A market no more? Why two state governments rebelled against NEM

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Premiers and senior Ministers in two of the six states in the National Electricity Market are now actively campaigning against market outcomes.

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Australia relies on politicians to set long-term energy policies that facilitate a flexible, reliable and low-emissions energy system.

For renewable energy developers, one of the most important (and obvious) risks is policy uncertainty.

Policy malaise in the sector — including the failure to achieve a sustainable carbon pricing mechanism, a freeze on renewables and arbitrary restrictions on gas supply — has contributed to higher wholesale prices in both the electricity and gas markets by delaying new investment.

Unfortunately, we are now seeing a backlash from the political class — reflecting the collective opinion of the Australian public that cares little for underlying causes — against the market outcomes that the political class itself contributed to.

Premiers and senior Ministers in two of the six states in the National Electricity Market are now actively campaigning against market outcomes.

Tasmania is the smallest state in the NEM, which it joined in 2005. However, poor policy could have national consequences, so it is worth looking at the Tasmanian situation and the State Government’s election campaign announcement that it is “exiting the NEM”.

Hydro Tasmania is State-owned and operates a hydro-electric system that has capacity totalling 2,500 MW. This system is constrained by energy — water in storages — rather than capacity.

Physical connection via Basslink was completed in 2006. Basslink is a merchant rather than regulated interconnector, and its owners exchanged the variable cash flows arising from interregional price differences for a largely fixed facility fee paid by Hydro Tasmania under a long-term contract expiring in 2031.

Tasmania has three major wind farms with combined capacity of 308 MW. In the private sector, another three large-scale wind projects are at an advanced stage, a huge wind farm is proposed for the north-west that could add 1,000 MW and have its own transmission connection into Victoria, and several smaller wind and solar projects are in the development pipeline.

Hydro Tasmania has a suite of projects known as the “Battery of the Nation” and TasNetworks has commenced a formal study on a second interconnector.

The gas-fired Tamar Valley Power Station has one of the most efficient combined cycle turbines in Australia as well as peaking units.

These provide market-based opportunities and thermal drought support, which was proven during the 2015-16 energy crisis after an unexpected 6 month Basslink outage compounded low inflows.

A market-based price is essential for this complex system to work effectively, to progress the proposed projects, and provide a return to the Tasmanian public for their investment in Hydro Tasmania and Aurora Energy (the incumbent retailer).

From the time that Basslink was conceived, a foundation principle was that the Tasmanian price would follow the Victorian price.

For a decade, NEM prices were generally below the cost of new entry, which would generally cap wholesale prices in an efficient market. Accordingly, many Tasmanian consumers benefited from low wholesale prices under this principle.

An added complication in the market structure is that Hydro Tasmania could exert market power under certain conditions.

A competitive wholesale market has proven elusive, particularly after the failure of Babcock & Brown during the GFC led the State to buy the partly-built Tamar Valley Power Station and complete its construction. In the words of the Tasmanian Economic Regulator:

“in no other NEM jurisdiction is a single company responsible for such a significant proportion of all generation output within the region, with control of interconnector (Basslink) flows, and is the dominant counterparty for wholesale contracts.”

To formalise the pricing nexus, increase transparency in the wholesale market, mitigate this market power, and facilitate the sale of Aurora Energy’s customer book (later aborted), a new regulatory instrument from 2014 effectively capped the price for standard wholesale contracts with a rules-based link to the Victorian forward curve.

These regulated prices are available to all retailers and provide a signal to current and prospective market participants.

As the supply-demand balance tightened with the threatened (later confirmed) closure of Hazelwood from late 2016 — which exacerbated the public’s existing sensitivity to the cost of power given increased network charges — it was inevitable that Tasmanian prices would rise in line with Victoria’s.

Unfortunately, as the public’s confidence in the NEM breaks down — and our political leaders fail to support the market that five states and the ACT created — important microeconomic principles are being discarded.

This distaste for higher prices, and an untested economic development argument, underpin the Tasmanian Government’s election campaign announcement that it is “exiting the NEM” by 2021.

Despite the attention-grabbing (and confusing) headline, the Government actually intends to delink the wholesale pricing mechanism from the Victorian price.

This policy pre-empts a State Treasury review and targets a reduction of around 20 per cent compared to current wholesale contract prices.

The Government would also preserve the spot market to enable “selling at higher prices into the NEM”, notwithstanding the likely need for complex inter-regional hedging arrangements to secure these prices.

The specific mechanics of a new instrument are unknown. Like other well-meaning interventions, adverse consequences could easily result, such as:

  • jeopardising new investment, particularly in uncommitted projects;
  • undermining growth in embedded solar PV systems, and associated storage;
  • exacerbating perceptions about Hydro Tasmania’s market power if it leads to lower levels of wholesale contracting; and
  • further delaying — perhaps forever — the development of effective competition in the retail market.

The policy also has a sustained and significant cost to the State budget, at a time of rising long-term challenges for the State budget including threats to the State’s share of GST revenue, health and education funding needs, and an unfunded superannuation liability that peaks in 2031-32 with a cash cost exceeding $400 million.

At a time when political leadership is required, the NEM and the Tasmanian community would be best served by political support for the market and the principle of market-based wholesale prices, linked to Victoria, rather than a government intervention that could have significant adverse consequences.

Phil Bayley is a Director at Climate Capital — a developer and advisor specialising in renewable energy generation — and is experienced in commercial strategy, financing and market development in the energy sector. He worked for 10 years in Tasmanian Treasury, overseeing State-owned electricity businesses and several aspects of economic regulation, and is a former Chief Economist at the Tasmanian Chamber of Commerce and Industry.

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  1. Dee Vee 2 years ago

    Seriously, the author of this article has “foot in mouth” disease. How any thinking person can say Carbon “tax” and lower prices in one sentence defies reason.

    • Tom 2 years ago

      “Policy malaise in the sector — including the failure to achieve a sustainable carbon pricing mechanism, a freeze on renewables and arbitrary restrictions on gas supply — has contributed to higher wholesale prices in both the electricity and gas markets by delaying new investment.”

    • Lachie 2 years ago

      He didn’t. Maybe you should re-read the article.

    • Geoff James 2 years ago

      Whether or not you call it a tax, try this thought experiment. Suppose renewables produce cheaper electricity than fossil fuels. Suppose as a nation we’re having trouble weaning ourselves off fossil fuels. Well, then increasing their cost will give us a kick in the right direction, resulting in lower costs overall. I think that’s how it’s supposed to work, isn’t it?

    • My_Oath 2 years ago

      ….or read the article?

      He didn’t say ‘carbon tax’. He said ‘carbon pricing mechanism’.

      Simple fact is, a cap and trade system works. We know it works because Reagan demonstrated it with the cap and trade system on leaded fuel. There is no more leaded fuel. We also know it works because Bush Snr demonstrated it again with a cap and trade on sulphur dioxide emissions. Acid rain is just no longer the issue it was.

  2. neroden 2 years ago

    Market Schmarket. We all know the NEM is completely messed up. You didn’t make a defense of it — you just handwaved!

    Rated F for honesty. This is a bunch of unrelated sentences with some market dogmatism mixed in. No content. This piece qualifies as “Spreading Fear, Uncertainty, and Doubt” — aka FUD.

    Does not belong on Reneweconomy.

    • Geoff James 2 years ago

      The market has its problems, as the author admits, and lack of competition in both generation and retail in Tasmania is one of them. But overall I think it’s a good summary leading to some serious potential risks of the proposed policy. The author also seems eminently well qualified to comment with a treasury background and now a private-sector viewpoint. Thanks Phil. I’d be happy to read a similarly well-argued piece on the other side – haven’t seen one.

      • Mike Westerman 2 years ago

        And an unshakeable belief in “markets”. The Hydro is a public monopoly, always was and most likely, given the sentiment in Tasmania against privatisation on both sides of politics, will always be. The Hydro needs wind to provide the balance of energy no longer available in water, and so splitting these two would be a disaster. The differences in yields across regions makes splitting up the assets unworkable. Other than letting private owners invest in wind, we are fairly stuck with a regulated regime. Like SA and ACT, minority players in the NEM have not done well, more so as the NEM design has failed and the regulators have done little, in the face of destructive Fed policy, to do much about it.

        • Andy Saunders 2 years ago

          To some extent, the policy is a proposal to re-join the NEM…

  3. karabar 2 years ago

    “Hydro Tasmania is State-owned and operates a hydro-electric system that
    has capacity totalling 2,500 MW. This system is constrained by energy —
    water in storages — rather than capacity.”
    Statements like this are issued only by novices who have no clue regarding the production of electricity. NEWS FLASH. The bulk of that “capacity” is run of river power stations that have no storage. It can only produce when it rains. As with any other “renewable” nonsense, hydro cannot provide the three things essential to the consumer: Reliability, Security, Affordability.

    • Mike Westerman 2 years ago

      And it didn’t take long for ignorance to raise its head…someone so ignorant they don’t understand hydro supplies mission critical power to aluminium smelters across the globe at the lowest cost per MWh, so ignorant they can’t be bothered to even Google the details of hydro in Tasmania or the enormous capacity of reservoirs like the Great Lake or Gordon or King or Pieman schemes.

      • daw 2 years ago

        Add – Too sad that the Greens and Labour stopped the Gordon below Franklin Tas then added it’s only CO2 emissions generation at Bell Bay. Tough luck for the environment

        • Mike Westerman 2 years ago

          Gordon below Franklin saved the Franklin as an unregulated stream. Bell Bay was dumb politics. At least now the Hydro is getting on with more wind, something they should’ve been doing more of 20y ago.

    • Steven Gannon 2 years ago

      Well that makes Turnbull and Snowy 2 look a bit silly then.

  4. Farmer Dave 2 years ago

    Phil, thank you very much for illustrating so well what happens when a natural monopoly meets market fundamentalism. You say that there is a need to “mitigate this market power” (of Hydro Tasmania). Hang on, Phil, we Tasmanians own Hydro Tasmania, and we also own TasNetworks (the poles and wires company) and we own Aurora Energy, the main retailer. They are ours, we own them, as they are all owned by the Tasmanian Government on our behalf. Why should we fear the “market power” of something we own which is directly accountable to shareholder Ministers we elect? I simply don’t understand why we should fear such a situation when these companies must do what they are told. If there is a problem with their being told the wrong things to do, then we have a four yearly process called elections, in which we can throw out of office those who are not managing them properly and elect someone else to make a better fist of it. Where is the problem?

    Let me make very clear what I am suggesting (regular readers of my comments can groan and look away at this point.) The three companies are Government Business Enterprises, each with its own Board and well remunerated management team. Each are expected to pay dividends to the Tasmanian Government. I think we should sweep away this whole structure: sack the boards and two sets of managers and make the whole thing a single statutory authority accountable to the people of Tasmania through our elected representatives. Let’s call this new body HydroTas 2.0

    HydroTas 2.0 (or Hydro 2.0 for short) should be required to provide Tasmanians with a safe, secure, resilient, and to the maximum extent feasible, 100% renewable electricity supply. Within the boundaries of the excellent maintenance of the assets, Hydro 2.0 will be required to make electricity as cheap as possible for Tasmanians, and to make as much profit as possible from the rest of Australia. They should not be expected to pay dividends to the Government, but should be expected to commit an agreed amount each year to energy efficiency improvements in Tasmania, particularly in low income households and small businesses. They should also be expected to commit an agreed amount each year to the development of electric transport.

    All of this needs to set within the context of a highly transparent Government oversight regime. All directions from the Minister must be made public; reporting must be public, and there should be a bicameral, all party committee of the Parliament with strong powers to look over the shoulders of Hydro 2.0’s management team.

    It is not “market power” that should be feared, it is the zealous application of market fundamentalism that is truly scary.

    • Mike Westerman 2 years ago

      Dave the neolibs will be after you! But sensibly, if it looks like a monopoly and acts like one, it probably is one and ways to make it accountable and efficient sought. Accountability can as you say come thru transparent dealings, none of this commercial in confidence redaction nonsense. But it can also come thru the requirement to consult to the extent of public plebiscites on key decisions. Think back to the Franklin R saga, and the need to have voices other than government and industry driving Hydro policy.

      Efficiency can come by regional organisation to support local contracting of many of the repetitive O&M tasks to stimulate local employment, as well as benchmarking against other organisations, but with the emphasis on quality and asset value retention, not just short term dollars. I can’t see the ongoing value of Entura competing with private consultants, but I declare a conflict of interest on that!

      • Phil 2 years ago

        I think most of you missed my point. Market power residing in a monopolist (perceived or actual) can be managed through carefully targeted regulation, such as the current mechanism, while also allowing a market to function. Then new investment can be facilitated within that market to chip away at the monopoly.

        • Mike Westerman 2 years ago

          I think what we see in reality (banks, power, telecoms) is regulator capture by monopolies making markets expensive and inefficient. What would make sense is to bar monopolists from emerging sectors which would then be structured to limit concentration but neolib governments don’t do this as theu say in hobbles investment. Take mobile towers. If the government had wanted to limit Telstras market abuse it could have banned them from tower construction and opened this service to independents with services on regulated tariffs, but limited in market share. No way – Telstra had to be unfettered, and less capitalised competitors edged out.

    • MaxG 2 years ago

      Yes, the neolibs will be soon after you 🙂
      It is right on their agenda to abolish government and implicit any public asset with it.
      Unless people truly understand that, these clowns will keep dismantling what used to be a good thing… the same language that is used in SA, how the RE is killing it all; tell it long enough and the punters go with it.

      • MaxG 2 years ago

        And furthermore: it is against their (neolibs) ‘making profit’ notion. If government runs it, there is no profit for corporations, which is bad, because, running something for profit is a private domain.
        What I am saying sounds overboard for most, but once people take the time to truly understand the underlying system; e.g. what parties really stand for, the game of politics (incl feeding nonsense to the public), understanding the monetary system (which is not an easy thing to do), understanding the world as a system… then it makes sense.

  5. bruce mountain 2 years ago

    So, what are these “micro economic principles” that have been discarded? And, why does Tasmania have to be part of the NEM to trade?

    • Phil 2 years ago

      @bruce_mountain:disqus The generator on a string model was considered as an option for Basslink. However, this is a govt intervention in the contract market while remaining in the NEM. It is just one example of how the key micro reform principles (eg. non-intervention in competitive markets, competitive neutrality between public and private sector, cost reflective pricing, removing cross subsidies and independent regulation of monopolies) have been discarded, weakened and/or ignored over time. Obviously these weren’t listed in the interests of brevity.

      • bruce mountain 2 years ago

        Ok, thanks. I see where you are coming from. What does “independent regulation” of government owned businesses mean? And cost reflective pricing? Why do you need to be a part of the NEM for this? Non-intervention in competitive markets? The NEM is riven with intervention from top to toe. These are no “micro economic principles”. This is just turgid dogma and ideology. From what I can see Tasmania did a pretty fine job of electricity before it joined the NEM. It has a tough geography, distributed generation and a dispersed population. It lived within its means and from what I have seen of the engineering, did clever and innovative things. All that seemed to go out the window when Tas joined the NEM including a poor degradation in economic regulation. The Government is quite right to call time on this. Remember Adam Smith – the sole purpose of production is consumption. The Government sounds far more realistic in refocussing effort on this. The people of Tasmania should support this and applaud the Government for re-establishing Tasmanian accountability. With respect, the task for people like you is look with far greater honesty and candour at the mess that “reform” has brought. Remember Keynes: “When the facts change I change my mind. What do you do sir?”

        • Phil 2 years ago

          I don’t know how much experience you have in the Tas market, but I can assure you it was not as perfect as you might think – regular drought risk mitigated by oil-fired generators, minimal regulation, no price transparency, rampant cross subsidies, and chronic underinvestment in the transmission network. I also know your theory on the role of government and network regulation, but it was not even close to my experience. The Government is not chasing some old idyll, nor increasing accountability, but simply targeting a lower price through Ministerial intervention without recognising the unintended consequences. So I don’t really appreciate your assertion of dishonesty or patronising quotes from Keynes.

          • bruce mountain 2 years ago

            Assertion of dishonesty? No I don’t assert dishonesty. But you certainly seem to be dogmatic and ideological. Rampant cross subsidies – says whom? Where is the data? Chronic under-investment on transmission? Oh please. Transmission engineering in Tassie was smart with clever inter-tripping schemes, and condition monitoring to increase reliability on radial feeders. This was smart and Tassie has successfully exported this expertise. You are an engineer so able to assess the “chronic underinvestment”? Minimal regulation: where is the harm in that? Where is the gain from regulating a government-owned business though a separate agency? My theory on the role of government and network regulation? Yeah what might that be? Your experience? Who cares what you or I think. Its the data that counts and that could not be clearer. Oh and oil-fired generators: These were standard practice everywhere until gas and OCGT and CCGT became available, including in Tasmania. And failures since the NEM: Basslink and the appalling contract Treasury determined? Disgraceful hydro dispatch around time of carbon tax. CCGT built, idle, sold and then hastily recommissioned. Your dismissal of the Government’s action as some trite cynical ploy is patronising. It will re-establish proper political accountability of what remains a government-owned industry. You rightly have Keynes’ aphorism coming your way.

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