1 August 2018
Dr Kerry Schott
Energy Security Board

Clare Savage
Energy Security Board

Paula Conboy
Australian Energy Regulator

John Pierce
Australian Energy Market Commission

Audrey Zibelman
Australian Energy Market Operator
    Executive Summary		 1                      4   Reliability requirement             35
                                               	Step 1: Forecasting the
                                                 reliability requirement               37
    1   Introduction and next steps		 4
                                               	Step 2: Updating the reliability
        Background to this paper		 5             requirement                           37
        Process		5                             	Step 3: Triggering the reliability
    	Structure of final detailed                obligation                            37
      design paper		 6                             Step 4: Liable entities             38
                                                   Step 5: Qualifying contracts        39
    2   Context		7
                                                   Step 6: Procurer of Last Resort     41
        The status quo is not an option		 9
                                                   Step 7: Compliance                  41
    	Longer term price signals at
      the heart of the Guarantee          10       Step 8: Penalties                   41
    	Reducing electricity prices
      and improving affordability         10
                                               5   Governance                          42
        Managing reliability risks        15
                                               	Implementation through NEM
        Reducing emissions                17     governance arrangements               43
        Safeguarding competition          19   	Review of operation of aspects
                                                 of the Guarantee mechanism            44
                                               	Relevant Commonwealth
    3   Emissions reduction requirement   20     legislation                           44
    	Electricity emissions
      intensity targets                   21
                                               6. Modelling                            45
    	Entities covered by the emissions
      reduction requirement               21       Modelling framework                 46
    	Applying the emissions reduction             Assumptions and approach            47
      requirement                         22
                                                   Scenario 1 ‘No policy’              49
        Flexible compliance options       29
                                                   Scenario 2 ‘Guarantee’              51
        Reporting and compliance          31
                                                   Technology cost assumptions         54
        Other considerations              34
                                                   Projected jurisdictional outcomes   54
                                               	Operation of the Guarantee under
                                                 different circumstances               59
                                                   List of committed projects
                                                   to 2020-21                          59

                                               A Abbreviations and defined terms       61
COAG Energy Council

Dear Ministers

I am pleased to enclose the Final Design of the National Energy Guarantee (the Guarantee)
for your consideration.

The Guarantee integrates energy and emissions policy in a way that encourages new
investment in both low emissions technologies and in dispatchable energy such that the
electricity system achieves its share of emissions reduction targets and operates reliably.
It is designed to deliver long-term policy confidence and stability to reduce investment
risk and bring down electricity prices.

The Guarantee has five key drivers that will work together to lower retail prices:
• policy stability unlocking new investment
• policy stability reducing the risk (and therefore the cost) of new investments
• increased contracting unlocking new investment
• increased contracting in deeper and more liquid contract markets to reduce the level
   and volatility of spot prices, and
• increased voluntary demand response.

The final design is the culmination of almost a year’s work and a collaborative effort by
people and organisations from across the energy sector and the community. Stakeholders
have been clear with the Energy Security Board (ESB) that the status quo is simply not
acceptable and have demonstrated a commitment to work together to respond to the
changes that are underway in the energy market.

Many stakeholders have stressed that at least some of the existing pipeline of new
investment is predicated on the assumption that integrated energy and climate policy is
now within reach. Any delay, or worse a failure to reach agreement, will simply prolong the
current investment uncertainty and deny customers more affordable energy. The strength
of the Guarantee mechanism reflects the open and constructive input we have received
via written submissions, technical working groups, and public forums at each step of the

The ESB has designed the Guarantee mechanism to be fuel and technology neutral
and provide a clear investment signal so that the cheapest, cleanest and most reliable
generation (or demand response) gets built in the right place at the right time. There is
no revenue collected from the Guarantee and there is no certificate trading scheme.

The design incorporates specific measures to safeguard competition, and to enhance
liquidity and pricing transparency in retail and wholesale markets. Importantly, the
Guarantee is a flexible mechanism that can accommodate different levels of emissions
ambition over time, and work with state and territory emissions targets and renewable
energy schemes to create greater confidence for the industry.
The attached final design includes extensive, updated modelling led by the ESB, in
partnership with the Australian Energy Market Commission, drawing on expert advice and
capability from ACIL Allen consulting. The modelling by ACIL Allen (as with the modelling
previously conducted for the ESB by Frontier Economics) uses an economic model of the
wholesale electricity market and prices to forecast likely changes in the generation mix
under different policy settings and the consequential impact on customer bills. This is in
contrast to the Australian Energy Market Operator’s Integrated System Plan modelling
which is a cost-based engineering assessment focused on long-term transmission planning
and investment.

The most recent Guarantee modelling by ACIL Allen validates the conclusions of the
modelling previously undertaken by Frontier Economics on the Guarantee. This analysis
confirms that the mechanism can deliver much needed savings for households and
businesses that have been impacted by rising energy prices and can ensure the electricity
sector contributes its share towards Australia’s international emissions reduction
commitments, all while ensuring we have sufficient dispatchable resources for reliable
power. The average household bill is expected to be $550 lower each year through the
2020s than it is now, and $150 of those savings are because of the Guarantee.

Should the Energy Council choose to proceed, the Guarantee would be implemented through
existing governance arrangements for the National Electricity Market.

The Energy Security Board looks forward to discussing this with you at the next Energy
Council meeting on Friday 10 August 2018.

Yours sincerely

Kerry Schott AO
Chair, Energy Security Board
1 August 2018

The National Energy Guarantee (the Guarantee) is a                         • increased voluntary demand response.
mechanism designed to integrate energy and emissions                       NEM average wholesale prices are, on average,
policy in a way that encourages new investment in both low                 expected to be over 20 per cent lower over the
                                                                           2020s under the Guarantee than without it. Lower
emissions technologies and in dispatchable energy such that                wholesale prices are expected to translate into
the electricity system operates reliably. Providing long-term              lower bills for all consumers. The average
                                                                           NEM-connected household is estimated to save
policy confidence is critical to lowering investment risk in
                                                                           around $550 dollars a year (real $2018) on their
the National Electricity Market (NEM) and bringing down                    retail bill over the 2020s relative to 2017-18. Of
electricity prices.                                                        this, nearly $150 per year (real $2018) is forecast
                                                                           additional savings as a result of the Guarantee.

                     The Guarantee requires retailers to contract with     The Guarantee is specifically designed so that
                     generation, storage or demand response so that:       it does not undermine, and may indeed boost,
                                                                           competition through measures that enhance
                     • there are contracts in place to support a           market liquidity and pricing transparency in
                       minimum amount of dispatchable energy to            retail and wholesale electricity markets. Under
                       meet consumer and system needs (reliability         the emissions reduction requirement, smaller
                       requirement), and                                   retailers are supported through the exemption
                     • the average emissions level of the electricity      of the first 50,000 MWh of load and with
                       sold to consumers meets the electricity             relatively greater flexibility to carry forward
                       sector’s share of Australia’s international         any over-achievement. Under the reliability
                       emissions reduction commitments, as set             requirement, when the reliability obligation is
                       by the Australian Government (emissions             triggered, a Market Liquidity Obligation will
                       reduction requirement).                             require the largest participants to offer to buy
                                                                           and sell contracts with all participants.
                     The emissions reduction and reliability
The emissions        requirements work together so that the market         It is possible that higher emissions reduction
reduction            has a fair opportunity to deliver adequate            targets may be set in the future by the Australian
requirement is an    reliability while lowering emissions. The             Government. In this case, the Guarantee
                     Guarantee is fuel and technology neutral and          mechanism and framework will automatically
annual obligation
                     provides a clear investment signal, so the            accommodate the new targets. Further, the
on market            cleanest, cheapest and most reliable generation       design of the Guarantee does not limit the ability
customers in the     (or demand response) gets built in the right place    of States and Territories to set and meet their
NEM.                 at the right time.                                    own emissions reduction or renewable energy
                     The Guarantee has five key drivers that will work
                     together to lower retail prices:
                     • policy stability unlocking new investment           Emissions reduction requirement
                     • policy stability reducing the risk (and therefore   The emissions reduction requirement is an
                       the cost) of new investments                        annual obligation on market customers in
                                                                           the NEM. Market customers must ensure the
                     • increased contracting unlocking new
                                                                           average emissions intensity of their load is at
                                                                           or below the prescribed ‘electricity emissions
                     • increased contracting in deeper and more            intensity target’ for the compliance period.
                       liquid contract markets to reduce the level and
                       volatility of spot prices, and

Executive Summary

                        Compliance with the emissions reduction                                 allocate all generation and associated emissions,
                        requirement is assessed annually by the                                 a requirement against unreasonably withholding
                        Australian Energy Regulator (AER), based                                allocations, and a general anti-avoidance
                        on a financial year compliance period. The                              regime. These elements are not included in the
                        first compliance year proposed is 2020-21.                              final design. The AER will actively monitor the
                        An emissions registry, administered by the                              behaviour of registry participants and, if required,
                        Australian Energy Market Operator (AEMO), will                          the ESB will reconsider the need for a general
                        be established to facilitate efficient compliance.                      anti-avoidance regime and/or an unreasonable
                                                                                                withholding provision.
                        The registry allows market customers to be
                        allocated a share of a generator’s output and
                        its associated emissions, for which they have                           Reliability requirement
                        obtained the rights. The registry automatically
                        matches emissions to each market customer                               The reliability requirement is designed to
                        based on the generation allocated against                               incentivise retailers and other market customers
                        their load. Market customers that do not have                           (liable entities) to support the reliability of the
                        generation allocated for some or all their load                         NEM through their contracting and investment in
                        will be assigned the average emissions intensity                        resources.
                        of all unallocated generation in the registry, to                       AEMO will forecast annually whether the
                        cover their unallocated load.                                           reliability standard is likely to be met (or not)
                        The AER will compare each market customer’s                             in each NEM region1 over a 10-year period.
                        average emissions intensity against the electricity                     Where a reliability gap is identified, the market
                        emissions intensity target to assess compliance.                        will have the opportunity to invest to close that
                        To provide flexibility, market customers can carry                      gap. However, if a material gap persists or
                        forward a limited amount of over-achievement for                        emerges three years from the period in question,
                        use in the next compliance year. Similarly, limited                     then AEMO will apply to the AER to trigger the
                        deferral is allowed.                                                    reliability obligation.

                        Some elements of the final design have been                             If the reliability obligation is triggered, liable
                        revised from the draft detailed design of 15 June                       entities may be required to demonstrate future
                        2018, based on stakeholder feedback through                             compliance by entering into sufficient qualifying
                        the consultation process. These are:                                    contracts for dispatchable capacity (including
                                                                                                demand response) to cover their share of a one
                        • The emissions reduction requirement                                   in two-year system peak demand at the time of
                          has been designed as a whole-of-market                                the gap.
                          mechanism, in that every megawatt-hour (MWh)
                          of generation that occurs in a compliance year                        One year from the forecast reliability gap, if
                          will be recorded in the registry for allocation                       the AER confirms a material gap in resources
                          against every MWh of market customer load in                          remains, AEMO will use its safety-net Procurer
                          that compliance year. This includes pre-1997                          of Last Resort to close the remaining gap. At
                          renewable generation (such as Snowy Hydro                             this point, liable entities must disclose their
The reliability           and Hydro Tasmania).                                                  contract positions to the AER. If actual system
requirement                                                                                     peak demand in the compliance year exceeds
                        • The approach to over-allocations of generation                        that which would be expected to occur once
is designed to            has been revised. Market customers have an
incentivise retailers                                                                           in every two years, then the AER will assess
                          incentive to reallocate generation in advance                         the compliance of liable entities. Those whose
and other market          of the reporting deadline. Over-allocation will                       required share of load is not covered by
customers (liable         not attract a civil penalty.                                          qualifying contracts for the specified period
entities) to support    • The carry forward limit has increased, to up                          are non-compliant.
the reliability of        to 10 per cent of the first year’s electricity
the NEM through                                                                                 Some elements of the final design have been
                          emissions intensity target per MWh of load
their contracting                                                                               revised from the draft detailed design of 15 June
                          plus a fixed amount of 60,000 tCO2-e.
and investment in                                                                               2018, based on stakeholder feedback through the
                        • In the first year, market customers can defer                         consultation process. These are:
resources.                their full compliance obligation, but any
                                                                                                • Large customers will be provided the flexibility
                          deferral must be made up in the following
                                                                                                  to ‘opt-in’ to manage their own reliability
                                                                                                  obligation, if they consider this is the most
                        The Energy Security Board (ESB) reconsidered                              cost-effective and efficient approach.
                        the need for a requirement that generators

                        1 The regions of the National Electricity Market include Queensland, New South Wales, Victoria, Tasmania and South Australia.

Executive Summary

              • Retailers can adjust their contract position
                                                                     National Energy           National Energy
                within the compliance year when they take            Guarantee -               Guarantee -
                on new commercial and industrial customer            scheme mechanics          emissions
                sites with historic peak load less than 30 MW.                                 reduction target
              • Large vertically integrated retailers will be
                covered by a Market Liquidity Obligation             COAG Energy               Australian
                when the reliability obligation is triggered.        Council - all             Government
                Obligated entities will be determined based          governments
                on a size threshold and required to perform
                a market making function for the duration of
                                                                                               New legislation
                the gap period. Qualifying contracts will not be
                                                                                               to set targets
                required to be recorded in a trade repository
                with associated trade reporting for the              National                  National Greenhouse
                                                                     Electricity Law           and Energy
                purposes of the Guarantee.                                                     Reporting Act
              • Liable entities found to be non-compliant with       National
                                                                     Electricity Rules         Australian
                their contracting obligations will be charged                                  National Registry
                an amount that contributes to the costs of                                     of Emissions
                AEMO exercising its Procurer of Last Resort                                    Units Act
                function. This will be a proportionate cost
                contribution commensurate with the non-
                compliance, determined after the event and           Mechanism to              Emissions reduction
                capped at $100 million.                              deliver emissions         target and trajectory
                                                                     reduction                 including extension
                                                                     requirement               process
                                                                     and reliablity
              Governance                                             requirement               Surrender of offsets
                                                                                               and EITE exemptions
              The Guarantee is to be implemented through
              two legislative routes. The first route is through
              the existing governance arrangements for the         If the COAG Energy Council approves the
              NEM, agreed by all the Governments that are          final design of the Guarantee at its 10 August
              party to the NEM in the Council of Australian        2018 meeting, there will be a period of public
              Governments (COAG). The majority of the              consultation on the draft NEL legislation, which
              Guarantee mechanism is implemented through           is anticipated to occur from around mid-August
              amendments to the National Electricity Law           to around mid-September. It is expected that the
              (NEL) and the National Electricity Rules (Rules).    draft NEL legislation will then be finalised for
              • The NEL will set out who is liable under the       introduction to the South Australian Parliament
                emissions reduction and reliability obligations,   by the end of 2018.
                the key aspects of those obligations, and
                                                                   The necessary Rules to implement the Guarantee
                the compliance and penalty framework. It
                                                                   will be made by the South Australian Energy
                will also include a new emissions objective
                                                                   Minister in mid-2019.
                to guide rule-making in relation to Rule
                changes relevant to the emissions reduction        Limited aspects of the operation and
                requirement.                                       implementation of the Guarantee will be reviewed
              • Detailed aspects of the mechanism (as set out      after three years to ensure that it is working
                in the final detailed design document) will be     smoothly.
                included in the Rules.                             After the initial package of changes to the
              The second route of legislation is via the           Rules are made, the Australian Energy Market
              Australian Government. Australian Government         Commission (AEMC) is the rule-maker
              legislation sets the intensity targets, provisions   in response to rule change proposals and in
              for emissions-intensive trade-exposed (EITE)         accordance with its current functions under
              exemptions, the surrender of offsets, and            the NEL.
              emissions reporting and related information          Using an established framework, with clear
              sharing and gathering powers.                        accountabilities and change processes, will give
              The responsibilities of the COAG Energy Council      businesses and investors the confidence and
              and the Australian Government, as they relate        certainty they need to invest in the long-term
              to the Guarantee, are set out as follows.            and deliver cheaper, cleaner and more reliable
                                                                   electricity for Australian consumers.

1 Introduction
   and next steps
I ntroduction
 and next steps

         1.1 Background to this paper                        1.2 Process
         On 24 November 2017, the COAG Energy Council        Designing the Guarantee has been an iterative
         requested the ESB provide further advice on the     and inclusive process. Inception to final design
         Guarantee.                                          has taken almost a year with input through
                                                             multiple consultation processes.
         The ESB’s high-level design for the Guarantee
         was presented to the 20 April 2018 COAG Energy      The detailed design outlined in this document
         Council meeting. It was agreed that the ESB         builds on:
         would progress development of the detailed          • the model the ESB initially proposed in its
         design of the Guarantee, for determination at the     November 2017 advice
         COAG Energy Council’s 10 August 2018 meeting.
                                                             • the draft design consultation paper published
         The Guarantee comprises changes to the NEM            on 15 February 2018
         and its legislative framework which seek to:
                                                             • the high-level design published on 20 April
         • maintain the reliability of the system              2018, and
         • achieve the emissions reductions required         • the draft detailed design released for public
           from the electricity sector to meet Australia’s     consultation on 15 June 2018.
           overall international commitments, and
                                                             The ESB has benefited greatly from the
         • meet the above objectives at the lowest overall   engagement and feedback from a range of
           costs.                                            stakeholders on the detailed design of the
         This paper sets out the details of how the          Guarantee.
         Guarantee will be structured and work in            • The ESB convened Technical Working
         practice.                                             Groups to advise on certain detailed design
         The electricity emissions reduction target,           elements. The Technical Working Groups were
         trajectory and its subsequent review is the           comprised of a broad range of stakeholders
         responsibility of the Australian Government.          with relevant expertise from more than
         The Australian Government is also responsible         30 organisations.
         for whether external offsets may be used, and       • The draft detailed design was released
         whether EITE load is exempt.                          for public consultation on 15 June 2018.
                                                             • A stakeholder forum was held in Melbourne
                                                               on 2 July 2018.
                                                             • More than 90 submissions on the consultation
                                                               paper were received from a range of
                                                               stakeholders, including a number of retailers,
                                                               generators, and large energy users.
                                                             The ESB thanks stakeholders for their
                                                             participation in the consultation process.

Next steps                                             1.3 Structure of final detailed
    The COAG Energy Council will be asked to agree
    to the final design of the Guarantee mechanism              design paper
    at its 10 August 2018 meeting. Subsequently,           This paper is structured as follows:
    jurisdictions will be asked to approve the release
                                                           • Chapter 2 explains the context for and
    of an exposure draft of the Bill to amend the
                                                             expected outcomes of the Guarantee.
    NEL. Following a four-week consultation period,
    the Bill will be finalised for introduction to the     • Chapter 3 describes the ESB’s detailed design
    South Australian Parliament before the end of            for the emissions reduction requirement.
    2018. The amendments to the NEL deal with              • Chapter 4 describes the ESB’s detailed design
    the mechanism of the Guarantee and the way in            for the reliability requirement.
    which reliability and emissions are considered
    together to achieve the three objectives of            • Chapter 5 outlines the governance approach
    affordability, reliability and emissions reduction.      for the Guarantee.

    Draft rule changes will be presented to the COAG       • Chapter 6 outlines the market modelling
    Energy Council at its April 2019 meeting, after          undertaken to support the analysis in this
    a period of development and consultation. If             paper.
    agreed, these Rules will be made by the South          To make it easier to track how the Guarantee has
    Australian Energy Minister in 2019.                    developed, this paper is set out in a similar way
    The national emissions target and trajectory from      to the earlier papers.
    2020 to 2030, the review points for that target, the
    process for extending targets, and the treatment
    of offsets and emissions-intensive trade-exposed
    industries are matters in the jurisdiction of the
    Australian Government. These matters are
    all dealt with separately in Commonwealth
    legislation, which will be introduced into
    Parliament if COAG agrees to proceed with the
    Some State and Territory governments have,
    or are proposing, emissions reduction schemes
    and programs in their jurisdictions. These
    are matters for those governments and their
    legislation. If the Guarantee is implemented
    these schemes will coexist with it.

2 Context

Fifteen years of climate policy instability has impeded long-term                            “We are broadly supportive of the proposed
investments in the NEM and this has compromised system security and                          National Energy Guarantee design as per the
reliability. It has also impacted electricity prices and added to affordability              draft detailed design consultation paper. We
problems for consumers. As the Finkel Review noted, our energy system                        believe it appropriately addresses stakeholder
has been vulnerable to escalating prices while being both less reliable and                  concerns, while also integrating energy and
                                                                                             emissions policy in a way that encourages
secure. Increased market intervention has been necessary to maintain
                                                                                             new investment in clean and low emissions
the security and reliability of the system and this has further distorted
                                                                                             technologies and a dynamic energy market.”
price signals to producers and consumers. In short, the uncertainty about                    – St Vincent de Paul and South Australian Council
climate change policy has severely damaged the electricity industry and                      of Social Service (SACOSS)4
its household and business consumers. This cannot continue.
                                                                                             “Origin supports the objectives of the NEG to
                                                                                             bring together energy and climate change policy
                           The Guarantee brings together climate and                         and provide a clear investment signal for low
                           energy policy for the first time in Australia. It                 emissions and reliable generation sources at
                           ensures we can meet the electricity sector’s                      least cost to Australian homes and businesses.”
                           share of our international obligation to reduce                   – Origin5
                           emissions, while supporting the reliability of our
                                                                                             “When we saw the draft design… we liked
                           electricity system. Providing long-term policy
                                                                                             what we saw and we decided to invest in more
                           confidence will lower investment risk in the
                                                                                             generation on top of the generation we had
                           NEM and bring down electricity prices.
                                                                                             at that time, so we bought three hydro power
                           Submissions to the ESB’s consultation process                     stations and entered into a bunch of power
                           were widely supportive of the objectives and                      purchase agreements to support new build and
                           design of the Guarantee.                                          that has now translated into lower prices for
                                                                                             our customers… and we are in discussion with
                           “The Business Council believes that the
                                                                                             several parties about long-term contracts to
                           Guarantee will put in place a durable mechanism
                                                                                             support dispatchable power. …
                           that appropriately balances our economic
                           growth, energy security, and environmental                        So the point there is that at least some of the
The Guarantee
                           sustainability.” – The Business Council of                        benefit of the NEG is already built in to the forward
brings together            Australia2                                                        price and consumers are already starting to see
climate and energy                                                                           some of the benefit on their bills. So what that
policy for the first       “In our view, the importance of acting to rebuild
                                                                                             means is if the NEG is not approved – I don’t know
time in Australia.         the confidence of consumers in the sector and
                                                                                             what’s going to happen, but I think it’s reasonably
                           trust in the energy system cannot be overstated.
                                                                                             likely wholesale prices will increase. If wholesale
                           Consumers understand that there is a generation
                                                                                             prices increase, we’ll see some reversals of the
                           “supply” problem, with the ageing of the coal
                                                                                             positive situation we’re in now where we see flat or
                           fired power station fleet, and the need for a
                                                                                             declining price for consumers in the most recent
                           minimum amount of dispatchable energy to be
                                                                                             price changes, and I think that just gets us into
                           available to meet consumer and system needs,
                                                                                             a spiral that I don’t think is healthy for anyone.”
                           in the transition to a lower emissions economy.”
                                                                                             – Ed McManus, CEO of Powershop Australia,
                           – Energy Consumers Australia3
                                                                                             2 July 2018 stakeholder forum

                             Consultation%20Paper.pdf, p.7.
                             Consultation%20Paper.pdf, p.3.
                             Australian%20Council%20of%20Social%20Service%20%28SACOSS%29%20Consultation%20Paper.pdf, p.1.
                           5, p.1.

“EnergyAustralia considers that the main barrier                       These developments have encouraged
    to efficient investment in dispatchable capacity                       deployment of renewable generation in the NEM
    has been the policy uncertainty around emissions                       and these trends are expected to continue.
    reduction. If this is resolved through the
                                                                           The introduction of solar and wind into the
    Guarantee, or another policy, then it will help end
                                                                           NEM at this scale is a challenge that will require
    the paralyses of decision making that confronts
                                                                           adaptations to the existing framework. The
    long term investment and divestment decisions
                                                                           variable nature of wind and solar PV means it
    for assets worth hundreds of millions of dollars
                                                                           cannot be dispatched on demand. This requires
    which have lives of 15-20 years or more.”
                                                                           complementary capacity that is capable of rapidly
    – EnergyAustralia6
                                                                           increasing or decreasing output in response to
                                                                           changes in system demand or output from wind
    2.1 The status quo is not an option                                    and solar PV.

    Until recently, almost all of the NEM’s generation                     Developments in behind the meter technologies
    was supplied by large thermal generators (coal                         including rooftop solar, battery storage and
    or gas), or from hydro. Other forms of generation,                     electric vehicle charging are changing the shape
    such as solar or wind power, were not economic                         of daily demand, resulting in sharper peaks
    without significant subsidies. This is no longer                       and shallower troughs in average time-of-day
    the case. Substantial cost reductions in wind                          demand. This means much sharper increases
    and solar generation have occurred. These cost                         in output from the grid will be required in the
    reductions have been technology driven and have                        afternoon as demand increases and output from
    improved with manufacturing scale.                                     solar PV drops. Over the period to 2030, flexible
                                                                           generation resources that can rapidly ramp up to
    Customer preferences have also changed and                             the evening peak will be critical.
    encouraged increased deployment of wind and
    solar PV. Many large-scale solar and wind projects                     These changes underway in the NEM cannot be
    are underpinned by power purchase agreements                           reversed. They are now more market driven than
    from Australian businesses – reflecting the                            policy driven. The operating procedures and rules
    attractive electricity costs these agreements can                      governing the NEM must also adapt and do so in
    now offer and a preference from some businesses                        a coordinated way that supports the transition
    for low emissions electricity. Voluntary action                        while ensuring electricity is affordable. An
    schemes such as GreenPower and State based                             unstable and uncoordinated policy environment
    renewable schemes add to this demand.                                  exacerbates these issues.

    Nationally, more than 17 per cent of households                        National electricity prices have more than
    have either solar PV or solar hot water or both,                       doubled over the past decade – growing
    with almost 1.9 million small-scale solar PV                           much more rapidly than general inflation and
    systems now installed.7                                                lowering the purchasing power of all Australian
                                                                           households, especially the most vulnerable
    Recent increases in export coal and gas prices have                    (Chart 1). While much of the price increase over
    added to the challenges for thermal generators                         the past 10 years has been caused by network
    making it more difficult for these technologies to                     or retail pricing, the more recent increases have
    compete. In the last two years thermal coal export                     been largely attributable to increased wholesale
    prices, for example, have increased from around                        prices. These price increases have also been
    $73 per tonne to around $115 per tonne,8 and                           an impost on Australian businesses, potentially
    between 2015 and 2018 gas-fired generators’ fuel                       undermining their international competitiveness
    costs have risen from almost $5 per gigajoule to                       and weighing on economic growth.
    around $8 per gigajoule.9

    Chart 1: Cumulative increase in the price of Australian consumer goods
    120    Cumulative percentage
    110                                                                                  Electricity
           increase in nominal prices
     50                                                                                Average of all
     40                                                                                consumer
     30                                                                                goods
      Mar 08         Mar 10         Mar 12                         Mar 14             Mar 16              Mar 18
    Source: Australian Bureau of Statistics, Catalogue Number 6401.07

    6, p.11.
    7   Clean Energy Regulator Postcode data for small-scale installations and ABS 6523.0 - Household Income and Wealth, Australia, 2015-16.
    8   Resources and Energy Quarterly – June 2018, Department of Industry, Innovation and Science.
    9   ACCC Retail Electricity Pricing Inquiry—Final Report (2018), p.71.

The Australian Competition and Consumer                                 Increased contracting in deeper and more liquid
                      Commission’s (ACCC) recently released Retail                            contract markets is expected to reduce the level
                      Electricity Pricing Inquiry—Final Report10 is a                         and volatility of spot prices.
                      comprehensive study into the drivers of retail
                                                                                              The Guarantee has been specifically designed
                      electricity prices with a wide-ranging package
                                                                                              to ensure it does not undermine but rather
                      of recommendations to reduce prices. The
                                                                                              enhances the liquidity, transparency and the
                      ESB welcomes this report and looks forward
                                                                                              level of competition in the retail and wholesale
                      to working with the COAG Energy Council to
                                                                                              electricity markets.
                      consider how these recommendations are best
                      responded to and implemented. A cornerstone
                      of the ACCC’s recommendations to reduce                                 2.3 Reducing electricity prices
                      wholesale electricity prices is the adoption and
                      implementation of the Guarantee.
                                                                                                   and improving affordability
                                                                                              In the advice presented to the COAG Energy
                      Lowest cost outcomes for consumers will be
                                                                                              Council in November 2017, the ESB included
                      achieved by creating a stable policy environment
                                                                                              initial estimates of the effects of the Guarantee
                      which appropriately values an optimal mix of
                                                                                              based on detailed market modelling.
                      capacity and creates clear incentives for the
                      private sector to deliver it.                                           This section presents updated estimates of the
                                                                                              effects of the Guarantee, reflecting the final
                                                                                              policy design as well as developments in the
                      2.2 Longer term price signals at                                       NEM over the past nine months. The updated
                           the heart of the Guarantee                                         modelling results are detailed further in
                                                                                              Chapter 6.
                      Spot market prices for electricity are for the
                      very near-term, that is, the next 30 minutes.                           Current high wholesale electricity prices, as
                      In contrast, the agreements struck between                              well as the Australian Government’s Renewable
                      retailers and generators in the contract market                         Energy Target (RET) scheme, have incentivised
                      have a much longer-time horizon, sometimes                              a large pipeline of renewable generation. Already
                      spanning many years.                                                    committed projects and the first stages of the
                                                                                              Victorian Renewable Energy Target (VRET) and
                      The Guarantee addresses the market for
                                                                                              Queensland Renewable Energy Target (QRET)
                      wholesale electricity contracts. Derived from
                                                                                              schemes means that around 7,800 MW of
                      market expectations of future spot prices, these
                                                                                              large-scale wind, solar and battery capacity
                      contract markets focus on the longer term and
                                                                                              is expected to be added to the NEM between
                      deliver key signals for new investment.
                                                                                              2018-19 and 2020-21.
                      The NEM is designed so that price signals provide
                                                                                              But a failure, again, to agree and implement
                      the necessary information for market participants
                                                                                              an integrated energy and climate policy will
                      to make investment or retirement decisions
                                                                                              be disruptive and could result in a continued
                      concerning their physical assets and their
                                                                                              and potentially extended environment of policy
                      efficient operation. These price signals are borne
                                                                                              uncertainty. In this environment, it is reasonable
                      out in wholesale spot market outcomes and
                                                                                              to assume that only those projects currently
                      financial contract markets, both of which provide
                                                                                              financially committed would proceed to build.11
                      participants with strong incentives to deliver
                                                                                              In an environment of continued policy uncertainty,
                      electricity when it is needed. If participants fail
                                                                                              it is also reasonable to assume that financing
                      to manage their financial exposure to either low
                                                                                              costs and the associated hurdle for new
                      or high spot prices or make a poor investment
                                                                                              investment will be higher than under the
Lowest cost           decision (for example, in a new generator that
outcomes for          is under utilised), they alone face the financial
consumers will        consequences, not consumers or taxpayers.                               Chart 2 outlines the expected build profile over
be achieved by                                                                                the years to 2030 should the Guarantee not
                      The Guarantee builds on the existing pricing and
                                                                                              proceed. Only new-build projects that have
creating a stable     risk management frameworks used in the NEM
                                                                                              reached financial close or that will be funded
policy environment    to signal the need for investment in new sources
                                                                                              under Stage 1 of the VRET or QRET are expected
which appropriately   of generation.
                                                                                              to be constructed in the short-term. The
values an optimal     Market participants are expected to contract                            Australian Government’s Snowy 2.0 project is
mix of capacity       in a variety of ways to meet both the emissions                         anticipated to commence generation in
and creates clear     reduction and reliability requirements. Through                         2023-24. Some black coal generation is expected
incentives for        their contracting, market customers will                                to withdraw in line with announced closures or
the private sector    support a range of different generation and                             key contracting and technical milestones. Rooftop
to deliver it.        demand-side technologies. This will result in                           solar PV is expected to continue to expand
                      increased contracting levels, which in turn will                        through to 2030 in line with AEMO forecasts.
                      create deeper and more liquid contract markets.

                      10		 Available at
                      11 This estimate is consistent with the ESB’s market intelligence and supported by stakeholder submissions to the policy development process,
                         see for example the Powershop and EnergyAustralia comments published at the begining of this chapter.

Chart 2: Change in NEM generation capacity by fuel type without the Guarantee

                       5      GW, year on year change

                                           Utility solar
                                                      Wind                  Snowy 2.0              Rooftop solar
                            Liquid fuel               Gas
                       -1                                                            Black
                                                                                                   QLD black coal
                                                                   Black coal        Coal
                       -2                                          (Liddell)
                            18-19 19-20 20-21 21-22 22-23 23-24 24-25 25-26 26-27 27-28 28-29 29-30

                      Source: ACIL Allen consulting

                      The continued connection of additional renewable generation projects to the NEM in coming years is
                      projected to see prices fall from today’s elevated levels (Chart 3). The modelled short-term wholesale
                      price reductions are comparable to those currently implied by futures contracts.

                      Chart 3: NEM wholesale prices without the Guarantee

                      100    real 2018 $ / MWh
                                                                                              Current futures
                       80                                                                     pricing
                                                                                           NEM wholesale prices
                       30                                                                  without the Guarantee
                               NEM wholesale prices
                       20                                                                  (modelled)
                        99-00 02-03 05-06 08-09 11-12 14-15 17-18                            20-21 23-24 26-27 29-30

                      Sources: ACIL Allen Consulting, ASX Energy futures, ABS Catalogue 6401.0, AEMO, Energy Security Board

                      While the closure (as announced) of the Liddell          The Guarantee will lower prices in five key ways:
The Guarantee         coal-fired power plant in NSW in 2022-23 puts            • policy stability unlocking new investment
will provide          some upwards pressure on prices, in NSW in
stakeholders with     particular, the addition of around 2,000 MW of           • policy stability reducing the risk (and therefore
policy confidence     capacity with the completion of the Australian             the cost) of new investments
by comprehensively    Government’s Snowy 2.0 pumped hydro project              • increased contracting unlocking new
integrating energy    in 2023-24 is expected to extend this period of            investment
and climate policy    lower prices. However, prices are expected to
                                                                               • contract markets becoming deeper and more
                      rise again over the decade as the supply-demand
to guide an orderly                                                              liquid and reducing the level and volatility of
                      balance tightens and real gas prices are assumed
transition for the                                                               spot prices, and
                      to rise. Little further investment is required
electricity sector.   before 2030 under this scenario which assumes            • increased voluntary demand response.
                      no unexpected closures of major thermal
                                                                               The Guarantee will provide stakeholders with
                      plant. There is a further slight increase in the
                                                                               policy confidence by comprehensively integrating
                      price trajectory in 2029-30 associated with the
                                                                               energy and climate policy to guide an orderly
                      modelled withdrawal of some black coal capacity
                                                                               transition for the electricity sector. This will assist
                      in Queensland.
                                                                               in bringing forward additional new investment
                                                                               and reduce the cost of capital of those new

Through their contracting, retailers will support                         in contracted time-periods. In this way, higher
     a range of different generation and demand-side                           levels of long-term contract cover also slightly
     technologies to meet the emissions reduction                              mitigate the risk of short-notice generator
     and reliability requirements of the Guarantee at                          closure.
     the lowest possible cost.
                                                                               The incentives and structures created by the
     Increased long-term contracting is expected                               Guarantee are also expected to accelerate the
     to further lower prices under the Guarantee                               development of the demand-side response
     as all market customers (mostly retailers)                                market. This will give the NEM additional,
     will be required to have a reliable level of firm                         potentially-lower cost, ways to respond to peaks
     contracts in place at key times. This will lead                           in demand.
     to more competitive bidding in the spot market
                                                                               In aggregate these aspects of the Guarantee
     as generators reduce their bids to increase
                                                                               are expected to place significant additional
     their chances of being dispatched to cover
                                                                               downwards pressure on prices. NEM-average
     their contracted capacity.12 Generators with
                                                                               wholesale prices are, on average, expected to be
     high levels of long-term contracts in place face
                                                                               over 20 per cent lower over the 2020s under the
     strong financial incentives to be able to generate
                                                                               Guarantee than without it (Chart 4).

     Chart 4: NEM wholesale prices under the Guarantee

     90        real 2018 $/MWh

                                                                      Without the Guarantee
     30                                                                             With the Guarantee
       17-18 18-19 19-20 20-21 21-22 22-23 23-24 24-25 25-26 26-27 27-28 28-29 29-30

     Source: ACIL Allen consulting

     Lower wholesale prices are expected to lower                              over the 2020s relative to 2017-18 with network
     bills for all consumers. The average NEM-connected                        costs held constant in real terms. Of this, nearly
     household is estimated to save around $550                                $150 per year (real $2018) of projected savings is
     dollars a year (real $2018) on their retail bill                          directly attributable to the Guarantee (Chart 5).

     Chart 5: Forecast average retail bill savings relative to 2017-18 for NEM-connected households
     under the Guarantee

     700        real 2018 $ / annum
                                                                                    Additional savings expected
                  Savings expected                                                  under the Guarantee
                  even with no
     500          policy





              18-19 19-20 20-21 21-22 22-23 23-24 24-25 25-26 26-27 27-28 28-29 29-30

     Source: ACIL Allen consulting

     12 A generator typically offers contracted capacity at marginal cost (save for below marginal cost bids in respect of a minimum level
        of generation required to safely continue operation) and offers remaining capacity to maximise net revenues.

The price savings from the Guarantee are             hydro project in 2023-24 is projected to put
                     expected to be broad-based, with all NEM             further downward pressure on prices, broadly
                     jurisdictions expected to benefit from lower         offsetting the price effects of Liddell retiring
                     electricity prices as a result of the Guarantee.     and extending a period of lower prices. Some
                     These savings are not directly comparable with       Queensland black coal generation is projected
                     the estimated bill savings in the ACCC’s recent      to withdraw in line with key contracting and
                     Retail Electricity Pricing Inquiry—Final Report –    technical milestones around 2029-30 which
                     the estimated savings differ in scope and the time   causes a further slight increase in the modelled
                     periods compared.                                    wholesale price trajectory in Queensland at
                                                                          this time. The modelling suggests that under
                     Wholesale prices are projected to fall in all NEM
                                                                          this scenario, it will not be profitable for some
                     jurisdictions relative to 2017-18. Additional
                                                                          Queensland black coal capacity to undergo
                     committed supply and moderation in coal prices
                                                                          necessary refurbishments in 2029-30, a time
                     are projected to put downwards pressure on
                                                                          which coincides with the expiration of a major
                     prices even without the Guarantee (Chart 6).
                                                                          power purchase agreement. However, the
                     The closure (as announced) of the Liddell
                                                                          modelling does not consider the potential for
                     coal-fired power plant in NSW in 2022-23 puts
                                                                          particular commercial arrangements to be
                     some upward pressure on prices particularly
                                                                          extended or assess the additional value that
                     in NSW. However, the replacement capacity
                                                                          the flexibility of this type of plant might attract.
                     announced by the ownership of Liddell together
                                                                          As with any modelling, particularly over such
                     with the addition of around 2,000 MW of capacity
The price savings                                                         long time horizons, this should not be read as a
                     with the completion of the Snowy 2.0 pumped
                                                                          prediction of future events.
from the Guarantee
are expected to
be broad-based,      Chart 6: Wholesale regional reference prices without the Guarantee
with all NEM
                              real 2018 $ / MWh
jurisdictions         140
expected to                                                                               South Australia
benefit from lower    120
                                                                                       New South Wales
electricity prices                                                                  Victoria
                      100                                                         Tasmania
as a result of the
Guarantee.                                                                      Queensland




                         17-18 18-19 19-20 20-21 21-22 22-23 23-24 24-25 25-26 26-27 27-28 28-29 29-30
                     Source: ACIL Allen consulting

Wholesale prices are forecast to be lower in all NEM jurisdictions under the Guarantee than in its
     absence (Chart 7).

     Chart 7: Projected jurisdictional wholesale price outcomes

                        New South Wales                                        Queensland

               Real 2018 $ / MWh                            100   Real 2018 $ / MWh

         80                                                  80

                                     No policy                                         No policy
         60                                                  60

         40                                                  40

                                   Guarantee                                              Guarantee

         20                                                  20

          0                                                   0

                         South Australia                                        Tasmania
        100    Real 2018 $ / MWh                           100     Real 2018 $ / MWh

         80                                                 80
                               No policy
         60                                                 60                    No policy

         40                    Guarantee

         20                                                 20

          0                                                  0

                              Victoria                                                NEM
        100   Real 2018 $ / MWh                             100    Real 2018 $ / MWh

         80                                                  80

                              No policy                                                No policy
         60                                                  60

         40                                                  40
                              Guarantee                                                Guarantee
         20                                                  20

          0                                                   0

     Source: ACIL Allen consulting

2.4 Managing reliability risks                                           The reliability requirement is designed to
A portfolio of                                                                                 ensure that a portfolio of dispatchable power
resources is          The reduction in dispatchable coal-fired                                 is available when required as the system
required so           generation and the greater penetration of                                transitions. Increased contracting will also
                      variable renewable technologies such as                                  reduce the likelihood of unexpected closures.
that when wind
                      solar and wind generation present risks to                               For generators, greater levels of contracting will
and solar are
                      the reliability of our electricity supply.                               have the effect of increasing their commitment
not available,
                      Historically, most of the installed generation                           to future generation – as a failure to generate
alternative sources                                                                            at times they are contracted would leave them
of power can be       capacity has been dispatchable (that is, able to
                      generate as required) provided by coal, gas and                          exposed to significant financial risk. Transferring
dispatched.                                                                                    such liabilities is costly, and so being in a largely
                      hydro-electric plants. Provided these generating
                      units have sufficient fuel (that is, coal, gas,                          contracted position would increase a generator’s
                      stored water) and their operational positions                            incentive to keep the plant well-maintained
                      allow it – and assuming no unexpected outages                            and to quickly take action to respond to any
                      or transmission constraints – they can be called                         unplanned outages. The reliability requirement is
                      upon by AEMO to increase or decrease their                               expected to work in combination with the three-
                      output at any time in a predictable manner, given                        year notice of closure rule recommended by the
                      enough notice.                                                           Finkel Review to ensure market decisions are
                                                                                               made in a more orderly fashion.13
                      However, as Australia’s ageing generators retire
                      they are being replaced by cheaper variable                              The Guarantee also incentivises a more
                      renewable alternatives or increased output from                          developed demand response market, financially
                      gas-fired power stations.                                                rewarding action by consumers, which will aid
                                                                                               reliability and capture value for consumers who
                      The proportion of available dispatchable                                 choose to participate.
                      generation capacity in the NEM is therefore
                      declining. While some new wind and solar                                 Neither the risk nor the effects of unanticipated
                      investments in Australia are seeking to make                             outages or closures should be underestimated,
                      themselves dispatchable by co-locating with a                            especially as the share of dispatchable
                      battery or storage such as pumped hydro, this                            generation in the NEM decreases. Without
                      is not true for the majority of these resources.                         the Guarantee, the market will have a less
                      Therefore, a portfolio of resources is required                          coordinated response to unanticipated events,
                      so that when wind and solar are not available,                           and such disruptions could increase prices and
                      alternative sources of power can be dispatched.                          threaten reliability as has been seen over the
                                                                                               past few years.

                      13 The Finkel Review recommended that generators in the NEM be required to give at least three years’ notice to the market prior to closure
                         to support an orderly transition. The COAG Energy Council endorsed this recommendation on 14 July 2017 and the rule change request is
                         currently being considered by the AEMC:

Case study: The closure of the Northern Power station in
        South Australia
        The Northern Power Station (Northern) was a 540 MW coal fired generator located near Port
        Augusta in South Australia that had historically provided up to 40 per cent of the region’s
        electricity. In October 2015, Alinta announced it would be closing Northern in just five months’
        time, bringing forward the closure date by two years, due to an increasingly challenging
        operating environment and failure to secure support to remain open.
        At the time of its retirement, Northern was over 30 years old, though not yet at the end of its
        operational life. However, the mine that supplied the power station was running out of quality
        coal and the mine would have required significant capital-intensive augmentation to continue
        operation. Over the previous four and half years, Alinta had reportedly invested $200 million to
        extend the operating life of the generator. The key reasons for the difficult trading conditions
        faced by Northern included reduced electricity demand (partly driven by the uptake of rooftop
        solar PV) and increased competition from zero marginal cost variable renewable energy
        generation in South Australia.
        Prior to the closure, Alinta was reportedly seeking to secure customers (particularly commercial
        and industrial users) via long-term energy off-take agreements for the coming years to ensure
        Northern’s continued operation. The prices sought for these contracts, while likely higher than
        what commercial and industrial users were expecting to pay if they had otherwise remained
        exposed to the wholesale spot price, look very good value in hindsight.
        The closure of Northern in May 2016 resulted in a substantial reduction in supply in energy
        and ancillary service markets, and in contract market liquidity in South Australia. Contributing
        factors to these increased wholesale prices included a greater reliance on gas generators
        at a time when gas prices were increasing on the east coast, interconnector constraints, as
        well as limited availability of existing gas-fired generators due to mothballing. Had Northern
        successfully secured customers via long-term contracts, it is likely that it would have continued
        to operate through 2016 and 2017.
        Following the closure of Northern, the majority of new generation capacity constructed in South
        Australia has been variable renewable energy. As variable renewable energy traditionally does
        not offer firm contract products, this has not improved contract liquidity in the region.

        Counterfactual scenario
        Drawing on AEMO’s observation in its Integrated System Plan that a key element of a least cost
        approach to support an orderly transition of the energy system sees coal generators maintained
        until the end of their technical lives, a counterfactual scenario was modelled where Northern
        continues operating beyond May 2016 to assess the potential wholesale price outcomes.
        The Guarantee is intended to increase long-term contracting and help lessen the likelihood
        of unexpected sudden and early exits, where reliability is identified to be at risk. Increased
        contracting will incentivise generators to defend their sold contract positions or face significant
        financial liabilities. The reliability obligation will reinforce the value of firm contracts in times
        and regions when supply of these contracts is at risk of becoming scarce.
        The modelled price outcomes over the period May 2016 to December 2017 suggest that
        wholesale prices would have been materially lower than those observed over the period. This
        is particularly evident in the winter of 2016, where a series of high price events significantly
        drove up average wholesale spot prices, and in the first half of 2017 where the supply-demand
        balance was very tight. The average wholesale price in the counterfactual scenario is around
        $79/MWh compared with the actual price observed of $102/MWh (representing a 23 per cent
        reduction) (Chart 8).

The Guarantee can          Chart 8: South Australian wholesale prices in 2016 and 2017
also accommodate
different levels
                              $250        Nominal $/MWh
of ambition over
time, and work with
State and Territory           $200
schemes to create
greater confidence            $150                                                                                 Actual
for the industry.


                                $50                                                                            Counterfactual

                                   Jan 16         Apr 16         Jul 16        Oct 16        Jan 17         Apr 17        Jul 17        Oct 17

                           Source: ACIL Allen Consulting, AEMO actuals

                           These higher wholesale prices flowed through the residential retail bills over the 2016 and 2017
                           period. A conservative estimate of the impact on typical South Australian residential retail bills
                           of the higher wholesale spot prices would be in the order of $200 to $250 for 2016-17.
                           In this counterfactual scenario, the continued operation of Northern displaces gas-fired
                           generation in South Australia, and also reduces the reliance on imported energy from Victoria.

                      2.5 Reducing emissions                                                 expected that cumulative emissions over the
                                                                                             decade will not reduce enough for the NEM to
                      The Australian Government has proposed to set                          meet its share of the national target (Chart 9).
                      an emissions reduction target for the electricity
                      sector consistent with achieving a 26 per cent                         The emissions reduction requirement is designed
                      reduction on 2005 levels by 2030.                                      to ensure that the NEM evolves in a manner
                                                                                             that is consistent with the undertakings given
                      The currently committed pipeline of new                                by Australia under the Paris Agreement. The
                      renewable generation is expected to make a                             Guarantee can also accommodate different levels
                      substantial contribution to lowering emissions in                      of ambition over time, and work with State and
                      the NEM and the amount of additional abatement                         Territory schemes to create greater confidence
                      required. Annual NEM emissions are expected                            for the industry.
                      to fall by over 15 MtCO2-e between 2017-18 and
                      2020-21 reflecting the significant volume of                           The Guarantee is expected to deliver the
                      renewable energy committed to connect to the                           emissions reduction target for the NEM, with an
                      NEM over this period. By 2020-21, emissions in                         additional 38 MtCO2-e abatement over 2020-21
                      the NEM are expected to be around 24 per cent                          to 2029-30 relative to a scenario without the
                      below 2005 levels.                                                     Guarantee. The flexibility allowed by the carrying
                                                                                             forward of over-achievement and deferral
                      But without a specific policy commitment to                            between years will assist in lowering overall
                      achieve emissions reductions in the NEM, it is                         abatement costs.14

                      14 The modelling imposed a cumulative target for 2020-21 to 2029-2030 of around 1,320 MtCO2-e, consistent with the NEM achieving
                         a 26 per cent reduction on its historical 2005 emissions.

You can also read
NEXT SLIDES ... Cancel