Resource adequacy mechanisms and ageing thermal retirement

The NEM is rapidly transitioning to a lower-emissions generation profile, characterised by higher levels of near-zero marginal cost variable renewable generation. To encourage investors to take long-term capacity risk, we need market arrangements that explicitly value capacity, separately from the energy price, to support the quantum of build required over the next decade. The right incentives are needed to support the orderly retirement of thermal generators and timely investment in an efficient mix of resources (firm flexible generation, variable renewable energy and storage) to maintain reliability.

The challenge

During the next two decades Australia will replace most of its existing ageing generation fleet.

Over the same period, 26-50 GW of new, large scale variable renewable energy (in addition to existing, committed, and anticipated projects) will come online, supported by between 6GW and 19GW of new flexible and dispatchable resources. By 2040, up to 63 per cent of the current coal fleet in the national electricity market (NEM) is expected to retire.

The faster that new, more economic variable renewable electricity (VRE) comes into the market, putting downward pressure on energy spot and contract prices, the greater the pressure on existing, less economic generation to exit.

Under the current NEM design, new investment in generation relies on expectations that wholesale prices will be at sufficient levels long enough to provide adequate confidence, certainty and returns to investors. If the current spot price is not high enough, and expectations of sustained wholesale prices in the future are not held with enough confidence, then sufficient investment may not happen. Uncertainty attached to the level and composition of future demand, the timing of generation exits, technology costs, and government interventions all impact investor confidence.

What we’re doing

The ESB’s overall objective is to deliver reforms that ensure sufficient dispatchable resources and storage capacity are in place before anticipated plant closures, and before generator exits cause significant price or reliability shocks to consumers.

The additions to the existing investment signals in the market and related arrangements will maintain reliability by delivering a more orderly exit of ageing thermal generation and its timely replacement by a mix of new resources.

We recognise that any market and related arrangements need to operate effectively in the presence of substantial government investment schemes. These schemes are likely to be an enduring part of the electricity market for the foreseeable future, and often embody broader policy objectives such as supporting community transition and jobs or delivering low emissions and renewable energy policy targets.

What happens next

The Energy Security Board (ESB) handed its final advice on the national electricity market redesign to energy ministers on the Energy National Cabinet Reform Committee on 27 July 2021 and the advice was publicly released on 26 August 2021.

National Cabinet is now considering the full suite of recommendations.

In the interim, the ESB is continuing to work with the Australian Energy Market Commission (AEMC), Australian Energy Market Operator (AEMO) and the Australian Energy Regulator (AER) to progress reforms to the National Electricity Rules while the broader advice is being considered by governments.

Transparency of generator availability

The Australian Energy Market Operator (AEMO) manages the day-to-day operation of the energy system. It ensures that the system is reliable, secure and that electricity supply meets demand every second of the day. To avoid any shortfalls, it collects a range of information from participants to ensure the system will have sufficient reserve supply.

This reform will help to identify risks of insufficient generation capacity early. An example would be knowing when a generator was planning to mothball a plant, and the time it would take for it to return to operation if needed.

Through its current obligations and functions, AEMO continuously monitors reliability in the NEM. The new information gathered through this reform will assist AEMO in providing more granular information to jurisdictions about generator availability, and in turn, reliability, and security outcomes in specific regions. AEMO can do this through official market publications where appropriate and its regular discussions with jurisdictions on a range of matters including ongoing reliability and security issues.

Jurisdictional strategic reserves (JSR)

A JSR would allow states and territories to procure any required reserves that individual jurisdictions consider necessary beyond the market reliability standard. This would involve the purchase of additional reserve capacity from generators that don’t participate in the NEM or large energy users who can temporarily reduce their usage, during periods of very high demand.

In the JSR recommended by the ESB, JSR capacity would not be allowed to participate in the normal day-to-day operation of the electricity system but would be kept ready, as other emergency reserves are, for when it is needed. For example, during heatwaves or when natural disasters interrupt transmission infrastructure. This will ensure that state and territory governments are able to maintain enough reserve capacity in their region to ensure reliable and secure electricity for their consumers as the percentage of weather dependent generators increases. 

Ministerial lever to trigger the current Retailer Reliability Obligation (RRO)

Currently, only the South Australian Minister can trigger the RRO at T-3 in the event it is not recommended to be triggered through the Electricity Statement of Opportunities (ESOO).  A jurisdictional lever to trigger the RRO provides a tool for jurisdictions to manage reliability gaps, where a jurisdiction considers additional confidence, over and above other immediate reforms recommended by the ESB, is needed.

Energy Ministers have agreed to adopt a Ministerial lever to trigger the current Retailer Reliability Obligation as is currently in place in South Australia. Putting this in place will give Ministers the ability to strengthen the RRO if they wish while further detailed design work is undertaken on a capacity mechanism. 

Design of a capacity mechanism

Since 2010, 20 percent of NEM coal-fired generation has retired and a further 69 percent is expected to close by 2040.  AEMO forecasts that up to 19 GW of fast, dispatchable generation, equivalent to more than six times the largest generator in the NEM, will be needed to firm up the influx of variable renewable energy – for the times when the sun isn’t shining, and the wind isn’t blowing.  Currently, generators are only paid for the energy they produce. 

A capacity mechanism, commonly found in most international markets facing similar challenges to Australia, creates a second marketplace for availability. This puts a value on generators being available during periods where demand could exceed supply. To ensure reliable supply is maintained as the share of renewables grows rapidly, the mechanism’s intention is to create a clear, long-term signal for investment, in both existing and new dispatchable capacity (such as coal, gas, batteries and hydro). Detailed design work is needed to settle the details of how a capacity mechanism could operate and the ESB will provide advice on a final design by the end of 2022.

Orderly exit of ageing thermal generators

Orderly Exit Management Contracts are bilateral arrangements (usually between a government and a closing generator) that help to ensure that a generator does not exit the system until sufficient capacity can be brought online to replace it. 

Alongside the design work on the capacity mechanism, the ESB has been asked to do further work on orderly exit management arrangements for ageing thermal generators that are complementary to, or part of, a capacity mechanism.

In the meantime, the ESB recommended jurisdictional investment scheme principles apply to them where they are used. These principles have been adopted by jurisdictions to guide the development of future government investment schemes. They help remove uncertainty for energy market investors and ensure government-supported investments best match the physical needs of the energy system.

Reliability (Price) settings work

The Australian Energy Market Commission (AEMC) is considering a rule change request from Dr Kerry Schott AO that seeks to align the Reliability Panel’s current reliability standards and settings review with this design process. The outcome of the rule, if made as proposed, will require the ESB to consider:

  • the reliability (market) settings that would work alongside any recommended capacity mechanism to achieve the reliability standard
  • what reliability (market) settings, if any, should be in place for the interim period before a capacity mechanism is implemented, taking into account the impact of the timing of any changes on the contract market, and the potential to place a freeze on the settings before the mechanism is implemented
  • the reliability (market) settings that would achieve the reliability standard in the event a capacity mechanism is not agreed

The ESB notes that stakeholder engagement on each of the above scenarios for the price settings will be critical. The ESB and Panel are working to determine the best way that the ESB can leverage the Panel’s expertise and industry representation in the design process. 

Milestones for deliverables for this market settings work and its interdependencies with the detailed design of the capacity mechanism will be published shortly.

Where to next?

Following National Cabinet's endorsement of the Energy Security Board's (ESB) final package of reforms, the ESB is carrying out further design work on the proposed capacity mechanism. This will include comprehensive consultation with all relevant stakeholders and interested parties, the outcomes of which will be used to help achieve the optimal design of the final model. The ESB has therefore released two papers:

  1. A scope of works document to provide stakeholders with more clarity about the approach and process that we intend to use to progress the design of a capacity mechanism
  2. A project initiation paper, which outlines the main components of a capacity mechanism and the potential options, and gives stakeholders the opportunity to provide their views on these matters

The papers are available here:

Submissions on the project initiation paper are due by 10 February 2022.