Australia's National Energy Guarantee Is One Step Closer.
Legal News & Analysis - Asia Pacific - Australia - Energy & Project Finance
9 May, 2018
COAG agrees to send the NEG to the next stage, but with some fundamental design changes.
What you need to know
The Energy Security Board submitted its high level design of the National Energy Guarantee (NEG) to the COAG Energy Council on 20 April 2018. The COAG Energy Council has agreed to send the NEG to the next stage, being final design and drafting of the legislation and rule changes.
The Energy Security Board has taken on stakeholder feedback and made fundamental changes to the design of the emissions requirement by removing the link to financial contracts.
There will be no changes to the Renewable Energy Target – generators can create large-scale generation certificates and also allocate their emissions.
There is little further clarity on the forecasting of the reliability gap; this mechanism still appears to be aimed at dealing with events that may only occur over a few days in each year.
What you need to do
Stakeholders should stay tuned for the next stage – the Energy Security Board will soon be seeking stakeholder input on the detailed design elements, including legislative and rule change requirements.
COAG approval of high level design
The Energy Security Board (ESB) submitted its high level design of the National Energy Guarantee (NEG) to the COAG Energy Council on Friday, 20 April 2018. A copy of the design document is available here. The COAG Energy Council has agreed to send the NEG to the next stage, being final design and drafting of the legislation and rule changes.
Importantly, the ESB has departed from the design of the emissions requirement initially proposed in its draft design consultation paper. The ESB has taken on board the overwhelming stakeholder feedback that there are serious risks or impacts to the existing contract markets if retailers are required to tie their financial contracts to the physical supply of electricity and the emissions associated with that supply.
Further information is available in our 22 February 2018 Alert, National Energy Guarantee: Deconstructing the draft design consultation paper, available here.
The ESB is now proposing that retailers will allocate generation towards the emissions requirement on a new central registry. Retailers and generators will confirm, via this central registry, the number of MWh of emissions from a generation facility which are allocated to the retailer's load.
It is likely that this "allocation" will be an additional transaction, by which generators and retailers will agree on an emissions allocation. It appears that the allocation could be for:
- a fixed number of MWhs – however there is a potential risk for the generator as it could potentially over sell; or
- a percentage of the emissions of the generator.
The ESB assumes this will be dealt with in over-the-counter and futures contracts. While it could be dealt with this way, it is more likely to be a separate arrangement. The ability that emissions allocation can be traded after the end of the compliance year points to this. Additionally, if the allocation is included on a financial contract, it will have a physical link which will place limitations on the fungibility of the contract (which was a key concern communicated by stakeholders). For these reasons, we consider that it is likely to become a separately traded instrument.
Given the revised design framework and suggestions that the allocation mechanism could apply to the Northern Territory and Western Australia, the emissions requirement more closely resembles a certificate scheme than the initial design.
Pricing of the emissions requirement
It is difficult to work out, at this stage, the price for each allocated MWh as there is not a penalty for a shortfall. Instead, there will be a civil penalty, the quantum of which the ESB has indicated may be closer to that of the rebidding civil penalty.
Ultimately, the market will set the price, and this will likely effect wholesale prices, which ultimately will be passed on to end consumers.
The ESB has also proposed a new approach for allocating unallocated generation and emissions. These emissions will be divided between those retailers who have not fully allocated their loads.
This appears to be a better outcome than applying the intensity of the highest emitter, which was one of the options previously suggested in the design consultation paper.
Competition, larger and vertically integrated gentailers
The move to a reallocation mechanism through a central registry, rather than physically linking contracts to an emissions source, is intended to avoid the competition risk raised in a number of stakeholder submissions that the NEG could reduce contract liquidity and make it harder for emerging retail businesses to obtain hedge contracts.
In addition, by requiring vertically integrated gentailers to have all of the emissions from the generators of the retailer's controlling corporation allocated to the retailer, the design document anticipates that larger gentailers will need to trade out their surplus emissions to other generators and smaller retailers. This, coupled with limits on rolling forward overachievement of emissions reductions from one period to the next, is intended to increase market liquidity by incentivising retailers to contract with other market participants, promoting competition.
There may potentially be a number of issues with this approach:
- the document implicitly recognises that vertically integrated retailers will not necessarily have to trade out surplus emissions, as this will depend on their generation mix;
- while the trading of the surplus is said to be pro-competitive, it is not clear why other retailers would take an allocation of high emissions generation – there is a risk the gentailers could potentially be left with their "over-allocated emissions" or otherwise be forced to pay more, increasing, rather than reducing, wholesale prices; and
- by use of the "controlling corporation" definitions under the National Greenhouse and Energy Reporting Scheme, there could be some unintended inclusions of generators – the joint venture rules are complex and there are issues with operational control.
Use of offsets
The Commonwealth is going to allow external offsets to be used, see the Commonwealth's National Energy Guarantee Update on Commonwealth Design Elements paper dated April 2018, available here. Although it has not specified which offsets will be able to be used, it is likely these will be Australian Carbon Credit Units (ACCUs) and international emissions units.
Behind the meter and non-market generation
The ESB is now proposing that the load associated with the consumption of behind the meter and non-market embedded generation be added to the retailer's load for emissions requirement. The emissions from the generation will also be allocated to the retailer.
While the document does not specify who the retailer is, we assume it is the financially responsible market participant for the customer that is using the embedded generation.
This could be a driver for retailers to encourage behind the meter solar generation and might facilitate corporate PPA transactions.
Interaction with the Renewable Energy Target
The Renewable Energy Target will remain unchanged, and will continue as legislated until its closure in 2030. Consequently, it will not close to new entrants as has been previously suggested, which will likely mean a large-scale generation certificate (LGC) price of close to zero by 2030.
However, a renewable generator will be able to both create LGCs and allocate its emissions, meaning the "allocation" is likely to have a price set by the market.
There is little further clarity on the forecasting of the reliability gap, or exactly what issue the NEG is intended to fix. This mechanism still appears to be aimed at dealing with events that may only occur over a few days in each year (eg high temperatures leading to increased demand in the NEM).
However, the ESB has taken on stakeholder feedback and is proposing a 10 year forecasting horizon, which will give market participants a more realistic time to respond. That said, it is still likely that the market may wait for the AEMO book build, which may ultimately set the price.
While the ESB has removed the physical link for the emissions requirement, it has not adopted a similar approach for the reliability requirement. If a "gap" is forecast and the reliability obligation is triggered, liable entities will have to enter into qualifying contracts for dispatchable energy. The ESB refers to "qualifying contracts" being only those traded through centrally cleared trading platforms. However, for the contract to be a "qualifying contract" there must be a physical link created to the hedge contract so that it is able to be counted towards meeting the reliability requirement. In other words, there is a reliance on an assumption that these types of contracts will only be offered if the capacity is actually available when the system needs it, ie the capacity is dispatchable capacity or demand response.
While the ESB took on overwhelming stakeholder concerns regarding the fungibility and liquidity of the contract market in respect of the design of the emission requirement, it appears that these concerns have not yet been fully factored into this stage of the design of the reliability requirement. Stakeholders will need to closely review the detailed design to see how the ESB addresses these issues.
Extension to large customers
Compliance with the reliability requirement will be extended to large customers (which will be defined by reference to a specified load size). However, large customers will be able to have their retailers manage this obligation, which the ESB asserts will promote competition by giving all retailers an ability to compete to manage this reliability requirement.
It remains unclear how this will work.
Unless the large customer has signed a long term retail agreement, retailers may be concerned about picking up a position when the reliability requirement has been triggered and they are exposed to managing a large load.
Vertically integrated retailers
Vertically integrated retailers will also not be able to use their own generation to comply with the reliability requirement, unless it has been purchased via the centrally cleared trading platform and/or reported to centralised trade repositories. The design document argues that this will increase liquidity in the contract market and increase transparency in wholesale electricity costs, and therefore address concerns raised by stakeholders about the potential for the NEG to advantage vertically integrated retailers over other retailers.
Link between the emissions requirement and reliability requirement
The ESB has still not addressed how the emissions requirements and reliability requirements are intended to work together. It is likely to drive to low emissions dispatchable generation (ie batteries or hydro rather than gas or coal) to fill the gap.
Emissions-intensive trade-exposed activities
As anticipated, EITE activities will be exempt from the emissions requirement but will be counted in the reliability requirement.
For further information, please contact:
Paul Newman, Partner, Ashurst