Future governance of the NEM: Where to from here?

Now that the Energy Security Board (ESB) has handed its final advice on the proposed redesign of the National Electricity Market (NEM) to the Energy National Cabinet Reform Committee, it is timely to consider what governance structures might be required to support the effective delivery of a Post 2025 NEM. The ESB is expected to be wound up by Energy Ministers by the end of 2021.

Some of us have been in the industry long enough to remember the creation of the ESB back in August 2017. The nation’s Energy Ministers were at that time looking for the most efficient vehicle to coordinate implementation of recommendations from the Independent Review into the Future Security of the National Electricity Market (the Finkel Review).

The ESB has also subsequently provided whole of system oversight for energy security and reliability. As a central agency it has performed well and served as a convenient channel for Ministers to receive advice settled between its constituent market bodies - the Australian Energy Market Commission (AEMC), Australian Energy Regulator (AER) and Australian Energy Market Operator (AEMO).

Ably chaired by Dr Kerry Schott, the ESB was able to overcome a lack of clear governance framework and a minimal budget to work on the all-important market design challenge presented to us by the energy market transition. It has been a massive piece of work, driven by no less than 10 consultation papers and months of engagement with AEC members (and doubtless with Ministers as well).

That work may have concluded, but the job is not yet done and there will be an ongoing role for the ESB’s constituent bodies to refine advice to Ministers on the choice of market design for the post 2025 era, and other technical work critical to the maintenance of the system’s reliability and stability. Current media debates suggest that there is still no clear industry consensus on how best to proceed to deal with the challenges of a future lower emissions grid.

While the ESB has acquitted itself well through the P2025 project, its utility is less obvious in an extended period of detail and delivery – something the existing market bodies have long excelled in.

The AEC has undertaken a consultation with members on how best to proceed in a ‘post-ESB’ world.  We believe we have landed on a sensible solution which will minimise cost and maximise the efficiency of the important ongoing work that needs to occur.

But first, some background.

History

From 2005 the NEM operated with the tripartite governance arrangement shown below.

In 2015, the Vertigan Review recommended retention of this structure with suggestions to expedite the rule change process and to clarify AEMO’s role, particularly in market design. Vertigan’s recommendations were largely never completed.

In 2017, the Finkel Review was concerned about institutional discord and reform slowness, and recommended creation of an ESB, in which the heads of the institutions would sit alongside an independent chair and deputy chair. The ESB was to last until 2020 to implement Finkel’s own fifty recommendations. In the intense post-system black atmosphere of early 2017, the ESB was quickly created, appointments made, and given the National Electricity Law (NEL) Section 90F power to directly make Rules.

By 2018 the ESB had departed from the Finkel recommendations, with Ministers directing new tasks:

1. Developing the National Energy Guarantee, that subsequently reduced to the Retail Reliability Obligation (RRO);
2. Changing transmission rules to simplify Integrated System Plan (ISP) planning;
3. Conducting the P2025 review; and,
4. Implementing a temporary Reliability Standard.

The ESB concept had some success in aligning the market bodies, and Kerry Schott as Chair has been well regarded but is not expected to seek to extend her term beyond 2021.

However, the structure also has the effect of elevating AEMO and the AER to equal status with the AEMC with respect to market design and has the power to avoid the rigour of the normal rule change processes. In 2020. The AEC expressed its concerns about these aspects and recommended against a life beyond the P2025 review.

In mid-2020, the Edwards review^[i] considered the long-term role of the ESB. Edwards recommended the ESB continue until end of 2021 to complete the P2025, which was accepted by Ministers. It also recommended disempowering S90F (rejected) and completing AEMO’s statement of role (agreed but not yet actioned).

In late 2020 and early 2021, the AEC and Energy Networks Australia jointly commissioned work into AEMO’s governance that recommended more industry or regulatory oversight on its activities and expenditure along with completion of the statement of role.

Market Bodies Forum

Prior to Finkel, the institutions were developing between themselves a Market Bodies Forum (MBF) to improve co-ordination. The MBF was not intended to play a statutory role per se: its powers came about through the powers of each institution. The proposed MBF charter stated:

The objective of the Market Bodies Forum is to contribute to the efficiency and effectiveness of national energy markets for the long term benefit of consumers in accordance with the national energy objectives. To achieve this objective the Market Bodies Forum:

• • Offers a whole of energy-sector perspective on the overall state of energy markets.
  • Provides a single, authoritative source of reporting and coordinated advice, by leveraging the broad ranging skills, experience and knowledge of its members.
  • Coordinates timely responses to emerging issues and trends by utilising all mechanisms and powers available to its members.
  • Assists the COAG Energy Council in delivering its policy agenda for national energy markets and networks in an open and transparent manner.

The MBF is a non-statutory, unincorporated body and has no legal functions or powers separate from those of each member.

Edwards recommended in 2020:

“At the cessation of the ESB there will still exist a requirement for a body that brings the energy market bodies together to help integrate the interlocking responsibilities for overall national energy security and enable a collaborative approach to strategic policy and market development advice to Ministers. This is a role that could be undertaken by an MBF.”

and

“The Review recommends that there is representation by Senior Energy Officials on a MBF and that senior officials should be responsible for working with the market bodies to develop this forum. The Review agrees with the market bodies that the AEMC is the appropriate organisation to provide secretariat support to such a body. A range of other issues will need to be considered including: membership, which entity should chair the MBF, and in what way should the market bodies be given a statutory obligation to coordinate in pursuit of their common statutory objectives in order to underpin the working of the MBF.”

In response, Ministers stated:

“Energy Ministers will consider options for future energy governance arrangements in mid-2021 pending the recommendations of the post-2025 market design work.”

NEL Section 90F

The usual process for rule changes occur under AEMC’s S34 power, which is in turn subject to prescriptive S91-S108B Rule Making procedures requiring consultation.

On eight occasions Ministers have bypassed this and implemented major reforms by passing a direct NEL amendment through South Australian Parliament^[ii]. NEL clauses S90A to 90E are the result of this.

Section 90F however, provides a simpler mechanism for doing this, including making amendments to existing rules: if the ESB makes a recommendation to Ministers, which is endorsed by Ministers, it becomes a new Rule. ESB has already exercised the power and may well do so again with the conclusion of the P2025 review.

Submissions to the Edwards review, including the AEC’s, highlighted concerns about this mechanism. Edwards recommended the effective abandonment of this power:

“A revised Terms of Reference or Statement of Expectations (for the ESB) should make it explicit that the ESB will not use, or should not use, the s90F process for the making of recommendations to Energy Ministers.”

Edwards rejected the view of some jurisdictions that there should be an “enduring” ministerial rule making power. He argued focus should instead be on the responsiveness of the AEMC process.

Ministers responded to this recommendation of immediate abandonment of S90F:

“Not agreed. S90F provides a pathway for Energy Ministers to fast-track reliability and security rule changes.”

The bluntness of the rejection suggests jurisdictions are likely to seek some enduring power post the ESB.

So what governance structures are needed in the NEM in 2021 and beyond?

Effective governance for delivering a future NEM

AEC members are unanimous that clear, transparent, and fit for purpose governance arrangements are critical to the effective operation of a changing NEM. In developing this policy position, the AEC engaged broadly with its membership to seek to identify key features of what industry consider to be an effective governance framework. These views are preliminary, and the AEC has encouraged Energy Ministers to consult more broadly before any long-term decisions are finalised.  

In general, AEC members largely support the recommendations put forward by Edwards in the 2020 Review of the ESB, with key features of an effective governance structure as follows:

Function and interaction of market bodies:

The tripartite governance arrangements illustrated above remain largely fit for purpose in the NEM in 2022 and beyond, albeit with a need for increased clarity of the function and operation of the three bodies.  

The original roles and responsibilities of the market bodies should be retained, with their function clarified, to reflect the separation of powers model they intend to represent. As part of this, the AEC considers it is necessary for Energy Ministers to publish revised statements of expectation for the AEMC and the AER, and a statement of role for AEMO. These statements would provide clear guidance to the market bodies, industry, and consumers of the function of the governance framework.  

There may be benefits that arise from greater co-ordination between the three market bodies, and with jurisdictional officials. This could be through an informal market bodies forum as envisaged prior to the Finkel Review, or the statutory body envisaged by Edwards (the ‘coordinating body’). 

The need for enhanced coordination between the bodies does not represent a failure in the tripartite governance arrangements, but rather, ensuring greater collaboration between the three market bodies enables clearer objectives to be agreed upon, and better outcomes for consumers at lower cost. 

The AEMC should permanently chair any coordinating body and have a clearly defined remit. The role of the coordinating body should be to increase cooperation, collaboration and engagement between the market bodies and officials, rather than to develop overarching policy itself.  

There is no shortcoming in the rule making framework under the tripartite governance approach. In the time since the Finkel review recommended an ESB was required, the AEMC has streamlined its rule making role, with Ministers additionally agreeing to reforms in 2017 that have better enabled rulemaking to be expedited where necessary.  

Energy Ministers and SCO:

The AEC acknowledges that moving from the COAG Energy Council processes to the current National Cabinet has restricted the ability of officials to discuss key decisions and priorities of Ministers.

The transparency of key institutions, including the Energy National Cabinet Reform Committee and the Energy Ministers Meeting, are critical to industry confidence in the sector. The AEC encourages Energy Ministers to reinstate the historical practice of releasing a communique after each meeting as a means of delivering increased transparency without inhibiting cabinet-in-confidence processes. 

In addition, the AEC considers that Senior Committee of Officials should have a role in any coordinating body discussed above. As noted by Edwards, this would enable greater consistency and direction between decisions of the market bodies and the jurisdictions.

However, that co-ordinating body does not require unfettered rule making powers through the current section 90F mechanism in the NEL. Ministers remain able to make rules where they need to implement policy reform through mechanisms that existed prior to the implementation of 90F. The AEMC is also able to progress urgent rule changes where there is a threat to security, safety, reliability, or the operation of the wholesale market.

If an additional rulemaking power is retained, the AEC has urged Ministers to clearly define its intended use and mitigate its scope to the extent possible. This might include, for example, limiting its operation to instances where there is an ‘immediate threat to the security, safety, or reliability of the NEM’ and a reasonable belief that the AEMC process would be too slow to mitigate this threat. In all other circumstances, Ministers should commit to proposing rule changes to the AEMC to enable thorough and transparent consultation with industry and consumers to occur.

In addition, the AEC considers it crucial that Ministers recommit to principles within the Australian Energy Market Agreement and the recommendations of the ACCC in its Retail Electricity Pricing Inquiry. This should include, in particular, that derogations away from the national framework be as limited as possible, and only utilised where there is a locational necessity to do so.

Where to from here?

With the ESB delivering its final advice to Ministers on the Post 2025 market design, there is an opportunity for stakeholders to consider what is needed to deliver it. There should be an opportunity for broader collaboration with industry and the consumer sector to seek to develop agreement on an effective and efficient governance structure that will enable the benefits of the project to be delivered.

The coming years will require significant work to deep dive into the ESB’s recommendations – the governance structure within which this work is undertaken will ultimately determine its success or failure.

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[i] Review of Energy Security Board, June 2020. The Review was conducted by Rhys Edwards and Mr Rhys of RDME Consulting and commenced in March 2020.

[ii] The National Electricity Law and National Electricity Rules are created as subordinate legislation by the South Australian parliament in its role as lead legislator, and also applied in the other participating states and territories.