What will fix Australia’s electricity market (and what won’t)?

I won’t be telling readers anything new to say Australia’s national electricity market (NEM – which operates the east coast grid from QLD to SA) is broken. Every newspaper and TV headline has been shouting that message. The market has been suspended by AEMO (the market operator). This suspension was triggered by the deteriorating function of the market – including in the days before the suspension, the need for AEMO to constantly direct market participants outside the normal dispatch process. The market was also experiencing daily Lack of Reserve (LOR) warnings as extensive coal outages, record gas prices, arcane market rules and a winter cold snap combined to the leave the east coast short of electricity.

While many things are to blame for the crisis, I am reminded of the old adage of to “Never waste a crisis”.

All sorts of groups – each with their own agendas – are coming forward with suggestions about what to do to fix the NEM. It is always important to judge these solutions against the vested interests of the party suggesting them.

However, this is my take on the current crisis.

Let’s start with a list of things that won’t fix it:

- Capacity markets. This can’t make any difference in next one or two years. If we wanted this, we should have done it five years ago! We need to be very careful about paying capacity payments for capacity that isn’t actually delivered. Under the current market structure, a coal plant which is broken is potentially losing its owner in opportunity or direct costs of $14,000/MWh while it is broken. That is an incredibly strong incentive to get coal plants back online. Most capacity market designs have lower caps on spot prices (eg the cap in WA is $290/MWh compared to $14,000/MWh for the NEM). This actually means there are weaker incentives for plant operators to ensure availability, not stronger. There is a difference between being paid to exist (which is what a capacity payment ends up being) and a penalty for not operating when needed (which is what high current spot prices are providing).

- Gas reservation policy. This would just be a wealth transfer from exporters to domestic users. Australia is a nation of exporters – how will we maintain the high moral ground on trade issues if we do this? Australia needs to transition, and high prices is part of what drives that transition. It’s not in our long-term interests to hide from high gas (and fossil fuel) prices behind a trade wall.

- Building new coal plants. Too slow, too expensive (fuel and capital cost), too polluting. Building a new coal plant is trying to fix a short-term problem with a medium-term stranded asset.

- Building nuclear plants. Too slow, too expensive, too inflexible. Nuclear is baseload and we don’t need baseload in a world of cheap renewables. Maybe nuclear does make sense for countries with an established well-regulated industry (and who can manage the waste/safety risks) and who can’t access sufficient cheap renewables – but that is not Australia.

List of things that could help:

- Rooftop solar. This would be a small positive, but actually one of the quickest sources of new supply (ie individual installations only take a day or two). However, need to be smart, there are some suburbs that are saturated and so this isn’t open to everyone everywhere.

- Household batteries and EVs. Anything that makes demand more flexible will be a long-term positive. Flexible demand is the equivalent of dispatchable supply. Need to start building this into regulatory frameworks that flexible demand should be able to benefit from lower costs.

- Clear policy including specific climate objective in national electricity rules. Our planning framework would be much simpler (and improved) if we started with an explicit orderly shutdown strategy for all coal plants. That is, start with a plan to shut all coal plants (which is the best strategy from a long-term cost and environmental perspective) and then work out an orderly process for all the things needed to replace this capacity (ie more renewables, more transmission, more storage). If we have learnt one thing in the last few months – it is the simple fact that we need the replacements for coal plants to be in place before we shut them, not after.

- Time. Broken coal plants will come back online (and several units have come back in the last few days). Winter will end – and Spring is a period of abundant supply from renewables. This should materially reduce pressures. However, while ever international coal/gas prices are at sky-high levels we should expect expensive electricity in Australia. Ultimately the solution is building more renewables which will take two or three years. However, let us not screwup the medium and long-term as part of the desperate search for a short-term fix (eg capacity payments for coal plants anyone).

None of the above is new, and some of it is certainly challenging (with any policy there are winners and losers), but until there is clarity in the investment environment, it will slow the transition and have unintended consequences (as we are currently experiencing!).