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The National Energy Market

If the recent crisis in the Australian energy system has left you angry at the price you are paying for electricity and confused about how the whole system works, don’t worry – you’re not alone. The National Electricity Market is incredibly complex and not designed with the interests of ordinary Australians in mind. It’s designed to make sure investors in the electricity system make healthy profits. This brief explainer is intended to help workers understand how the electricity system works – or doesn’t work, as is more accurate.

How we got here...

First of all, a bit of history. Australia’s National Electricity Market (NEM) is a creation of the 1990s, when politicians and treasury officials were obsessed with privatisation and turning everything into a market. Before that, each state operated its own electricity system, which had been built over decades by public authorities like Victoria’s State Electricity Commission. The SEC owned the power stations that generated the electricity, the transmission lines that connected the stations to population centres, the distribution infrastructure that got the power to our houses and businesses – and billed us for the power.

These public authorities and their workers played a vital role in the electrification of the nation, from the biggest cities to the most remote areas, ensuring industrial development and the creation of jobs and wealth, and the provision of the reliable electricity supply that is the hallmark of a modern society.

This all changed in the 1990s, when Liberal Party governments came to power in several states and began to sell off our public electricity assets. This was called “privatisation”, but in many instances our public assets were sold to state-owned companies from countries like Singapore and China.

At the same time as these changes were occurring, the system was broken up, so that public electricity authorities were divided into companies responsible for generation, transmission, distribution and retail (some big companies combine generation and retail, like AGL, Origin and Energy Australia). Some elements of the system compete with other companies – generators compete with each other to produce power, and retailers compete to sell it, but transmission and distribution are natural monopolies, and the companies that run them get profits guaranteed by legislation – otherwise known as “rent seeking”.

Another big change in the energy system has occurred in the last couple of decades – large amounts of renewable energy have entered the system, and some fossil fuel generators have closed down (in fact, 12 coal-fired power stations have closed in the last decade and several more big ones will close before 2030). Australians now get about 30 percent of our electricity from renewable energy generated at large-scale or on rooftops.

The other big changes that occurred in the 1990s were the creation of a grid connecting all the states (except WA) and the ACT (but not the NT), and the establishment of the National Electricity Market (NEM) to manage the energy system in this grid.

How it works

The NEM is a complex beast. To make sure this market works, there are multiple regulators, the most important for the day-to-day running being the Australian Energy Market Operator (AEMO). AEMO manages a wholesale market where generators of electricity sell power to retailers. Retailers then sell it to households and businesses.

This is how it works. Each day, generators bid for how much electricity they want to sell. The price of their bid will depend on their costs. Different technologies have different generation costs, ranging from gas, which is the most expensive, to renewables, which have no fuel costs (but construction, maintenance and financing costs they have to cover, of course).

A generator will usually want to have as much of its generation capacity “dispatched” – that is, used – as possible. So they’ll want to bid at the lowest price they can manage. Usually this has to be enough to cover their costs and profit demands, but sometimes they will bid at a lower price because it is too hard or costly to turn their generators on or off – this is mostly a problem for coal-fired power stations, which can’t be just turned on or off with a flick of a switch.

Generators have to get their bids to AEMO by 12.30pm the day before dispatch. AEMO compiles the bids into a “stack” (this is why it’s called a “bid stack system”) from lowest to highest in cost. It then works out how much generation is needed to meet demand and “dispatches” generation, with the cheapest being dispatched first.

Here’s an example.

Generator A bids 1200MW at $60/MW.

Generator B bids 600MW at $100/MW

Generator C bids 2000MW at $200/MW

Generator D bids 200MW at $1000/MW

If demand is for 2500MW, Generators A and B will be fully dispatched, and 700MW of Generator C will be dispatched. Generator D will not be dispatched.

Dispatch or “spot” prices are determined in five minute intervals. It is important to understand that the spot price for any given interval is determined by the most expensive generator. So in our example, the dispatch price for all generators will be determined by Generator C, $200. All the generators A, B, C get paid $200/MW for the power they dispatch.

During periods of low demand, prices will be determined by low-cost bids. But if, in our example, demand was for 4000MW – usually demand spikes late afternoon-early evening, when everyone gets home and turns their appliances on – then all the Generators would be dispatched and the spot price would be $1000/MW.

So what happened?

So far, so good. But why did the system go pear-shaped in recent weeks, and why were we worried about blackouts?

After Russia invaded Ukraine in February this year, the global prices for gas and coal have soared. Because Australia pegs its gas and black coal prices to international markets, this means our prices have soared too, even though the cost of producing those commodities in Australia didn’t really change, and there is no shortage of them here. There was also an unusual cold snap across a lot of the east coast in early June, and several big coal-fired generators were struggling with maintenance issues. So, as prices were rising, so too was demand, while supply was decreasing.

Gas and black coal generators bid higher prices to cover the increased costs of their fuel. It is important to note that these increased costs are the result of a deliberate policy by Australian governments to let fossil fuel companies get increased profits from international prices, rather than making sure Australians benefit from our own resources. This has had long-term harmful effects on Australian industry that has to use gas, in particular, at international prices, and is now being felt by Australian households. It is another example of how the fossil fuel industry’s interests have been given priority over Australian people and businesses.

It’s also important to know that, even though Victoria’s brown coal is not sold in international markets – no-one else wants this dirty fuel – brown coal generators have been benefiting from the skyrocketing price of gas and black coal. The same goes for renewables. Their fuel is free, but as the spot price has increased with bids from gas and black coal generators, everyone has been getting the higher price. This sounds crazy until you remember that the NEM is designed to deliver electricity in a way that is profitable to generators, mostly privately-owned, not in a way that maximises public or social benefit to Australians.

To manage their increasing  costs, some of the generators started to submit very high bids to AEMO, and when AEMO enforced price caps, a number of generators effectively went on strike – taking thousands of megawatts offline, and creating blackout risk. AEMO is able to direct generators to switch on and was doing so. But generators that didn’t want to generate at prices that didn’t suit them said they were undertaking “maintenance”.

AEMO responded by suspending the whole market trading system, enforcing a fixed price for all generators and guaranteeing compensation so that none of them would lose money. All of a sudden, the generators were back online again, and the “crisis” had passed.

Of course, as has been well publicised, some small electricity retailers have gone under in recent months. Some retailers have reported they are unable to buy what are called hedges to lock in future supply at a workable cost. This leaves the retailer exposed to high NEM spot prices that they can’t pass on to their customers due to the cap on retail prices. These unhedged retailers would have to buy high priced electricity and sell it to their customers at a loss. Other retailers are what’s called gentailers – both generators and retailers – and can manage this problem much more easily. AGL, Energy Australia and Origin are gentailers. Other retailers have hedges in the form of long-term contracts for electricity at prices that protect them from big electricity market price spikes. They can survive as long as the price increases don’t continue for ever. We’ll see…

Where to from here?

So, what can we learn from the energy “crisis” that led to an unprecedented suspension of the market?

The most obvious lesson is that markets don’t always work, and are sometimes the drivers of chaos. Suspending the market was what fixed the system and avoided the risk of blackout. So why reinstate the market, which is what has now happened? The answer is that the whole Australian electricity system, as is the case in many other countries, is now designed around ensuring that private investors can profit from investing in electricity generation.

If we were talking about something unimportant this wouldn’t really matter. But not only is electricity obviously vital to the functioning of our societies – transforming electricity generation so that it is produced without carbon emissions is essential to the survival of human civilisation.

Governments have decided that their role is to set up markets like the NEM and “de-risk” private investment in generation, transmission and distribution infrastructure. No longer do they think the role of government is to invest in the energy infrastructure that we need, and to set prices that would benefit Australian households and businesses.

We’ve seen the problem this creates when market conditions get difficult, as they have in recent months. But a bigger problem in the long-term is that governments are saying that the whole transformation of the energy system, which is vital to avoid the calamity of climate change, has to depend on the profit needs of (mostly) private investors in a pretty volatile market. If those investors don’t think they can make enough money out of the system, they won’t invest.

It’s hard to believe it, given current electricity prices, but this has been a growing problem with the NEM. Until this year, the growing amount of renewable energy in the system had been driving the spot price down. It was often going below zero, which means that generators were having to pay to offload their electricity in the NEM. This was causing real problems for higher-cost generators, whose generation capacity was still needed but were getting prices below their generation costs.

This is one of the causes of long-term maintenance problems for coal-fired power stations. Why would an owner invest in long-term maintenance when they are often having to run at a loss? It’s also causing uncertainty around closure of coal-fired power stations. The decreasing financial viability of these older generators means they are likely to close earlier than presumed.

 

This might sound like a good thing for the environment. The problem is that the decisions around closure dates are being left to the owners of the power stations – mostly private companies, very often overseas-owned. This means that power station workers and the communities in which these facilities exist don’t have a clear sense of what their futures are. And, crucially, we don’t have any clear plan for what is going to replace the generation capacity and when it will be needed. This means uncertainty, potential electricity system instability, and potential generation shortfalls.

What we’ve seen in recent years is that at times of high renewable energy generation and low demand, prices have increasingly tended towards zero and below. It doesn’t take a genius to realise that no private investor can make money when the price paid for their generation output is close to zero – even if their cost of generation is very low too. So, why invest in new generation capacity when you aren’t guaranteed to make money out of it?

Privatisation was supposed to lead to lower prices for consumers. In fact, the opposite has occurred. Reinstating public ownership would eliminate rentier behaviour by transmission and distribution companies and the need to concede to the profit demands of big overseas investors. It would enable us to plan the energy system transformation, with a clear schedule for closure of fossil fuel generators to give certainty to workers, their communities and electricity grid managers. It would enable us to schedule fossil fuel generation replacement by renewables in a way that guaranteed supply, efficiency and reduced cost – and ensures we meet decarbonisation targets. It would enable us to ensure that workers are guaranteed a just transition to new opportunities and new industries.

The case for public ownership

Public ownership would allow the benefits of renewable energy’s low generation costs to be passed onto customers – us – rather than allowing a market to artificially create a margin to satisfy the profit demands of private investors. Most importantly, public ownership would enable the permanent abolition of a market system that is designed around investor profits, rather than the broad public interest.

Advocates of privatisation argue that public ownership means higher costs for taxpayers. But this ignores the fact that the costs of electricity generation in a privatised system are still borne by ordinary Australians – private companies pass those costs on to us through our electricity bills. In fact, what we pay through our bills in a privatised system ends up more than we’d have to spend in public money because of the profits that get extracted from the system by private companies at every stage. And, as we’ve experienced recently, the lack of planning and chaos inherent in a market-driven system drives up costs of long-term transition because no-one has any certainty about investment decisions, and because the interests of private fossil fuel companies in profiteering from global price shocks are given priority over household and business needs.

In a world that is still dominated by free market ideologues, and in which governments are often captured by rent seekers and fossil fuel companies, the idea of reinstating public ownership over what is probably the most important service for modern society may seem far-fetched. But if we really want to see an end to the kind of market chaos we’ve had to endure recently, and an orderly transition to a zero carbon energy system that leaves behind no workers or communities, then we have to make the case for reasserting social control through public ownership.

 

- Colin Long is the Just Transitions Organiser at Victorian Trades Hall Council

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