UCL Australia
Presentation to the Nuclear Engineering Panel
Engineers Australia (Sydney), 27 March 2013
Is the National Electricity Market impeding the effectiveness of energy-sector
policies designed to mitigate climate change through long-term investment in lowcarbon technologies?
ABSTRACT
Prior to market liberalisation, the Australian electricity sector comprised state-based vertically-integrated
monopolies, with largely capacity-driven investment, average cost pricing, and consumers (i.e. tax payers)
bearing market risks. However, since market liberalisation investment and market risks have been borne by the
investor, with short-run marginal cost (SRMC) pricing determined by market forces and, as a consequence,
generating price uncertainty.
Current government policy in the electricity sector is primarily focused on policies to support the development
and deployment of non-nuclear low-carbon technologies in order to reduce their costs and thus reduce the longterm costs of decarbonising the sector. However, the design of the National Electricity Market (NEM) may make
low-carbon investment riskier than continued investment in fossil fuel technologies. Thus, even with a carbon
price, investment in low-carbon technologies may be discouraged.
The NEM is an energy-only obligatory market for trading electricity. Generators offer price and associated
quantity bids for five-minute dispatch intervals, with prices average over a thirty minute trading interval. The
marginal generator (i.e. the highest accepted bid) sets the wholesale price, which then applies to all successful
bids. The marginal generator is generally a fossil fuel generator. Thus, marginal bid pricing will include the
carbon price, since this will be part of a fossil fuel generator’s short run costs. This should give a competitive
benefit to low carbon technologies. However, the risks attached to recovery of fixed costs of new generation
assets will vary considerably depending on the capital intensity of the different technologies.
Wind power operates as base-load, ahead of coal and CCGT, because of its lower short run marginal cost
(SRMC), and can therefore offer very low (or even negative) price bids to ensure dispatch. However, the large
gap between the SRMC and the average cost of wind gives rise to a high level of risk that full cost recovery will
not be achieved. Combined cycle gas turbine (CCGT) technology, however, has a much lower capital cost than
wind (about 40% of the cost), plus it is partially hedged against price volatility as it is generally the marginal-bid
technology. Thus price volatility for CCGT is likely to be significantly lower than for wind, and full cost recovery
less of an issue.
The problem is to replace, or complement, long-term market arrangements with technology-specific policies that
encourage investment in long-term low-carbon technologies. The challenge is to combine public and market coordinations in order to maintain financial incentives, while simultaneously reducing the risks inherent in the
market regime sufficiently so as to ease investment.
There are two broad options for government intervention:
1. Feed-in tariffs
Structured either as fixed payments, premium payments on top of the electricity price, or financial
contracts for difference against the market price.
2. Establish a market for clean energy
Imposition of quantity obligations on suppliers (such as a renewables obligation).
1
Alternatively, it may be preferable to reform the structure of the NEM to address the issue on a market-wide
basis. Possible market reform may include the following:
•
•
•
•
Carbon price support: the guarantee of a minimum carbon price in the electricity market;
Long-term contracts for all low-carbon generators: structured as contracts-for-difference against the
market price;
Targeted capacity payments for flexible/peaking plants; and
Emission performance standards.
To conclude, liberalised electricity markets such as the NEM have raised the risks faced by investors in highcapital-cost, low-operating-cost generation, thereby discouraging investment in low-carbon-technologies. A key
question for governments, therefore, is whether to use targeted measures to reduce risk and ensure capital cost
recovery for low-carbon investments, or whether to reform the NEM so that market-based policies can be
incorporated into its structure.
Failure to act may delay investment in a low-carbon technology future, thus raising the cost of de-carbonising the
electricity sector.
2