The Government’s proposed National Energy Guarantee (NEG) is closer to reality with the Energy Supply Board (ESB) releasing the first public consultation paper on the scheme last week. The NEG is admirable in its attempt to manage the dual (and often conflicting) issues of lowering carbon emissions from the electricity sector yet still ensuring the on-going reliability of electricity supply. However there are some significant issues still to be resolved, and the complexity and potential costs of the NEG are concerning.
The NEG will create two obligations on retailers (and large direct consumers) of electricity in the National Electricity Market (NEM):
- ensuring their electricity purchases meet emissions intensity targets; and
- ensuring dispatchable or “reliable” generation targets are met for each NEM region.
The emissions and reliability obligations will be implemented as changes to the National Electricity Law (NEL) and National Electricity Rules (NER). As a result, the NEG will not apply to non-NEM jurisdictions such as the Northern Territory and Western Australia.
The reliability component of the NEG will commence in 2019 and the emissions requirement in 2020. The NEG will not affect the existing Renewable Energy Target (RET) which will continue to operate until its scheduled expiry at the end of 2030.
The emissions reduction target
Unlike the RET, or earlier proposals for an emissions intensity scheme, the emissions target under the NEG will not involve the creation and surrender of compliance certificates. Instead, electricity retailers will be required to “contract” generation that meets an average annual emissions intensity target (in tCO2-e).
The consultation paper assumes that the emissions intensity target will initially be set to achieve a 26% emissions reduction from the electricity sector on 2005 levels by 2030, consistent with Australia’s international obligations. However, the emissions target will ultimately be determined by the Government and the NEG will be designed to allow the emissions target to change from time to time.
A retailer’s average emission intensity for its “contracted” generation will be calculated as the weighted average of its “purchases” under:
- contracts specifying a generation source, with the emissions intensity of those purchases being determined as the intensity of the relevant generation source;
- contracts that specify emissions per MWh but do not specify a generation source;
- contracts that do not specify either a generation source or emissions per MWh (the consultation paper provides the example of existing exchange traded contracts and OTC swaps and caps); and
- uncontracted purchases from the NEM.
The difficulty with this mechanism is that the NEM is a gross pool and retailers generally do not “contract” for physical electricity supply or “purchase” from individual generating plant. Most retailers purchase their electricity requirements from the NEM but (to the extent they do not own their own generation plant) enter into financial cap and swap products with owners of generation plant, or exchange traded futures, weather derivatives and other instruments to provide price certainty. These products may have no reference to any specific generation plant.
By placing the emissions obligation on retailers, the NEG needs to trace through to the generation “source” of the retailer’s electricity purchases and seeks to assign emissions intensities to all of these arrangements. However, calculating the emissions intensity for OTC swap and caps, futures and other products, and uncontracted electricity purchases from the NEM, is potentially complex.
The consultation proposes a range of options for a retailer failing to achieve its target average emissions intensity, including civil penalties, mandatory injunctions and enforceable undertakings. The ability to “bank” and trade annual emissions intensity over-performance is not yet clear. Similarly, the consultation paper proposes that retailer can roll some level of non-compliance into subsequent years, but the details are still to be developed.
Other key policy decisions still to be decided by the Government include:
- whether to exclude the loads of energy intensive trade exposed (EITE) industries such as steel and aluminium production/smelting from the emissions obligations under the NEG; and
- whether external offsets such as Australian Carbon Credits Units or international units of an equivalent standard can be used to satisfy retailers’ emissions obligations under the NEG.
The reliability target
Reliability requirements will be set for each NEM region by the Australian Energy Market Operator (AEMO). Where AEMO identifies a “reliability gap” in a NEM region, the retailers operating in the region will be allocated responsibility for meeting the reliability gap based on their share of the peak load.
A retailer will be able to meet its obligations by building or contracting reliable generation capacity and penalties will apply to retailers who do not meet their responsibility. AEMO will retain an ability (and perhaps obligation) to step into the market as a “procurer of last resort” if an identified reliability gap is not met within the relevant period.
The consultation paper does not describe which types of generation will be considered “reliable” for the purposes of the NEG. Other key issues still to be determined include: what the reliability requirement will be, how will reliability shortfall obligations be allocated between retailers, how will compliance be measured, and what will be the consequences of non-compliance?
It also needs to be considered whether the price signals created by the reliability obligation under the NEG are sufficiently strong and enduring to support the development of new reliable generation or demand reduction capacity by the private sector. Fragmentation of the reliability shortfall obligation among retailers risks dilution of the price signal. The key concern is that NEG simply defaults to an AEMO last resort function that is similar to the existing reliability and emergency reserve trader function (RERT), a mechanism that already has some shortcomings.
The proposal to impose emissions and reliability obligations on retailers makes some aspects of the NEG proposals feel like putting a square peg into a round hole, particularly the linkages to “contracted” generation. It is not clear why this approach is more efficient than a simple cap and trade / certificate-based scheme for emissions and an ancillary service market for reliability (with the costs of that service allocated to generators who cannot provide the required reliability).
As noted above, there are some significant issues still to be resolved and the full implications of the NEG arrangement are yet to be revealed. Above all else, there remains the issue whether the State and Territory governments will agree to change the NEL and NER to allow the introduction of the NEG.
The ESB is seeking feedback from stakeholders on the high level design of the NEG mechanism. Submissions are due by 8 March 2018.
David Ryan is a Partner at Herbert Smith Freehills, with expertise in the energy and infrastructure sectors.