The NEG: getting the balance right

This article has been published in the Energy Source and Distribution Magazine – Mar/Apr 2018 issue – read magazine article here.

Ahh, the NEG, the National Energy Guarantee.  Resolving the policy impasse that has plagued the energy sector for a number of years is high on the to-do list of many people.  So strong is the desire to reach a resolution that stakeholders and commentators are getting behind the NEG even before we have more than the sketchiest outline of its design.  Many articles are appearing summarising its intent and praising its objectives, and those views are not repeated here.

What does this author think?  First, I want the policy impasse to be resolved.  Second, I recognise that a good resolution will need to meet a number of imperatives: political, policy (for example relating to emissions), economic efficiency and financial viability (including affordability) and technical (making sure the lights stay on).  Third, experience tells us that there will be multiple solutions that could, if well implemented, work but will balance each of the imperatives differently.

But, can the NEG work?  Yes, if allowed to by enough interested parties and not compromised along the way.  A good design can fail if implementation is poor and a not so good design can work if it is well implemented and there is a will to make it work.  I am not aware of any market design anywhere around the world that is universally regarded by all its stakeholders as ideal.  This means compromise is an essential part of the process of design. Indeed, I make a living helping interested parties argue for change and helping market authorities reset the balance between imperatives.

The NEG has well-publicised, explicit objectives of jointly meeting technical (the reliability guarantee) and emission targets.  Other objectives are expected to be met along the way including political alignment, downward pressure on consumer prices and economically efficient decisions about investment and operation still being made by market participants.  At the time of writing the Energy Security Board, which is developing the arrangement, has issued a second paper on its design which provides more of its thinking and asks a lot of questions.

A principle stated by the ESB is for the NEG to be compatible with the existing NEM and its mechanisms including those for contracting activity by commercial participants.  Put another way, the NEG is not intending to introduce fundamental changes to the design of the NEM.  The questions asked in the latest paper from the ESB start from this position.  This is an understandable objective, but it comes at a price that has not been not widely discussed as yet.  The choice the ESB has made in this regard is important as it narrows the scope of possible design features and sets principles for compromise.

One observation is that the decision to retain the core design of the NEM mechanisms comes at the cost of additional administrative measures that will be needed to decide, amongst other things: what amount of dispatchable capacity will be needed (both in total and regionally), what form of contract will be able to be used, how to allocate the responsibility for dispatchable capacity between retailers and the attendant additional complexity and overheads these matters will entail. The ESB asks questions about most of these matters.  Other matters include how to decide how much each generating unit can contribute to dispatchability and more subtle questions about how a floor on the level of dispatchable capacity might impact the market price cap which is currently relied on to create an incentive for investment in capacity.

A key, and deliberate, characteristic of the current design of the NEM is that historical and importantly forecast future market prices should be a prime guide for investment and contracting activity in general.  Prices rise if shortfalls occur or loom.  We have a ‘need’ for a NEG because this is no longer possible as the NEM does not price dispatchability (as opposed to total) capacity or emissions.  I don’t disagree that it is very hard to price dispatchability, much less emissions at the same time.  However, the ESB is effectively ‘putting a peg in the sand’ to say that we can successfully continue to price energy and capacity investment most of the time in the same way we have for the last 20 years.  That is leadership.  Good, it’s been missing.  But as noted, there is a price to pay in terms of more centralised administrative decision making and complexity.  We, collectively, need to be careful about what we wish for.  We spent about 5 years designing the NEM.  We debated many of the same questions about contract forms and administrative decision making. We had strong political alignment, a vastly different suite of generation technology, no thought of peer-to-peer trading, emission limits were treated as a side issue, live and paper trials of different designs were run – and only after all that did we choose the current NEM.  On the other hand, we now have considerably more experience within Australia and internationally that we can draw on than was the case 20 years ago.  Still, change is hard – harder in some ways than a new design.  So, let’s give this current debate about the concept and the one to come next on its detailed implementation the careful attention it deserves.

Author:

Greg Thorpe

Executive Director, Oakley Greenwood

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