Adding colour to the NEG: public consultation underway on the design of the National Energy Guarantee - Environmental Law

Up until now, the Federal Government's long-awaited response to the Finkel Report, the National Energy Guarantee, has remained a skeleton policy with much of the 'colour' and key details to be filled in.

However, shape and form has now begun to emerge with the release of the Energy Security Board's (ESB) Draft Design Consultation Paper on 15 February 2018 (the Paper). Charged with the considerable task of developing the design and implementation plan for the NEG, the ESB has produced a number of design options for public consultation. This presents a key opportunity for businesses to have their say on the design of the NEG and other operational issues.

Some key themes emerge in the Paper:

The NEG scheme must be flexible: This is reflected in the options proposed by the ESB in relation to compliance and enforcement.
The urgency of the task: it is proposed that COAG will make a decision on the final design of the Guarantee in the second half of 2018, at which time legislation and rule drafting will commence. The emissions requirement will be implemented in 2020, and the reliability requirement process will commence in 2019.
The preference for the NEG scheme to fall within existing governance and legislative arrangements: ESB's preferred option is for COAG Energy Council agreement with implementation thought amendments to the AEMA, NEL and the National Electricity Rules (NER).
Assessment of the impact of the Guarantee on competition to be deferred: The ESB's view is that whilst it is important that the design of the Guarantee does not unintentionally entrench market power and create barriers to entry for smaller participants, it says that consideration of these issues should be deferred until the Guarantee is further developed.

Below, we summarise the key elements in the Paper regarding the proposed design of the NEG, and provide some analysis that may be useful to businesses formulating their submissions to the ESB.

NEW DETAILS ON THE NEG ARISING FROM THE ESB'S CONSULTATION PAPER

Who is responsible for meeting obligations under the NEG?

It is proposed that the obligations under the NEG will apply to anyone who is a "Customer" under the National Energy Law (NEL), namely electricity retailers and each large energy user registered under the NEL.

In relation to the reliability requirement, the Consultation Paper raises the possibility that obligations may be imposed on all large commercial and industrial users as opposed to "Customers" under the NEL. This approach would be legally difficult to achieve if the NEG is to be implemented by way of amendments to the NEL and NER as is currently proposed by the ESB.

It is also suggested that electricity sold or used for the purposes of emissions intensive trade exposed (EITE) activities would be exempted from the emissions requirement but not the reliability requirement. The rationale provided by the ESB is that a reliability exemption given to EITE businesses creates a risk that reliability across the market will be impacted (for example if an EITE activity chose to contract with a portfolio of renewable generators with the effect that there is not sufficient dispatchable capacity to meet demand when renewable output is low but demand is high).

A critical outcome of any exemption of EITE activities from the emissions requirement is that the participants in the NEG will need to 'make up the difference' to achieve the desired level of emissions reductions, thereby effectively cross subsidise EITE businesses.

How is the emissions requirement met?

Each Customer will be required to meet an average emissions intensity for MWh purchased on the wholesale spot market in the compliance year. The Customer's average emissions intensity would be derived from their contracts to procure MWh from generators.

These contracts could either specify a generation source (from which one can relatively easily calculate emissions per MWh based on type of generation) or simply specify the emissions per MWh but not a generation source. The latter will need to be supported by evidence, for example through records of each MWh generated by a relevant plant. The third option is where a contract does not specify either a generation source or emissions generated, in which case a deemed emissions mechanism will need to apply. By way of example, this could be done by applying a regional emissions average.

How will enforcement be achieved?

The Consultation Paper suggests a range of flexible compliance options should apply, such as carrying forward overachievement of emissions targets from previous years, deferring compliance, or the use of offsets such as Australian Carbon Credit Units (ACCUs) or international carbon credits.

Failure to comply with any of the flexible compliance options would trigger the AER's existing suite of compliance mechanisms such as administrative undertakings, infringement notices, enforceable undertakings, instituting civil proceedings resulting in injunctions or civil penalties, suspending or revoking authorisation.

The reliability requirement

The ESB sets out an 8 step process for delivering on the reliability requirement.

It is proposed that, to ensure there is enough electricity supply to meet peak demand in the NEM, AEMO will forecast whether the reliability standard is likely to be met or not in any NEM region over a forecast period. The ESB expect that, if AEMO identifies any such gap in a forecast period, the market will respond by investing in new capacity or offering additional existing capacity to the market.

At a particular point prior to the forecasted gap occurring the reliability requirement will be triggered, and Customers under the NEL (or otherwise large commercial and industrial users) will be required to demonstrate they have entered into sufficient 'eligible' contracts to cover their share of the peak demand requirement

Should it appear to AEMO that a supply gap will occur despite the above measures, AEMO is able to act as a 'procurer of last resort' and can procure the resources to fill any remaining gap in the market. It is unclear if this is a reference to the 'Strategic Reserve' that AEMO has procured through the Reliability and Reserve Trader process.

How is reliability enforced?

In the case of non-compliance with the reliability requirement, the ESB has suggested that penalties will apply. The ESB favours an approach that aligns penalties with the cost of the AEMO centrally procuring resources to meet the supply gap. In the case of significant or repeated failures to comply, the AER's usual suite of enforcement options will apply.

Some key design issues that businesses may wish to consider in their submissions on the NEG:

Interactions in a shifting energy policy landscape
The NEG is being developed at a time of dynamic shifts in Australia's energy market. In order to provide the market with clear investment signals and stability, the ESB will need to ensure that its design provides further clarity regarding how the NEG will interact with the rest of the energy landscape, particularly the Finkel Report, the 'Strategic Reserve' procured through the Reliability and Emergency Reserve Trader process, the Safeguard Mechanism (which provides for a single electricity sectoral emissions baseline that, if exceeded, triggers a requirement for individual generation facilities to reduce their emissions) and the various state renewable energy targets and supporting state-based mechanisms.

Market Certainty and the Timing Challenge
The need for regulatory certainty will be challenging in the context of international emissions reduction commitments. The NEG will need to incorporate some degree of flexibility so that emissions targets can be revised if necessary. Too much flexibility will, of course, stifle investment in the market, but this effect can be mitigated by building in requirements for longer lead times for policy changes to take effect.
The ESB have suggested that emissions abatement targets should be set for a minimum of five years which aligns with the requirement under the Paris Agreement for each country to reset its "nationally determined contributions" (NDC) every five years. It is intended that the Commonwealth Government will initially set an emissions target trajectory for ten years, from 2021 to 2030. To provide further investment certainty, future changes to emissions abatement targets will have a minimum 5 year lead time. Such long timeframes run the risk that Australia will lock itself into emissions abatement trajectories that are too low, and will be unable to correct prior to the end of each relevant NDC period.

A key challenge, which is recognised by the ESB, is managing the timing of the AEMO forecast, the updating of that forecast and the triggering of the reliability requirement. The proposals are that the forecast horizon be between 2-3 and 10 years, and that the trigger could be short term (3 months to 1 year ahead of the gap) or long term (ie 3.5 years ahead of forecast gap). The design must ensure that the market can respond sufficiently quickly to forecasted gaps under the reliability requirement. In its own way, the pricing mechanisms in the wholesale spot market already operate to incentivise generators to increase supply as 'supply gaps' emerge. However, the market has historically reacted slowly, which is not surprising given the long lead times involved in financing and delivering the infrastructure required. Whilst the design of the Guarantee is intended to be transparent, it is not clear what transparency will apply to responses to any reliability gap. Will a retailer wait to see if another retailer invests in additional generating capacity? Will retailers be able to aggregate or group together for the purposes of responding to a forecasted gap?

Clarifying what constitutes 'reliable' energy generation
Key concepts such as 'reliability' and 'dispatchability' still remain undefined. However, the ESB Consultation Paper indicates that Customers will be able to fulfil reliability targets by ensuring that a required proportion of procured MWh is sourced from particular types of sources 'deemed' to be dispatchable. The ESB has indicated that system security issues will not be dealt with under the NEG. In other words, it appears that it will not be necessary to enquire into the actual performance of those generation sources. For example, contracting for a requisite proportion of MWh from gas, coal or battery generation sources will presumably meet the reliability requirement irrespective of whether those sources performed reliably in reality. Some may argue this is a counter-intuitive result in light of the performance of aging coal and gas infrastructure across the country, particularly in extreme weather events. By way of illustration, it was found that during a heatwave in February 2017, 14% (3600MW) of coal and gas generation across the NEM failed during peak critical demand periods as a result of faults.¹

Non-NEM jurisdictions
The NEG will apply only to the National Electricity Market (NEM), which does not include Western Australia or the Northern Territory. As a result, the efficacy of the NEG as a national energy policy, and even more so as a climate change policy, is severely curtailed. Could a similar pro-rata emissions abatement mechanism be imposed on the non-NEM jurisdictions for their own electricity markets?

Costs of Compliance and pass through
In the context where affordability is a key driver underpinning the NEG, the ESB will need to take care that the NEG is not unduly complex or lead to high compliance costs. At a minimum, compliance costs should not outweigh any downward pressure on electricity prices. The ESB has suggested for example that large users registered as a Customer should be subject to a different level of compliance and reporting requirements.
To the extent that electricity prices fall, the ESB should ensure that retailers pass on all cost savings to consumers. Some measure of oversight may be required, as occurred when in 2014 when the ACCC was given powers to ensure cost savings from the carbon tax repeal were not retained by businesses.
Should costs in fact rise, who ought to bear those costs? In the normal course of events, it would be expected that any increased costs to retailers would be passed through to consumers. Thought should be given to whether costs should be allowed to flow through, or if they should be borne by other parties and if so who? If costs are to borne by consumers then those flow-throughs must be transparent and monitored.

ACCUs and a secondary market
The ESB has suggested that the purchase and surrender of offsets such as ACCUs or international carbon credits may be used to achieve compliance with the emissions requirement. Whether offsets should form part of the NEG will be primarily determined by the Commonwealth Government.

Should offsets be available, it is possible that a limit will be imposed on the volume of offsets that would be used to achieve compliance across the NEM for the compliance year. The use of ACCUs should be encouraged as tradeable emissions abatement credits generally allow for emissions to be reduced in the most efficient and cost-effective way across the economy. Should this occur, the ACCU market will need to be strengthened and supported in Australia.

Corrs has a depth of public and private sector experience in the electricity industry and renewable energy sector, and is well-placed to help you formulate your submissions to the ESB. Submissions on the consultation paper close on 8 March 2018.

Footnote

¹The Australia Institute, " Can't Stand the Heat" (Nov 2017)

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.