Our spectacular energy failure: governments hobbled the market and now they must rescue it

The Australian Energy Market Operator, with the support of the states and federal energy minister, suspended the National Electricity Market in all five regions this week. While suspended, decisions on generation dispatch and prices will be determined by engineers at AEMO, rather than from the outcome of five-minute auctions.

For consumers and policymakers, this is a huge relief: there can now be some confidence that the lights will stay on.

In every other respect, this is a spectacular failure. Never before in its 24-year history has the market failed so much that it is has had to be suspended.

Why has this happened? A definitive account will be years in the making. Immediate factors include: scarcity in coal and gas markets; the way competing generators have responded to that scarcity; the poor reliability of ageing coal generators; the impact of recent floods on coal production; the way the market arrives at prices; and possible responses by suppliers to extract rents at the public’s expense.

Forensic post mortems of aeroplane crashes often unearth underlying factors that explain the observed failures. Might this be true here? I think so. To explain, let me retrace the foundations of the National Energy Market.

The NEM came into service in 1998, a crowning achievement of Hawke-Keating microeconomic industrial reforms, allowing competitive processes to determine decisions on the operation, closure and expansion of electricity production. Although contentious at the time, the idea was eventually widely embraced.

An essential premise on which the NEM stands is that it’s five-minute spot prices contain all the information necessary for efficient operation of the existing generators and for future investment in generation. If spot prices increase or became volatile, it is argued, this will signal the need for more supply and market participants will invest.

However, the equilibrium that has been reached after the Gillard/Rudd/Abbott climate wars is the continued pursuit of emission reductions (the Australian government has now committed to 43 per cent reduction on 2005 levels by 2030) but no price on emissions, or at least not in electricity.

If emission reduction is not to be achieved through the stick of emission prices included in electricity prices then the NEM’s prices can’t be relied upon to drive renewable generation and storage at the rate that will achieve the government’s emission-reduction objectives. Instead, government has no choice but to intervene either by contracting for renewable generation and storage, or by providing incentives to private investors.

Evidence of both can now be found. The governments of NSW and Victoria are at early stages of the implementation of ambitious programs to contract for new renewable generation and storage, and the Albanese government was elected on the promise of a $20 billion fund as its contribution to the delivery of its remarkable target of 82 per cent renewable electricity generation by 2030.

So, if new investment is to be driven substantially through policy, what then is the purpose of the NEM itself, since its principal purpose – to let market forces determine investment – has been irreparably hobbled by the government’s rejection of emission prices?

I do not think that Australia’s energy polity has properly grasped this truth. A successful career in regulation in Australia requires fealty to the dogma that the market should decide new investment and this requires wilful blindness to the inconvenient truth that governments have hobbled the market.

The failure to properly grasp this truth has resulted in half-baked policy support for renewables and storage (indeed the Abbott/Turnbull/Morrison governments actively sought to reduce such support). It has also resulted in much wasted effort in attempting to tweak the NEM to somehow magically conjure up renewable generation and storage needed to meet governments’ ambitious targets and at the same time ensure reliable supply.

The abandoned NEG – the national energy guarantee – was one such conjuring trick. Regulators are now expected to reheat proposals for a capacity mechanism and dish it up to ministers at the end of this month. This is another such conjuring trick.

So, what to do? Government must accept that as long as it refuses to price emissions, it has no option but to itself drive investment. It needs to ensure it has the capacity to do this properly. As noted, NSW and Victoria have already started down this track.

The federal government needs to work out how best to support the states. We have argued elsewhere that it has a particularly valuable role to play in driving the rapid expansion of electricity storage, without which its renewable electricity target will not be achieved.

As for the regulators, they need to stop trying to solve policymakers problems for them. They must be slimmed down to focus only on regulation, not market design or policy development.

What about the NEM? If its main purpose is to ensure efficient dispatch, not drive investment, economists might be invited to propose new arrangements that provide adequate compensation and incentives to reduce operating costs but not to signal scarcity. This recognises government’s – not the market’s – role in driving new investment.

Something good must come from this embarrassing failure. Might we hope for more honesty, courage and imagination?

Bruce Mountain is director of the Victoria Energy Policy Centre. An energy econmist, he has been a longstanding adviser to governments, regulators, market participants and interest groups in Australia and internationally.

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