbourne Australia.

Download a PDF version of this speech

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Thank you, Elise, for that kind introduction.  As I tell most groups, I'm not in the forecasting business but, nevertheless, we can have a bit of a stab at a few things.

It's certainly a pleasure to be with you all today as it gives us an opportunity to talk about some of the issues and indeed the opportunities that the sector faces and the role that the Commission has in that.  But before doing so it is perhaps worthwhile reminding ourselves of a bit of the broader context in which we are operating.

Last Tuesday evening, following the Reserve Bank's announcement of a lowering of the cash rate to the remarkably low 1.25 per cent, the Governor of the Reserve Bank, Dr Philip Lowe, gave a widely reported speech in which he reflected on Australia's general broad level of economic performance, but in particular the role of what's referred to as structural reform policies.

That is - policies that drive innovation, lift productivity, these being key determinants of sustainable economic prosperity.

It was the logic of this relationship that saw the decentralisation of key operating and investment decisions in the electricity sector, where that was possible, during the 1990s, not only because of the need to lift the sector's own productivity, which it did for many years, but because of the flow-on consequences to the rest of the economy.

So as we address the questions posed by today's policy objectives, technologies and consumer choices – the relationship between competitive markets, innovation and productivity and economic prosperity needs to be the backdrop to the answers we provide to today's questions.

But before I turn to the issues we see facing the market today I will just say a few words about the role of the Commission.

First, we provide advice to governments on market developments but, secondly, perhaps more importantly for today, we are the rule maker for Australian electricity and gas markets.  We adapt market and regulatory frameworks as the world around us changes, specifically by making amendments to the National Electricity Rules, the National Gas Rules and the National Energy Retail Rules – and this is the important bit – in response to proposals that can be submitted by anybody.

Anybody that is except the AEMC itself.

This is a significant responsibility.  We are effectively delegated law makers, and the AEMC Commissioners and I take that role extremely seriously, particularly as we are operating in times of sweeping change.

Through all that change we are focused on what's best for consumers and how change can be brokered at the lowest cost to families and businesses.

At times like these, there are certainly great opportunities for entrepreneurs and innovative thinkers to deliver great benefits to the community as a whole, often leveraging off the promise of the new technologies.

But there are also challenges, and it must be said people talk their own book.

So in the Commission's work we are deeply consultative and stand for evidence based decision making.  All the change coming from industry, from policy changes, from the Commonwealth, the states and territories must be dealt with in our work program.

But our advice must not shift from finding the lowest cost options to just managing these changes for consumers. We are required to make decisions about proposals to amend these rules that are submitted by stakeholders, customers, consumer groups, peak bodies, market participants, some market bodies, governments and indeed from civil society.

And it’s really because of this today I wish to give some guidance as to the areas that the Commission believes deserve particular focus.

I would like to nominate five priority areas that the Commission will be focusing on in the coming year.

Just to be clear, we are required by law to address all rule change proposals that are sent to us as soon as practical.  But, with the volume of rule changes being submitted to the Commission and the call from many stakeholders to address issues and problems that the national electricity market (NEM) is facing, we believe it's necessary to provide some guidance around the types of rule changes the Commission will prioritise.

The NEM of course is a rather complex beast, or system, that delivers electricity to homes and businesses from Far North Queensland to Tasmania and to South Australia.  It was set up in a way to allocate the risk of investment to commercial market participants rather than taxpayers and consumers.

Protecting consumers from these risks and costs is one of the Commission's key objectives when making decisions that are in the long-term interests of consumers.

Perhaps as we manage the issues and the sorts of transitions we are going through at the moment it's never been more important to focus on making energy policy that’s in the long-term interests of consumers.

What does that mean?  It means delivering secure, reliable, low cost power for Australia as the system changes to incorporate these new technologies, new behaviours and new expectations on the part of consumers.

Technology and consumer choices, consumer decisions, and consumer preferences of course change continuously.  Right now new technologies, perhaps more than anything else, are changing the way the electricity system operates.

A couple of big things worth noting are really the shift from large geographically concentrated electricity generation to smaller perhaps more modular renewable investments; along with widespread adoption by households and businesses of solar PV generation and increasingly of battery storage; and the digitalisation of consumer interactions or the means of those interactions.

Our priority areas of reform will accommodate these and indeed any future changes and disruptions because that's our job, to change the rules as the world changes - but always in ways that deliver what consumers want and need.

So what are these areas?

The first of our priorities is generation access and transmission pricing.

This needs to be reformed because we are moving, as I said, from a small number of large generators concentrated in regions usually with access to nearby coal - to a large number of small generators that are far more geographically dispersed to places where the wind blows or where there is room for solar arrays.

The sheer number of new generators coming on line and the lack of coordination between connecting generators and transmission businesses means generators are being built in places where there is not enough transmission infrastructure to get the generation to the market.

This trend will continue with the decline in the costs of renewable technologies, and changing patterns of electricity demand that will also require complementary – often gas-fired, pumped hydro, energy storage sorts of technologies, plus investor concerns about carbon risk.

There's around 8,000 megawatts of new power generation currently under construction or at financial close, and in the coming years this should place downward pressure on prices.

We are understandably considering how best to support this transition so we can get the best outcome for consumers.

The Integrated System Plan completed by the Australian Energy Market Operator provides a useful starting point for thinking about what the grid may look like in the future.  Within the Commission our coordination of generation and transmission investment review, which goes by the very attractive title of COGATI, is considering how to reform the way generation gains access to the market.

Our present access and transmission pricing arrangements presume that transmission is built for and in effect used by consumers -and hence consumers pay for transmission.  If the changing nature of generation technology investments means that people are starting to argue that transmission needs to be built for generators, it seems reasonable to ask what transmission investments should be paid for by generators and how.

If we don't reform generator access and transmission pricing on access arrangements, then consumers or indeed taxpayers may end up footing the bill for transitioning towards the grid of the future.  Hence we will prioritise rule changes that seek to reform generation and transmission frameworks to try and address these access issues.

The second of our priorities is system security.

Reform is needed in this area because the levels of such things as inertia, frequency control, and system strength have been deteriorating as the generation mix changes - that is the stuff that keeps the system ticking along within its technical limits. 

Significant investment in new forms of generation has been positive in that it reduces greenhouse gas emissions from the sector. But the types of generation being installed have different technical characteristics from the types of generation that have been retiring; as referred to before, the coal-fired stations.

Services that were once provided as a by-product of the technology that was producing energy, the sort of positive production externalities, aren't being provided to the same extent anymore. 

The system needs these services to continue to operate in a secure state.  So there needs to be incentive for participants to invest in the sort of technology and kit that provides these services.

It is this deterioration in system security that actually keeps me awake at night.

This is primarily because, unlike reliability gaps that can be evaluated many years ahead, system security tends to be a rather binary thing: you either have it or you don't.

The statement of opportunities reports and indeed market participants' own forecasts give people fair warning about emerging reliability gaps, and the COAG Energy Council’s retailer reliability obligation will require retailers to address those reliability gaps as they emerge.

But a secure system is one that operates within a fairly narrow band of technical parameters constantly, and there will always need to be the right amount of frequency control, voltage management, inertia, system strength et cetera.

If these parameters are not within the appropriate narrow bounds in real-time the system becomes unstable and of course, as we have seen, some uncontrolled blackouts are indeed possible. We have been working hard with AEMO to address these issues and we have made some significant changes to improve system security frameworks in the last two years. But, even with the significant changes made, it remains a priority area of reform for the Commission and we will prioritise rule changes that seek to reform the way in which security is maintained into the future with our changing power system.

The third priority area is integration of distributed energy resources. 

Reforms are needed in this area because consumers’ uptake of distributed energy resources is not just fast; it's exponential.  More than 2 million homes are now energy producers as well as consumers.  In the March quarter alone nearly 500 megawatts of small-scale solar PV have been installed.  Batteries, electric vehicles are also set to be embraced in a greater numbers by households, as costs fall.

So the people that run the power system and distribution networks are coming to grips with understanding how these DER resources are impacting on grid operations and what the waves of change may mean as more and more distributed resources are being installed.

There is an opportunity for policy makers to focus on how these distributed resources can be utilised and how consumers can be rewarded through access pricing and cost reflective or – my preferred term – customer reward pricing. Because, properly implemented, network pricing structures that reward customers by leveraging rules that are in fact already in place would, for instance, allow customers with distributed resources to be rewarded when their resources are integrated in an operational sense with the rest of the system. That in turn would allow all consumers to benefit by lowering the average cost to serve to all consumers.

The Commission is considering a lot of these issues through its electricity networks economic regulation review.  We will prioritise rule change proposals that come to us that seek to address the efficient integration of distributed resources into our networks.

The fourth priority area is the digitalisation of energy supply.

Reforms are needed to help consumers take advantage of these emerging technologies.  Digital technologies in homes and workplaces are creating significant opportunities for consumers to self-manage their energy that was previously not possible.  These smart technologies mean households and businesses can take advantage of things like demand response, and that means the power system can avoid the cost of more resources to service peaks in electricity demand for only a few hours of the year.

In this context the Commission is designing new frameworks to support efficient demand response, embedded networks and stand-alone power systems.  Focusing on this priority will allow consumers, through energy service companies, both big and small, to respond in real-time and be rewarded for doing so in relation to what the system actually needs.

Hence we will prioritise rule changes that seek to empower consumers, particularly through the application of these digital technologies.

Finally, the fifth priority area is aligning the financial incentives that operate on market participants and the physical needs of the power system. 

The market was set up to pay generators for making electricity when consumers need it.  The design of many tools that have been used to achieve environmental goals have broken the link between demand and the financial rewards and costs faced by the generation we need for reliable and secure supply.

This is important because obviously electricity supply and demand needs to be balanced at all times, otherwise things break.

The incentive for sellers to generate electricity when consumers and the power system need it is when spot prices are high or low – this has been blunted.  The NEM allows spot price volatility to drive the most efficient dispatch within the wholesale market of course, but generators and retailers manage that risk through the use of financial derivative products, hedging contracts.

Entering into wholesale hedging contracts obviously helps retailers manage their financial risks and have more certainty over their wholesale energy costs, hence allowing them to offer stable retail prices to consumers.  They also increase the certainty for generators' revenue streams which then obviously has a flow-on effect to their funding of the business operations and investment.

But it is a particularly important risk management tool for generation companies seeking not only to build a new power station; they also provide very strong incentives for generators to be there when the system needs it most.  A generator covered by a swap contract can lose in excess of $14,000 per megawatt per hour if they are not generating when the system needs them.

For a 500-megawatt set, that's the equivalent of in excess of $7 million or the equivalent of burning $7 million per hour for not generating when they are covered by a swap contract.

In other words, the interaction between the spot and wholesale contract prices links the physical needs of the system with financial outcomes.  The emergence or the way in which a lot of production subsidies have been structured has broken the link between the physical needs of the system and financial incentives for generators.

As an example, the increased use of contracts that are structured so as to reward the seller for generating as much electricity as possible at any time is the sort of development off the back of these production subsidies that affects this link, this relationship between physical and financial.

We see the need to restore those links between financial outcomes and what the system physically needs. In fact, as an aside, the recent moves by Infigen to firm up their wind resources with a gas turbine to enable them to write swap contracts against a portfolio of resources is, I suppose, one company's response to this issue. 

Therefore we will prioritise any rule change proposals that are put to us that seek to align financial incentives with the physical needs of the system.

So, in summary, over the next 12 months and perhaps beyond the Commission will seek to prioritise rule change requests within its broader work program that fit within one of these five areas.  I would expect that each year the Commission may again express a view as to which are the priority areas for rule changes, again to provide guidance to people such as yourselves and other stakeholders when they are considering putting rule changes to us.

As I noted earlier, the Commission is required to consider all rule changes as soon as we can.  In other words, we cannot and will not ignore rule changes that are made by any of our stakeholders, and certainly, those that come to us as urgent or critical for operational or other reasons will be addressed in a very timely manner.  But the transition that's underway in the energy sector means we do need to prioritise our work program to make sure the right questions are addressed in the long-term interests of consumers.

Since the Commission's inception the market design has been subject to a constant process of review and adaption reflecting changing conditions, technologies and government policies. We will continue to do so in the years to come.  Someone suggested that the fact that we are up to version 122 of the electricity rules, version 45 of the gas rules and version 17 of the retail rules is one indicator of how these frameworks are fundamentally different now than they were just a few years ago, let alone when the NEM started.

As we manage this change, I would like to suggest it's perhaps never been more important to continue to leverage off the disruptive nature of rigorous competition to drive productivity and, through that, lower costs to consumers.

By that I mean protecting and empowering consumers by ensuring that the commercial market risks associated with investments in these new generation technologies, business models and the like remain with the market participants rather than consumers.

I suppose for our part the Commission is and will continue to work as hard as we can with our counterpart market institutions, so the transition that's currently under way, and will inevitably continue, delivers on our national electricity objective, being the long-term interests of consumers.  Thank you.

Small business energy forums across Australia

11 April 2019

Australian Chamber of Commerce and Industry

Chairman John Pierce AO 

Australian Energy Market Commission

The Australian Chamber of Commerce and Industry has invited our chairman to address members at a series of energy forums around the country. John will speak to members in Melbourne on 6 June  and Brisbane on 18 July. 

Here is his Sydney address delivered on 11 April 2019 (edited)

***

MR PIERCE:  Thank you James and Stephen and to the chamber for organising this forum, it’s a great opportunity for me to listen and to hear from you in regard to the issues that you're confronting in the sector at the moment and I’m very much looking forward to that interaction later. First I'll say a few things to perhaps frame some of the discussion.

There are two things I wish to touch on.  One is to say a few things about prices of course and what's caused them to go where they have, in very broad terms, and then second just a few words about the Commission, who we are, and what we do. 

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In terms of background and context prices are really derive from two main parts of the supply chain, one part being the competitive generation and retail components, and the other regulated monopoly network sector.

Now how much of your bills is accounted for by each of these two parts can vary widely,  depending upon what sort of customer you are, where you are located and how much of this stuff you can consume. But in very broad terms in New South Wales the average is for the network sector to account for about 47% of people's bills and the competitive sector including the impact of environmental policies makes up the rest. That  gives you a sense of the weight and the relative importance of these sectors.  

So what's happened?  The Commission has published a time series of price trends data for the best part of a decade. In that work we have focused on the major drivers of electricity prices – what’s driving them up and down over time. The price trends annual report is not so much about specific numbers but to produce a clear picture of how policy and market decisions affect consumer prices. It provides the transparency that governments need to understand whether price changes proposed by retailers are consistent with changes in underlying costs. It provides context for government policymakers to understand how decisions being considered now are likely to affect prices in the future.

This next chart highlights the pattern of what's been driving prices.   

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In the earlier period the major driver of the price increases were decisions to boost distribution network reliability which saw investment costs rise in that regulated network sector.

We had a blip, for want of a better term, during the period when the carbon price was in.  Then followed a few years of slightly falling – what I would call essentially stable prices, until we started to get large chunks of capacity being withdrawn from the market with a series of power station closures including Hazelwood.

So in recent times, the major driver of changes in electricity prices has been the generation sector and if you want to do something about these price increases we think it's rather important to be able to diagnose where pressures are coming from so that solutions can be targeted to the right part of the supply chain.

So what's happening now? The Commission's been talking about this for a while now.  To state the obvious, the biggest energy sector restructure in Australian history is underway. This change means there are opportunities and challenges at both ends of the supply chain – wholesale generation and also retail.

The data we produce and analyse shows a long, slow, steady improvement in retail competition  - and remember this is very recent for energy – electricity retail deregulation  is a lot, lot younger than mobile phone market competition. So retail competition is stronger and starting to deliver benefits to consumers – with new deals and services, and opportunities to switch and save - but wholesale costs are driving up retail prices and putting those emerging benefits at risk.

Certainly for us right now, there's a focus on the wholesale sector and the effect that the changing generation mix has on security, reliability and price. Wholesale generation is in transition to a cleaner, greener system but the scale and speed of renewables connections is causing stability problems that have to be fixed.

And above all the changes in the technical characteristics of the generation happening has to be managed to keep the costs of transition as low as possible for all consumers.

Changes in technology and those impacts on the economics of the generation sector does pose different issues than faced in the past but with the right agreement among governments, industry, consumer representatives and market institutions quite solvable - a bit more on that later on.   This chart is an indication of the nature of these very significant changes that are underway - with big chunks of coal power stations exiting from the market.

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And in contrast is the very significant increases in capacity with megawatts coming from technologies with different technical and operating characteristics.

The other thing about this sector of course is that every bit of it is connected to every other part - like a machine where every component has to work in harmony with every other component for the machine to work.  The totality of those effects is what drives the resultant total industry costs and consumer prices.

A consequence of this change in technology is a changing pattern of demand that the centralised or large-scale power system has to meet. The chart below is an example of this change over time – you can get similar examples form different parts of the country at different times of the year. They all generally tell the same sort of story.

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The amount of load that needs to be met during the middle of the day by the large-scale power system is diminishing. In some parts of the sector, especially at the very heart of distribution networks, there are now particular times of day where demand is negative because of the amount of generation that’s being fed into the network from solar PV. This is manifested by the fall-off of load in the middle of the day. The result is a new operating environment for large-scale generators which cannot just run consistently during the day. Now generators are being asked to turn on and off. Consequently generators will face increasing costs to stay in the market.

Now the Commission is not theological about technology at all.

I'm obliged not to be in statutory terms, but I am statutorily obliged to care about reliability, security and price for consumers.  So who is the Australian Energy Market Commission?  We are rather unusual.  The Commission is a creature of the Council of Australian Governments (COAG). We basically do two things.  We have a statutory role in making rules that govern the gas and electricity markets.  We also provide advice to the council’s energy ministers about broader market development and policy outcomes.

Our rulemaking role is quite unique. The institution was set up and given this role as a by-product of the nature of our federation.  The end result is a system of open access rule making. Anyone, any company, government, advocacy group or individual person, can propose a change to the rules. Anyone, except the AEMC itself. We are very careful about how we express ourselves during the rulemaking process. We want anybody who proposes a change in the rules to be confident that their proposal is going to be evaluated on its merits against the statutory obligations that we have around the long-term interests of consumers and the national energy objectives which are enshrined in law.. In that sense, how the market develops, and how the regulatory arrangements and rules develop is I think in your hands as much as it is in the hands of governments.   I think that's an important characteristic of this sector.  We of course in the process of making the rules, affect the outcomes of consumer experience but over and above the rules are outcomes which you experience as a result of the things that governments do in and of their own right.

The thing that keeps me awake right now and most immediately are the technical security issues facing the power system.

In energy world speak there is a significant difference between the meaning of reliability and security. Reliability is about whether at any particular point in time there are enough megawatts on the ground and operating to keep the lights on.  The security issue is all about whether the power system is being operated so that it stays within its technical operating parameters even in the face of shocks that can hit the system at any time on any day.

You may have heard discussions around things like voltage and frequency. These can be, and are, impacted by things like lightning strikes, bushfires and equipment failures on the demand and supply sides. Those technical things, how they are managed, has changed a lot, and will continue to change a lot because of changing technology in the generation mix.

When you are a customer and the lights go off – that difference will probably be lost on you. But it’s important for everyone who is responsible for the power system.

Security events tend to be things that you cannot control. The classic example was when South Australia blacked out. Maintaining a system that is secure and safe means understanding the technical characteristics of all the components that make up the power system and how they will behave when shocks to the system happen. That's the most immediate issue, and most immediate priority for us – making sure that security is delivered at the lowest cost possible for consumers.

So in conclusion – we have already discussed the ability of individuals and organisations to submit rule change requests. That does not need to be a very complicated process.  We offer a service that's been taken up by NGO groups and consumer groups, where people with concerns about the system or ideas on how to fix a problem can come to sit down with our staff.  We can't tell you whether your proposal is going to be successful or not in the beginning before we consider all the evidence and give stakeholders the chance to provide feedback. But we can guide you through how the proposal may be structured so it can meet the criteria for formal submission. We'd certainly welcome anybody who has ideas on how best to respond to the sector’s continuing evolution.  Thank you.  

Integrating renewables with rules that put customers first

31 July 2018

John Pierce AO

Australian Energy Market Commission

Presented at Australian Clean Energy Summit, 31 July 2018, Sydney Australia

Download a PDF version of this speech.

 

Thank you for the introduction and to the Clean Energy Council for inviting me to speak today.

Our panel topic today “reshaping policy” is particularly fitting because that’s what the governance and institutional arrangements of the national electricity market were set up to do. 

This was in recognition of where responsibilities for the sector sit within the federation and knowing that;

  • policy objectives would change, 
  • technology would change, and
  • consumer preferences and business models would change. 

Hence, regulatory arrangements would need to change.

But the power system would still need to deliver reliable and affordable energy supplies. 

More specifically the Commission was set up to change the rules in response to rule change requests that are put to it. We are charged with evaluating these proposals against legislated policy objectives tied to consumers’ interests in relation to security, reliability and price.

The phrase, proposals that are put to it’ – is an important part of that statement.  Anyone can propose a rule change except the Commission itself. This means that people in government, industry, and consumers themselves, can drive the reshaping of the rules.

To deliver this reshaping in a rule-making sense is, a lot of the time, about the nuts and bolts of a market that delivers 200 terawatt hours of electricity each year to 9 million connections; and organises $16.6 billion worth of financial transactions between market participants who own generation assets that would cost somewhere in the order of $250 billion to replace. A lot at stake there.

And while the rule making process can be about nuts and bolts, it opens up a whole new world of opportunities for those of you with new technologies and business models who want to give consumers a better deal or a better energy experience, and so attract new customers.

I’ll give you some tangible examples of this. 

Cost reflective network pricing supports the transformation of the network, providing a foundation for efficient usage and investment decisions by consumers. 

In particular, network tariff reform will be one of the keys to unlocking the value of distributed energy resources like solar and batteries.

I’m not saying that it’s necessary for retailers to structure their prices in a way that matches network prices. 

It is a signal to energy service providers and retailers so they can work out where and what they do to best meet consumers’ needs.

We have made data more accessible – to consumers and their agents, so that products can be tailored to meet individual needs. 

Last week we published three reports that focus on how the regulatory framework can support power system evolution. 
From those reviews will flow;

  • New trials to determine how power system performance can be improved and new business models like virtual power plants can be integrated.
  • More transparent and consistent forecasting information to help market participants make better investment and operating decisions.
  •  A new mechanism to integrate more demand response into the wholesale market.

Generator technical performance standards is another vital, nuts and bolts project.

Generators play an important role in helping keep the grid stable and so it’s important that they have specific technical capabilities when connecting to the power system.

We are in the middle of consulting with stakeholders on a draft rule that proposes changes to technical performance standards for generators which are seeking to connect to the grid. These changes reflect the transformation of the energy mix. The proposed standards, and the process for negotiating these, are key to smooth transition as new generators with different technical characteristics join the power system.

The consideration of this new rule also deals with cost and system security for consumers by addressing the need to match technical requirements to local power system needs.

For example, if provision of voltage control isn’t an issue in a particular region because there is already plenty of this capability nearby then we don’t need to oblige new generators connecting to that part of the grid to pay for unnecessary voltage control capability.

This approach would enable standards to be negotiated for each connection – tailored to circumstances – which provide the best outcome for investors, and for consumers who won’t pay more than necessary.

Another example of rules that facilitate new technology integrating into the system in a way that delivers the best outcomes for consumers is the new five minute settlement we made last November. 

The purpose of five minute settlement is not to favour or to disadvantage any particular technology. 

Rather, it is to produce an improved price signal that more accurately reflects the reality of what’s happening in the physical power system at the time.

These price signals will lead to more efficient bidding, operational decisions and investment decisions.

There are those that see five minute settlement as a way of providing a better price signal for investment in fast response technologies, such as batteries, new generation gas peaker plants and demand response. And these fast responders are needed to support the increasing penetration of variable generation in the market.

Yes that’s true – but as always, above everything else the Commission is focused on the best, low cost outcome for consumers.

We are redesigning the regulatory frameworks so that customers experience the benefits of new technologies by having access to better options, greater choice and more control over their bills.

The instructions, or rules, that we write are meant to incentivise, and support you to do that. 

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Laying out strategic priorities for the National Electricity Market

11 May 2018

John Pierce AO

Australian Energy Market Commission 

Presented at Australian Energy Week, 11 May 2018, Melbourne Australia

Download a PDF version of this speech.

 

Thank you Minister, colleagues on the panel, ladies and gentlemen.

We’re all familiar with the technological revolutions that have changed our world: steam; the age of science and mass production; the digital revolution; and now . . . the internet of things . . . artificial intelligence.

What do they have in common?

They disrupt the status quo.

In every case, someone or something triggered innovation.

Edison of course . . . the first large-scale AC hydro power plant of 1895 designed by Edison’s acolyte Nikola Tesla . . . to Elon Musk and everyone in between.

And what are the lessons that we learn from these disruptors? That businesses come and go. Technologies come and go.

Indeed it is this very process that economists…always a cheerful lot…sometimes refer to as “creative destruction,” that is, the fundamental driver of lasting economic growth and progress.

So here we are . . . looking to seize the latest opportunities – from changing energy technology.

What that means is the structure of the energy sector will change along with the way capital is employed and businesses are organised. 

This is what always happens when economic growth is driven by technological progress.

This process is of course not without its problems.

In order to manage we need effective institutional and governance arrangements – with regulatory and policy frameworks that put consumers first . . . deliver required protections . . . and then get out of the way of innovation and competition. Because that’s what delivers the services we want at lowest cost.

One of the virtues of workably competitive markets in our current circumstances is their ability to sift through the new ideas, technologies and business models to find the ones that best serve consumers’ interests.

I want to talk about four areas where the Commission is addressing challenges facing the national electricity market in this time of transitional change:

  • The first is the positive power of retail disruption
  • The second is using factfulness, a term I’ll explain later, to cut the cost of wholesale market transformation
  • The third is the need to define and understand the change the market is going through so we can look forward with a clear perspective
  • and finally, the need to stay the course on reliability reform for the sake of Australian consumers.

First, the positive power of disruption.

For some time the Commission has tracked electricity market trends through two annual reports – which after half a dozen years represent the most extensive body of longitudinal research on retail prices and competition.

Next month we release the 2018 review of retail energy competition. Six months later it will be followed by the annual price trends report. I have to say I take no pleasure in re-reading past volumes of this work and noting how prescient much of it has been.

Keith Orchison put his finger on it this week in his ‘power post’ when he described the context for this year’s Australian Energy Week as “the best of times and the worst of times.”

In a similar vein, the 2017 competition review talked about a “two-speed market.” On one hand, research showed consumers felt they had more choices to manage their energy use and bills – a definite trend flowing from the new retailers entering the market with new business models, more varied products and better priced deals.

Consumers were also optimistic about opportunities linked to new technology:

  • 20% of consumers surveyed had solar panels
  • 21% said they were likely to adopt battery storage in the next two years
  • 18% said they were likely to take up a home energy management system in the next two years.

But while competition can drive innovation and new choices for consumers in the retail market – those benefits have been put at risk.

Why?

  1. Well first, retailers are still too slow in building awareness of the cost savings, concessions, hardship schemes and other essential information that would help consumers pick the offer or product that’s right for them. Consumer awareness of the government’s energy-made-easy power-bill comparison website remains unacceptably low.
  2. Second, because of the undermining effect in recent years of rising costs in the wholesale market which are driving retail prices up. 

These two oil slicks are still spreading under the wheels of market transformation.

Staying with consumers for a minute – I’ve been thinking for some time that we need more disruptive leadership in energy retail. 

As I said, technologies and businesses come and go and change. Remember, Origin sprang from the demerger of Boral Limited, a brick and construction company; ERM started out building gas plants and then got into retail; Alinta was a major player in Australia’s west, now it’s moved back east and is giving local retailers a run for their money. A couple of years ago who had heard of Powershop, Greensync or Flow Power?

Industry structures and technology will change.

If incumbents get complacent, others are more than willing to have a go at doing a better job for customers . . . as long as regulation doesn’t get in their way.

The impetus for change is strong. We’ve been talking about the acceleration of consumer-led market transformation since we started our power of choice work program in 2012. This redesigned framework helped families and businesses choose new ways to use electricity and manage their bills.

The right foundations for change are in place. The dynamic processes we need are underway. It’s a critical time for market participants to step up.

What you want in the market today is experimentation – and offers of new products and technologies that work for consumers – but what do we see?

Continuing confusion around retail price offerings means most consumers don’t grasp the opportunities on offer. Yet innovation in pricing and new products is starting to happen. New energy entrepreneurs and traditional energy retailers are starting to rise to the challenge.

But progress is at the margins, and not fast enough for consumers wanting to take action to reduce their energy bills.

Just over a week ago the Commission started work on a joint rule request from Minister Frydenberg and NSW Energy Minister Don Harwin. It would require retailers to notify customers in advance if their energy prices are going to increase. This is the fifth initiative from ministers since the Australian Government’s round table with energy retailers last year to help deliver more affordable energy for consumers . . . thank you Minister.

We’ve already made another rule in the ministerial consumer protection package. Since 1 February retailers must give consumers advance warnings to shop around before their energy discounts finish.

Also underway is the ministerial request which seeks to stop retail energy discounting on inflated base rates that can leave customers worse off. And there are two more on the table relating to maximum timeframes for meter installations and improving the accuracy of energy bills by allowing customers to have electricity or gas bills based on their own reading of the meter.

It’s important to have rule requests like these so the power system can respond without affecting the ability of competition to deliver.

But ours is a notoriously complex business. It wasn’t long ago that the UK introduced regulation to restrict the number of retail deals on offer to make their system simpler. Simple yes, but lots of people ended up paying more. It would be simpler to have a one size fits all system for, say, mortgages. A fixed rate mortgage for everyone – how would that go?

But there are areas where retailers can find inspiration.

The telco market has been deregulated for 20 years in retail price regulation. If you count the period of managed competition in mobile phones, it’s been deregulated for 24 years. Yes, that’s very much longer than any of the electricity regions have been deregulated across the states and territories.

Nonetheless, what disrupted that market was Vodafone, which leapfrogged its competition by importing simple plans from overseas and it was game on – giving consumers better deals.

What the electricity retail market needs is a disruptor like Vodafone – to cut the complexity away from retail offers, and make bills easier to understand and compare. 

Of course the uptake of technology innovation has been dramatically faster in the telco world – but putting that difference aside, consumers have been very clear, for some time, on what they want and need.

The industry cannot let them down. Our competition review will have more to say on that in a few weeks.

Number two – factfulness and wholesale market recovery. 

Have you come across factfulness? I have for a long time followed the work of Swedish statistician Hans Rosling. His last book Factfulness, why things are better than you think -- was published posthumously in April. 

He says the mental picture in most westerners’ heads today is that the world is getting worse. He calls it the “overdramatic” world view – and misleading.

The facts say different. Hans concludes the facts of change reveal room for optimism about innovation and mankind’s ability to solve problems.

That resonates with me – especially because energy is a highly complex, deeply interconnected area -- so we need to avoid ideological stances and silver bullets -- to focus on the facts of economic and engineering realities.

In examining issues that are important to the future of the NEM, we have focused particularly on the growing level of intermittent power in the system – and the need to manage the system differently if we want to keep the lights on.

We started this work in advance of the South Australian blackout, and all the market bodies have been working together to make the system stronger, including:

  • new rules on managing the rate of change of power system frequency by requiring minimum inertia levels
  • managing power system fault levels by maintaining minimum system strength levels to keep the system stable and 
  • improving guidelines for generating system models to give AEMO and networks the data to efficiently plan and operate the system. 

Now there are folk who think just saying intermittent generation won’t affect system security makes it so. The market bodies are united in dealing with the facts of change. And the fact is that while technological disruption will throw up problems; it also brings with it innovation that will help us come up with solutions.

We have a plan in place and we are working with our colleagues at the AER and AEMO to change the way we manage the power system. 

At all times we are focused on considering precisely how that transition should occur while keeping the lights on and consumer costs reined in – bearing in mind the more costs you put into the system, the more burden there is on consumers.

We are working through the Energy Security Board, with AEMO and the Australian Energy Regulator to facilitate the shift from a centralised fossil-fuel driven network to one dominated in the future by a decentralised, increasingly intermittent system.

Which brings me to number three: defining and understanding that change.

Defining and understanding the change so we can look forward with a clear perspective has never been more important.

The AEMC’s annual residential electricity price trends review that I mentioned earlier, has reported a roller-coaster effect for energy consumers that is unacceptable, and needs to be addressed by restoring the integrity of price signals in the market.

The power price rollercoaster is being driven by the changing mix of generation, with the proportion of weather-driven power supply rising fast and the closure of ageing coal stations. The failure to agree a mechanism that integrates energy and emissions reduction policy has broken the links that make the market work.

Appropriate investment signals, risk allocation and risk management tools are critical in achieving sufficient and timely investment in the technologies necessary to maintain reliability, security of supply and competition in the retail market.

The efficacy of the price signal is critical to market participants making efficient decisions. This is because short-term dispatch and long-term investment decisions are driven by derivative prices in the wholesale contract market. If this market is influenced by external factors, such as subsidies for particular technologies that are financed by mechanisms outside the NEM,  the ability of price signals to coordinate investment and divestment decisions in ways that achieve reliable, secure and least cost supply is undermined.

So our final priority is the national energy guarantee and staying the course on reliability reform.

The national energy guarantee, guided by my colleague Dr Schott, is all about shifting energy policy back to its true focus – the consumer.

It aims to meet emissions reduction commitments set by our governments without putting cost burdens on households and the Australian economy that could be avoided with better co-ordination and more efficient practices.

We’re focused on creating the right investment climate for energy market transformation – and the national energy guarantee is central to that objective. A policy that can integrate emissions and energy policy and deliver transformation, at least cost to consumers, is very compelling.

It’s critical that the nation stay the course on that reform – to provide a mechanism which can adjust to change, whatever the future may bring at the lowest cost possible.

For us staying the course also means:

  • providing governments with the most sophisticated data-driven advice possible to support their decision-making
  • identifying least-cost solutions to key market transition challenges – and that list is a long one including responding to:
    • world leading levels of renewable energy penetration
    • renewable energy zones and connections
    • consumer driven demand response in all its forms
    • the rise of micro-grids
    • smart metering and IT communication challenges
    • addressing changing patterns of power usage including electric vehicles
    • creating a market that can deliver  energy at affordable prices and allow Australia to meet its global emission abatement agreements.
    • all just the tip of the iceberg.

At the AEMC we address the here and now through new rules and look to the future through our reviews.

Another key piece of work due in June is the annual networks regulation review which explores options for the grid of the future. 

It’s looking at how to support continued uptake of distributed energy resources like solar PV, battery storage and ‘smart’ household appliances that respond to changes in electricity prices.

The COAG Energy Council asked us to undertake this annual monitoring - recognising the importance of providing early warning of market developments that may need to be addressed by changes to the National Electricity Law or Rules.

The energy sector has been in transition before. We got through it with cooperation and clear policy objectives – after all, the national energy governance arrangements were introduced by governments in the first place to address a need for investment and manage the development of a market.

It wasn’t easy then. It won’t be easy now. It won’t happen overnight – but we will be guided by the long-term interests of consumers, analysis, and optimism. 

Let’s stay the course.  

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AEMC Strategic Priorities forum: Opening remarks

12 September 2017

AEMC Chairman John Pierce spoke at the Commission’s Strategic Priorities forum in Melbourne on 12 September 2017.

In his comments, John noted the Commission is working closely with the AER, AEMO and through the Energy Security Board process, to deliver advice to the COAG Energy Council as an input into their Strategic Energy Plan - a Plan that the Finkel Review recommended to guide the evolution of the market into the long-term.

“There can be only one agenda in the room today – and that must be a focus on the outcomes of this transformation for consumers, large and small.”

Speech

AEMC Chairman John Pierce

AEMC Strategic Priorities forum

Opening remarks

Melbourne, 12 September 2017

*****CHECK AGAINST DELIVERY*****

Download a pdf version of this speech.

 

Good morning everyone and thank you for joining us.

I’d like to begin by acknowledging the traditional owners and custodians of the land on which we meet today, the people of the Kulin Nation. I pay my respects to their Elders both past and present.

Before I make a few comments on why we’re here today I’d like to introduce my colleagues here today. I am very pleased to welcome Dr Kerry Schott, independent chair of the Energy Security Board and Clare Savage the ESB deputy chair, Audrey Zibelman, CEO of the Australian Energy Market Operator and Paula Conboy, Chair of the Australian Energy Regulator. We will also hear from Rosemary Sinclair, CEO of Energy Consumers Australia who will be sharing her thoughts later in the session.

This is the first time that all of us have shared a public platform but it certainly won’t be the last. That is because the transformation agenda we have ahead of us will take the combined efforts of us all - working with you, our stakeholders.

The Commission has undertaken a Strategic Priorities analysis every two years since 2011. It was our tool to engage with governments, consumers, market participants, businesses and other market institutions on the key issues facing the market. That collaborative work with stakeholders raised big issues for reform, the features of the decentralising market, the scope of the emissions mechanisms, the need to redesign the gas market.

This current Strategic Priorities process builds on that previous work and pushes it to greater prominence on the COAG Energy Council agenda. And this time the Commission is working closely with the AER, AEMO and through the ESB process, to deliver advice to the Council as an input into their Strategic Energy Plan - a Plan that the Finkel Review recommended to guide the evolution of the market into the long-term.

So, as I mentioned, many of you have already been on this journey of priority setting with us before.

But this time it’s different – there’s a lot more at stake and the decisions that governments make in the coming months could have fundamental consequences not just on the energy sector, but for the wider economy, for decades to come.

Our energy markets are undergoing a massive transformation.

Domestic gas markets are adjusting to the impact of LNG exports at the same time significant reforms are being introduced to make it easier to buy and sell gas across the East Coast.

Our electricity market is moving from decades of centralised energy production to a system with a much greater penetration of intermittent, and increasingly distributed, generation – and without any certainty over future emissions reduction policy.

That’s why there can be only one agenda in the room today – and that must be a focus on the outcomes of this transformation for consumers, large and small.

These changes working through the sector necessitate a different way of doing things - but how do we make this transformation work – for businesses, for consumers, for those wanting to invest and in a way that allows us to reduce our emissions footprint?

It’s a fact – there are no silver bullets. But how do we make sure we are asking the right questions – questions about how reforms will interact with each other, how they will affect prices – and stay focused on outcomes – when many want to make the questions about a particular technology or even a particular power plant?

The Finkel Review identified a number of recommendations that will go a long way to helping achieve the transformation, and the AEMC, working with the ESB and the teams at AEMO and the AER, are getting on with implementing those recommendations.

We’re doing that in the short term through our rule changes – new rules have been made to provide emergency frequency control tools. And we’re currently finalising rules to deliver more inertia into the system and require maintenance of a minimum level of system strength that will help deal with greater voltage fluctuations.

But importantly, we’re also focused on making the transformation work in our market development role – through our Frequency Control Frameworks Review, the Reliability Frameworks Review and other processes we have in play. The Reliability Frameworks Review particularly, will consider a range of fundamental changes to the design of the market that may improve the ability of the market to deliver more capacity, and capacity valued by the power system, when it is needed – both in the short and longer term.

These review processes allow us to take a broad perspective on the required market changes. They allow consideration of a full range of options and to seek your input on their pros, their cons, their impact on market participants, and their interaction with other reforms already underway.

For example, in making recommendations on additional changes to the market design in the Reliability Frameworks Review, understanding the implications of moving to a 5 minute dispatch and settlement world will be vital.

And, going back to asking the right questions, one of the most important things that the Commission seeks to understand, particularly in a time of significant change, is how these reforms will interact to deliver benefits to consumers?

Because there are lots of actions we could take to keep the lights on, and the gas flowing … …but not all of these will deliver the objectives while keeping bills affordable for consumers, and supporting much needed private sector investment, which in the electricity sector at least, is estimated to be in the billions.

The Finkel Review will take us a long way – particularly on system security and reliability issues. The strategic priorities process is however an opportunity to identify additional priorities that are also vital for market transformation. The Finkel Review touched on some important elements associated with the transformation of distribution networks, but efficient utilisation of distribution assets is increasingly important in a distributed energy future and so greater focus is likely required there. Paula may well have more to add on this topic.

And of course, there are a range of other issues that you will identify and I encourage you therefore to use this forum and the other consultation processes we are running to share your views on how we make the transformation work. We are releasing a discussion paper today that lays out some of the opportunities and challenges that the Commission has identified. We welcome your input and perspectives on this and the AEMC team will provide you more details on how to do that later in the session.

I believe we will have time for Q&A at the end so now I will turn things over to Kerry.

- Ends -

Media: Prudence Anderson, 0404 821 935 or (02) 8296 7817

 

Evolving Faster

26 July 2017

ENA Regulatory Seminar: Evolving Faster 26 July 2017

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**Check against delivery**

The theme of today is “evolving faster”. And I couldn’t agree more. But while the speed of evolution might catch us off guard sometimes, the evolution itself shouldn’t.

It was always envisaged that technology, business models and customer expectation in the energy sector would change. That’s why the Commission and the rule change process exists – so that there is an opportunity for all of you to be involved in the change – so that the responsibility to keep up with change doesn’t rest solely with governments.

When the NEM was established, we expected that the power to determine how the sector developed would sit:

• first with generators – while the market was established,

• then with retailers as competition took hold and participants matured,

• and ultimately with consumers…after all consumers are the ones we are all here to serve.

So this “evolution” we talk about is really just the market maturing to a point where consumer choice drives industry investment.

At all points in this evolution, the role of networks has and will continue to be central – mainly because your businesses sit, quite literally in the middle of all the change. I don’t need to tell you that the generation fleet is changing. I don’t need to tell you that customers have different expectations and preferences than they did before.

The three points I want to make today are:

1. Networks are key to the transformation

2. We need to get ready for a two-way world; and

3. Your businesses need to embrace the change but not the spotlight

Networks are key to the transformation

Network businesses will be absolutely key to supporting the transformation of the energy sector.

At the big end of town, more generators, of varying size, technology and business model, will be connecting to the system as we reduce the emissions intensity of the sector. The timing and location of these investments is uncertain, but it will require better coordination of transmission and generation investment.

The Commission’s Review into the drivers of change that impact transmission frameworks, flagged this as did Dr Finkel’s in his reform blueprint. The Commission is currently assessing options to improve coordination with the aim of minimising total system costs through efficient and coordinated investments – and your businesses will be key to achieving this.

The change in generation mix is also challenging the security of the system. The Commission has recently proposed new obligations on transmission networks to provide:

• a minimum level of inertia – to resist frequency disturbances,

• and a minimum level of system strength at generator connection points to strengthen the system against voltage disturbances

Ideally, a market mechanism will be used in the future to value, buy and sell these services, but in the meantime, network businesses will play a key role in maintaining system security.

At the smaller end of town the take-up of distributed energy resources is expected to continue. The Commission released its fourth annual review of the state of competition in retail energy markets yesterday which showed that consumers have more choices and are taking up new technology options:

• 20% of consumers now have solar panels

• 21% are likely to adopt battery storage in the next two years

• 18% are likely to take up a home energy management system in the next two years.

As this plays out, consumers and their service providers will want more control over how their rooftop solar, battery storage, electric vehicles, smart energy appliances and other distributed energy resources are used. Networks will be a key platform supporting consumers to take control.

Get ready for a two-way world

Which brings me to my second point: we need to get ready for a two way world. And I mean the royal we.

In recent years the Commission has been putting down the foundations with rules that make it easier to:

• choose and switch retailers

• access and understand consumption data and

• receive and respond to price signals

Cost reflective network tariffs and the competitive provision of advance meters are now starting to provide consumers with more accurate information and price signals that can inform their purchasing and investment decisions. At the end of August we will publish draft rules that seek to open up the space behind the meter to greater competition.

We are also looking ahead to future opportunities to buy and sell distributed energy and energy services in better, more competitive and flexible ways through a project we have named the Distribution Market Model. Those that are familiar with the project will know that platforms to better-utilise distributed energy resources would encourage customers to weigh up the value of using the electricity produced from their solar panels or battery against the value they could gain by selling it to whoever values it the most.

The Distribution Market Model is not intended to be a prediction of, or pathway for future regulatory reform, but rather an exploration of a potential evolution of the sector. After all, we already know that distributed energy resources can:

• help networks manage peaks in demand

• compete in the wholesale electricity market by exporting electricity

• help make the system secure

• help consumers reduce electricity bills

We are making these changes to deliver benefits to consumers. But there are also benefits across the industry if you get to know your business in a different and more detailed way.

Where are the constraints in your network? What is valuable to you? How will customers want to use your assets, and how can you use customer assets or their demand response to make your business operate more efficiently?

You’ll recognise this thinking from our recent transmission connection and planning assessment framework rule change and one last week on replacement expenditure. Key aspects of these new rules require information about network constraints, load forecasts and asset retirements on your network to be published.

Information like this can decrease total system costs by helping participants make efficient investment decisions about where to connect to the network or about alternative solutions to address network needs.

Understanding what is valuable to your business will help you take advantage a broader range of opportunities that will become available as consumers invest in distributed energy and other energy services.

Embrace the change but not the spotlight

The last point I will make is that we - collectively - will have failed in meeting our objective to serve the long term interests of consumers, if we don’t do it at lowest cost.

Our 2017 Retail Competition Report (published yesterday) noted that that retail price rises this year are largely the result of increases in wholesale prices. Rising wholesale costs are being driven by a range of factors, including the increasing costs and decreasing numbers of hedging contracts, and higher gas prices.

When people think of “wholesale prices” they think of spot prices because that’s what they can see. But the spot market is just a way of coordinating the physical dispatch.

When it comes to setting retail prices or financing new investments, decisions are driven by the price and availability of forward contracts which in turn, are driven by what people expect to happen in the future.

What people can’t see today (as distinct from what they could see in the past) is new generation coming online that will provide not just megawatts or megawatt hours, but forward contracts.

The Commission’s retail competition report shows that we are seeing the emergence of new retailers and energy service providers offering a huge variety of products to help customers manage their energy use and bills. But in order for these new players to enter the market and compete with the majors, they need to access wholesale forward contracts to help manage spot price risk.

So while our report shows that competition is driving innovation and new choices for consumers in the retail market, these benefits are under threat from a wholesale market with rising costs and fewer contracts.

The wholesale challenges mean that the spotlight is not on network businesses right now. But your businesses will be adapting to a lot of change: new security obligations, more generator connections, increased levels of distributed energy.

I want to stress the point that your businesses, like the Commission and the national energy objectives, will do well to think about embracing change that is in the long term interests of customers.

And with that I’ll finish by saying that the purpose of work the Commission does through its rule changes, reviews and technology work is to create a framework that minimises the total system costs faced by consumers.

Sometimes you’ll agree with the changes we propose, sometimes you won’t, but we take the view that if energy consumers are better off, then the economy is too.

Thank you.

ENDS.

Australian Gas Domestic Outlook Conference 2017 – Speech by AEMC Chairman

14 March 2017

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Address by Australian Energy Market Commission Chairman Mr John Pierce Australian Domestic Gas Outlook 2017, Tuesday 14 March 2017

Introduction

In a room full of energy experts, I hardly need to point out that the energy sector is changing.

These changes are increasingly driven by new technologies, changes in consumer preferences, the growing interconnectedness between both energy markets within Australia but also between Australia and the rest of the world….and of course government policies.

The market frameworks supporting the energy sector were designed to, and do change continuously.

In responding to rule change proposals, the AEMC has a significant role in this evolution and has made 214 changes to market rules and completed 102 formal reviews and pieces of advice to the COAG Energy Council since the Commission was established.

With the recent events in the electricity sector, it should be clear to everyone that any discussion of system security in the electricity sector must however include some consideration of what’s happening in Australia’s gas markets.

So it won’t surprise you when I say that I am here today to talk about how the two – gas and electricity markets - are inextricably linked, and what that means for their design and the ongoing reforms in those markets.

*********

The relationship between the two can be summarised like this:

  1. The east coast gas market has seen a huge increase in demand and the market is a lot more dynamic, fluid and potentially more volatile. As a result, the gas market is undergoing reforms so – at least at the wholesale level – there is more flexibly buy, sell and transport gas. This includes access to better information to inform their decisions and manage their risk.
  2. These reforms should make it easier to move gas to wherever it needs to be within the interconnected network so it arrives at the place where it has the most value, thereby making a greater contribution to the value of Australia’s economic output. One of the places gas may be highly valued is in the electricity generation sector as that sector itself goes through its own transformation.
  3. Gas fired electricity generation has four features that make it particularly useful as part of the electricity supply mix and because of these, gas can play a crucial role in Australia’s future electricity mix:
  • it is lower emissions than coal
  • it can balance intermittent renewable supply by varying its output
  • it can provide services to are necessary to operate the power system in a secure state
  • it can be a source of supply of hedge contracts into that market that help customers manage price risk

Gas market reforms can therefore contribute to our ability to achieve a reliable, affordable and lower emissions electricity.

The sheer availability of gas supply will obviously influence the success of gas market outcomes and, as the recent Gas Statement of Opportunities shows, and as you have been discussing today, that in itself may be a significant challenge.

However, the AEMC, as is our remit, has been focused for a number of years now on putting forward options to improve the functioning of our east coast markets so that, where gas is available, it can be traded more easily, and based on better information.

At this conference last year I spoke of fact that we only have a relatively small window of opportunity to adjust our domestic gas market arrangements and make lasting change.

Since then, Ministers of the COAG Energy Council have agreed to a suite of reforms that aim to make it easier to buy and sell gas and transport gas to where it is valued most.

*********

The east coast gas market reform package focuses on three areas:

1. Pipeline access

Reforms to pipeline access arrangements that will mean participants that value the gas the most will be able to access the pipeline capacity they need through:

  • day-ahead auction of contracted but un-nominated pipeline capacity;
  • standardised provisions in capacity agreements which will make capacity more fungible;
  • new capacity trading platforms to facilitate sales;
  • the publication of information on secondary trades; and  binding commercial arbitration framework on all pipelines if there are access disputes.

These improvements in transportation capacity trading arrangements will improve the liquidity of trading at hubs, the reliability of prices at those hubs, and in turn provide better signals for pipeline investment, and gas consumption and production.

2. Additional information to support the market

Secondly, additional information in the market will enable market participants to more better- informed decisions about trading, investing in, and using gas. New, more frequent and more accurate information will be reported on the gas bulletin board including:

  • annual information about reserves to give insight into where gas may be supplied from in the future
  • information on capacity and gas flows around gas supply hubs
  • large users including LNG facilities will report nameplate capacity and daily consumption.

These are designed to instil a greater level of confidence in the reported information and address information gaps and asymmetries. There will be standardised presentation requirements making the new information easier to interpret and use, and this will also strengthen the compliance framework.

3. Consolidating the various market designs

The east coast gas market has three different “facilitated trading designs” – hubs, short term trading markets and the Victorian declared wholesale market - three different sets of rules, if you like. Consolidating the design of these markets so that common trading arrangements and price discovery mechanisms exist across the east coast, will reduce barriers to participation. Market participants will only have to learn one set of rules and will be able to trade the same type of product regardless of geography.

To achieve this, a number of actions were agreed by the Council, including:

  • Concentration of wholesale gas trading at two primary trading hubs - a Northern and Southern hub - that share common trading arrangements
  • For the Northern Hub at Wallumbilla, optional hub services will help overcome the existing physical trading limitations of the hub – these will commence later this month.
  • For the southern hub, there are opportunities to align the trading arrangements in Victoria more closely with arrangements across the east coast. We are currently working with industry to develop the detail around this.
  • Finally, the Short Term Trading Markets in Sydney, Brisbane and Adelaide can then be simplified so they act as balancing mechanisms for the northern and southern hubs, supporting the development of meaningful liquidity at those hubs.

*********

Reforms in these three areas will reinforce each other and will lead to improved price and investment signals, make it easier to buy and sell gas over different time periods, make trading between locations easier, give investors more of an ability to manage risk and ultimately deliver lower transaction costs that will flow through to consumers.

Many of you in this room will be working with Dr Vertigan and his gas market reform group in developing the detail and implementing these reforms.

At the AEMC, our focus has now turned to improving the trading arrangements in the Victorian declared wholesale market in consultation with Industry.

The outcomes we would like to see in the Victorian market are:

  • Improving the ability and options available for participants to manage risk
  • Improved trading across interconnected pipelines
  • Promotion of upstream and downstream competition.
  • Support for efficient investment

Our final draft report proposed a number of options aimed at achieving these outcomes and we appreciate the input we have received to date and we hope that many of you will continue to work with us to develop the most appropriate approach for consideration by the Victorian Government.

*********

If both the east coast reforms and the Victorian-specific reforms are implemented, this will go a long way towards achieving the gas market vision that was set out by the COAG Energy Council.

The vision seeks to develop a market:

  • that provides a “clean” reference price that can be used to manage risk,
  • that gives efficient market signals for new investment,
  • where trade is focused at a point that best serves the needs of participants; and
  • where producers, consumers, and trading markets are connected in a way that allows flexible trade of gas

In other words, the vision aims to free up the trading of gas – making it easier to buy and sell and transport gas to where consumers want it.

*********

But that’s probably enough about what is being done. There is also a question as to why.

A major objective, if not the over-riding objective, we are seeking to achieve is to be confident that gas is supplied to those consumers that value it most at the lowest possible price over time.

*********

One such consumer or group of consumers are gas powered electricity generators.

And this is where gas reform becomes important for the electricity market.

I spoke earlier about the features of gas turbines that make them useful as part of the overall electricity supply mix:

  • the ability to balance renewable output with changes in consumer demand;
  • supporting the maintenance of a secure power system
  • lowering emissions; and
  • the ability to be a source of hedge contracts.

Gas generators are one option for the provision of hedge contracts within the electricity market which is a fundamental part of being able to manage price risk and is in fact a prerequisite for a competitive industry structure and delivering reliable supply of electricity over time.

The effective functioning of the hedge contract market is critical to maintaining reliable and secure supply to consumers, and in promoting competition in wholesale and retail markets.

Understandably, in recent times there has been a lot of focus and discussion about physical supply, reliability and security of physical assets, and the technical and engineering characteristics of different types of technologies.

Wherever those particular discussions may lead, it is absolutely essential that any decision criteria address the questions ‘Will this add to or detract from the diversity, liquidity and duration of the hedge markets? Will it add to the competitive supply of hedges as well as produce energy?’

Hedge contracts operate as a form of insurance against fluctuating spot prices and are also used to underwrite investment in new generation so there is enough capacity to meet demand. They are the critical fulcrum upon which these markets depend.

With a number of coal generators exiting the electricity market, the availability of hedge contracts appears to have decreased, resulting in consumers being more exposed to fluctuating spot market prices or receiving less reliable supply.

The decrease in the availability and competitiveness of contracts can really be used as the “canary in the coalmine” – excuse the pun - for future reliability and price rises in a region.

South Australia is an example of this: when Northern power station exited the market in May 2016 it didn’t just leave a gap in electricity supply to be filled by other technologies. It left a gap in both the availability and competitiveness of South Australian hedge contracts, which was not filled.

While large gentailers have the ability to hedge risk across their businesses, smaller retailers and industrial customers were faced with a choice of locking in higher contract prices, or exposing themselves to fluctuating spot market prices. Many chose the latter.

Over the long term, a reduction in contract market liquidity leads to a decrease in the levels of retail competition and small consumers start to feel pain.

The other side of the hedge contract coin is that without customers signing hedge contracts with generators at prices that reflect the value of that power and the cost of supply, this ultimately leads to less than efficient investment, and less reliable supply.

Having seen the course of events in South Australia, I’d suggest that contract market duration and liquidity is something we should keep a close eye on in other regions, particularly Victoria.

To emphasise the point: you cannot and will not have a reliable physical supply of electricity, nor a workably competitive industry structure or competitive pricing unless investment in physical plant also means a potential new source of supply of hedge contracts within relevant regions.

Because of the ability of gas power generators to be a source of supply of these contracts, there is a key link the between the reforms in the gas market which can support investment in gas fired power stations and in turn, support changes to the electricity market.

*********

So to take stock: Gas generation – along with other technologies that can complement the intermittency of renewables - provides system security benefits, and can help customers manage their price risk by offering hedge contracts.

These characteristics all point towards gas playing a growing role in any future electricity mix. How big a role, is yet to be seen. Irrespective of the size of the bet you wish to place about what the future may bring, a more flexible wholesale mechanism for buying and selling gas is essential for both gas consumers and electricity retail consumers.

The east coast gas reforms that are being implemented in the gas markets will go a long way to improving those markets, but taking opportunities to improve trading arrangements in the Victorian market will be particularly important, especially given how the Victorian generation mix is set to change this month with the exit of Hazelwood power station.

*********

Before I conclude, I want to talk briefly about another challenge facing the energy sector today, and that is in relation to investment confidence.

The overall aim of Australia’s energy markets is to provide a reliable, secure energy supply at the best possible price for consumers. It must continue to deliver this while the sector transforms in response to the other objectives of governments and structural changes within the sectors themselves.

Significant investment is needed to deliver these outcomes and this involves co-ordinating a complex set of commercial and technological considerations that result in a series of investment and disinvestment decisions - that is:

moving people and capital from one place to another…

moving from one business model to another….

moving from one form of technology to another…

and effectively managing the risks along the way.

It is a truism that our future prosperity depends on how well that process is managed. History teaches us that the co-ordination of all these decisions, the management of all these risks, is what workably competitive markets do best, given a credible policy framework and effective governance.

A key element of any credible policy framework that investors need in order to continue to provide secure, reliable energy at the best price for customers, relates to the emissions reductions policy for the energy sector.

*********

Many of you would be aware that the AEMC recently completed a report at the request of the COAG Energy Council that analysed three types of emissions reduction policy mechanisms, each designed to meet the electricity sector’s share of Australia’s Paris targets. The mechanisms we looked at were:

  • A market-based mechanism which would involve the establishment of a declining Emissions Intensity Target and scheme for the electricity sector.
  • A technology subsidy which would involve extending the existing LRET subsidy mechanism for new renewable generation capacity.
  • Government regulation involving a staged approach to fossil-fuelled generator exit.

The absolute outcomes of the analysis are less important than the relative performance of each of the mechanisms. It wasn’t a forecasting exercise, rather an exercise in explaining the characteristics of each of the three broad choices of mechanisms that could be used.

For example the analysis showed that an emissions intensity target is the most cost effective, scalable, and robust emissions reduction mechanism of the three. This was the case even when it was tested against a range of sensitivities – different views of the future - including high demand and low demand, high gas prices, low technology costs, and variations in the emissions reduction target.

The aim of this work however was not to recommend a particular mechanism, but to explore the impacts each would have on the energy market and consumers and to highlight the policy design characteristics that allow some mechanisms to better integrate with the energy sector than others.

A key characteristic that helps a mechanism achieve emissions reductions at the same time as supporting the delivery of secure, reliable energy at the best price for consumers is the ability to self-correct when future demand and technology costs inevitably turn out to be different from what is expected today. They also allow a mechanism to accommodate changes in the emissions reduction target over time.

Ultimately it is these characteristics that give investors and consumers’ confidence to invest and change behaviour. If the mechanism that we use to achieve emissions reductions target is built around a particular forecast of say demand, technology, fuel prices or any other variables that affect outcomes and change overtime, the credibility of the policy mechanism depends on both the confidence the market has in government’s forecasts and in those forecasts being pretty well correct.

It is the confidence of investors and consumers to invest and change their behaviour that will underpin the transformation of energy markets so they continue to provide a reliable, secure energy supply at the best possible price for consumers.

*********

So, back to what this means for gas markets. Gas reforms are not only critical for large users of gas, they support a whole range of other important objectives. It will be very difficult to achieve an electricity sector that provides secure, reliable electricity at the best price for customers and in a way

that also reduces emissions over time, without access to gas, and without the means to easily buy and sell the available gas across the east coast.

In that regard, the Gas reforms in Victoria particularly will be vital not only for the large gas users there but also to support the maintenance of a secure and reliable electricity system.

The Commission is therefore very focused, as we recently outlined in our submission to the Finkel Review, on supporting the transformation of Australia’s energy markets by providing flexible, resilient energy market frameworks that can adapt and change over time. It is this ability that underpins the confidence that investors can have in identifying investment opportunities and putting their money where their beliefs are. Without that, the rational response is to sit on their hands or to take a ‘no regrets’ position no matter how the future turns out.

The key challenges currently facing the energy sector are all interrelated – the sector often gets described as a tube of toothpaste being squeezed at one end and something comes out the other, or a bowl of spaghetti that is all joined up together. The success of any regulatory framework largely depends on how the people who operate the system and its many parts respond when something happens that had not been anticipated.

The Commission recognises this and the fact that any reforms we propose must balance and achieve multiple objectives and be designed in a way that is flexible and resilient and not dependant on any particular single view of what the future will look like.

I’ll leave you with that thought as you seek to navigate through what promises to be a very interesting time in energy.

Ends.

The (Energy) Restaurant at the (Other) End of the Universe

13 September 2016

Australian Energy Market Commission Chairman John Pierce presented his analysis of the evolution of energy regulation in Australia in the keynote address to the 25th Anniversary Conference of the Regulatory Policy Institute at the University of Oxford this month.

Mr Pierce was invited to deliver the keynote for the two-day retrospective on regulatory and competition policy experiences over the past 25 years both in the United Kingdom and around the world to explore what has worked well; what hasn’t; and to critique lessons learned.

“As policy priorities and regulatory mechanisms evolve there is a need for everyone involved to be disciplined and clear about the specification of objectives, constraints and institutional roles,” Mr Pierce said.

The address explores the essential feature of Australia’s electricity reforms – the reallocation of risk in a workably competitive market, so that responsibility for investment decisions rests with the business making those decisions and consumers do not subsidise industry through higher prices: “In the simplest of examples, overinvestment and excess supply leads to falling prices in a competitive market,” Mr Pierce said. “The incentives on consumers, retailers and generators are all very different in these circumstances. This changes real decisions and actual outcomes.

It also explored the experience and importance of Australia’s energy governance framework: “In reflecting on what has worked well and what hasn’t over the last 20 years or so, it appears that the following three things are determinative. The sharper the distinction between specification of policy objectives and the design of mechanisms used to achieve them the better. If the design of a policy mechanism or a regulatory framework depends on a particular view of the future, such as forecasts of demand or the relative costs of different technologies for it to be successful, you are heading for a world of pain. When joining together the mechanisms used to achieve different policy objectives, great care is needed to make sure they fit snugly together, or you risk damaging them all.

The Regulatory Policy Institute was founded in 1991 to promote the study of the regulation of economic activity. It aims to deepen understanding of the drivers and impacts, intended and unintended, of public policies; and to contribute to more effective policy development.

The Institute’s Distinguished Fellows include

  • Sir Bryan Carsberg first Director General of Telecommunications, later Director General of the Office of Fair Trading.
  • Sir Ian Byatt first Director General of Water Supply, later Chair of the Water Industry Commission for Scotland
  • Peter Freeman QC, CBE, current Chair of the Competition Appeal Tribunal ,former Chair of the Competition Commission
  • Professor Stephen Littlechild, first Director General of Electricity Supply, later a Member of the Postal Services Commission
  • Eileen Marshall  CBE, Deputy Director General of Gas Supply, later Managing Director at Ofgem
  • Sir Callum McCarthy, first Director General of Ofgem, later Chair of the Financial Services Authority
  • Clare Spottiswoode CBE, first Director General of Gas Supply, later a Member of the Independent Banking Commission
  • Sir John Vickers, former Director General of Fair Trading and Chair of the Independent Banking Commission, now Warden of All Souls College, Oxford Univeristy

Speakers at the RPI 25th anniversary conference included

  • Steve Smith, former Managing Director of Markets, then Networks at Ofgem
  • Harry Bush, former Head of Economic Regulation at the Civil Aviation Authority
  • Lord Currie (David Currie), now Chair of the Competition and Markets Authority, former Chair of Ofcom,
  • David Gray, now Chair of the Gas and Electricity Markets Authority, former Managing Director (Networks), Ofgem,
  • John Pierce, Chair of the Australian Energy Market Commission
  • Maxine Frerk, former Partner Ofgem
  • Martin Stanley, former Chief Executive of the Competition Commission and of the Postal Services Commission
  • Professor George Yarrow, Chair of the Regulatory Policy Institute, former Member of the Gas and Electricity Markets Authority,

Speech

The (Energy) Restaurant at the (Other) End of the Universe

John Pierce
Chairman
Australian Energy Market Commission

A speech presented at the Regulatory Policy Institute 25th Anniversary Conference,
12-13 September 2016, Oxford University, United Kingdom

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