Finkel’s blueprint: A chance for stability or more climate wars?

Last Friday the much anticipated Finkel Blueprint for the Future was released.  It is the culmination of seven months of consideration by an expert panel led by Dr Alan Finkel, AO.

Having been given the extremely tall task of identifying the issues and providing a politically palatable response, the Independent Review into the Future Security of the National Electricity Market (better known as the Finkel Review) has produced a sensible and workable way forward for durable energy policy.

The Finkel blueprint has not tried to pick technology winners.  Its Clean Energy Target does seek to get investment back into the electricity market, increase reliability and bring down prices for consumers.  The trick, however, is it will require both major parties to back the recommended reforms, and as the Prime Minister Malcolm Turnbull pointed out earlier this week, that debate has only just begun.

Regardless of the political process, what are the implications of the blueprint for the energy industry? 

A broad set of recommendations

Many of the 50 recommendations are either benign (like the recommendation to institute an Energy Security Board) or welcome (like the recommendation to have an independent third party review of AEMO’s short-term forecasting methodology).

Others seem to be a duplication of existing arrangements.  For example, Recommendation 6.1 expands upon the directions given to the ACCC to inquire into the electricity retail market, suggesting that it recommend that the transparency and clarity of retail prices be improved – despite the availability of government-specified price comparison websites, using standardised reporting parameters.

Of course some of the recommendations are high level guidance only, and we will only know if they improve the market once we have the details.  These will emerge from the various political and regulatory processes.  For example, the benchmark energy intensity for the Clean Energy Target (discussed below).

Clean Energy Target and Generator Reliability Obligation

Of course the recommendations which have attracted the most media coverage have been those related to the Clean Energy Target.  Similar in design to the well understood and functioning Renewable Energy Target framework, the success of the measure will be dependent upon setting the following parameters fairly and consultatively:

• the emissions intensity threshold;
• the term of the target; and,
• the overall emissions target.

It will also be interesting to see if there is a push for a penalty price for exceeding emission levels and, if so, the level at which this would be struck.

By being technology neutral the CET should be less distorting of investment decisions.  Importantly the mechanism is intended to encourage investment in new low or zero emissions generation rather than punish existing generators.

This is where the devil is in the detail.  And there is plenty of jockeying for position on what should be ruled in and out.  In early positioning on Finkel’s blueprint, Labor does not want a level set that allows new coal developments to qualify for certificates, while the Minerals Council of Australia wants it set at a level that could incentivise clean coal.  It fears that the “implicit” baseline in the Finkel report (which modelled, but did not endorse an emissions intensity of 600kg/MWh) will do just that[i]  Dr Finkel and the Federal Government have pointed to the fact that the CET does not impose a prohibition on coal. What inhibits new coal plant (without carbon capture and storage) is the long-term carbon risk that exists because Australia and 190 other countries agreed to seek to limit global warming to two degrees. There has been further commentary from interested parties on whether a CET will benefit wind and solar[ii], or hamper new enterprises[iii].

In practice, based on current costs of different generation technologies, and taking account of carbon risk, the CET on its own is likely to act much like an expanded RET, and drive further wind and solar PV into the market. While the report recommends new variable renewables be obliged to comply with a range of Energy Security Obligations including having fast frequency response capability, these obligations will not address the issue of declining dispatchable capacity.

Accordingly, Recommendation 3.3, the generator reliability obligation (GRO), is a key component of the reform package. This would entail AEMO “undertaking a forward looking regional reliability assessment, taking into account emerging system needs, to inform requirements on new generators to ensure adequate dispatchable capacity is present in each region”. For variable renewable plant, this could entail them demonstrating that they have procured new dispatchable resources equivalent to a given proportion of their own capacity. There are many ways this could be achieved, including building their own assets or contracting with another provider. By implication storage could qualify, but it’s not clear whether firm demand response would be eligible.

It is essential that these two mechanisms are implemented together. This could take the form of requiring plant seeking to create CET certificates to be certified by AMEO that it had met its GRO target. Alternatively, it may be feasible for the GRO to be converted into a tradeable instrument and “stapled” to the CET certificates.

Energy Security Obligations

It’s worth highlighting that there are a number of energy security-related recommendations which, in their attempt to increase energy security, impose additional obligations on the market and change the market design.

Some recommendations, such as the requirement for new generators to have fast frequency response. Can be planned for when proponents are planning construction and assessing likely returns.

Not so Recommendation 2.3  “Tighter Frequency Control”, which proposes that AEMO and the AEMC consider:

• requiring all synchronous generators to change their governor settings to improve frequency control; and
• Tightening the frequency operating standard.

Aside from the technical and maintenance challenges which may be imposed on old plant, there may be additional unbudgeted costs, for both implementation and ongoing adherence, which may change the economics of generators.  It would be a perverse outcome if a recommendation intended to improve energy security led to the withdrawal of capacity from the market.

Generators’ withdrawal from the market will be constrained by Recommendation 3.2, requiring all large generators to provide a binding three years’ notice prior to closure in order to signal investment opportunities for new generation and give time for communities to adjust.  The practicalities of this need consideration – what if a generator suffers unexpected damage which is not economic to rectify, for example?

However the three years’ notice may not be needed, if Recommendation 3.4 “Strategic Reserve” is implemented.  This will require AEMO and the AEMC to assess whether a Strategic Reserve is needed as an enhancement or replacement to the existing Reliability & Emergency Reserve Trader.  Similar to the SA Government’s plan to build its own gas-fired power station, a Strategic Reserve will empower AEMO to contract for a targeted level of capacity that would be held in reserve outside the market.  In addition there is Recommendation 4.2, which provides AEMO with last resort powers to procure or enter into commercial arrangements to have gas-fired generators available to maintain reliability.  This seems to be an extension of AEMO’s existing powers to direct generators under Clause 4.8.9A of the National Electricity Rules.

While providing these additional powers will enhance energy security, there is a risk that despite being “outside the market”, these powers may interfere with the market and jeopardise future investment, thereby compounding the need for more Strategic Reserve and directions in the future.

Besides tinkering with the market in this way, the Report also recommends that demand response should be investigated by the AEMC (Recommendation 6.7).  This has been investigated at length recently, particularly in the Demand Response Mechanism and Ancillary Services Unbundling rule change proposed by the COAG Energy Council.  More investigation is unlikely to change the outcome of previous studies.

Conclusion

While it appears there are some recommendations which may affect the markets, overall the blueprint is a step in the right direction and deserves broad support.  The breadth of the Report and its key recommendations offer a degree of certainty which has been lacking for some time.

Overall it is intended to encourage a refocusing on a national approach to energy policy.  The concern, as with all energy policy in recent times, is if the inevitable political arm wrestling will hobble the blueprint.

Let’s hope the principles and details can be settled quickly so that the future can be planned and there can be a period of relative stability.

[i] Jacobs Group (Australia), “Report to the Independent Review into the Future Security of the National Electricity Market – Emissions mitigation policies and security of electricity supply”, 13 June 2017

[ii] Australian Financial Review “Finkel Review to open renewable floodgates”, 13 June 2017

[iii] Australian Financial Review “Start-ups say Finkel energy reform will favour incumbents”, 13 June 2017