Energy Security Board's capacity payment: Burden on households

CORRIGENDUM: This report has been slightly amended from the original published version to reflect that 5,311MW of advanced dispatchable capacity projects were not taken into account in AEMO’s 2020 Statement of Opportunities rather than the 3,200MW stated in original published version.

With the backing of the Federal Energy Minister Angus Taylor, the Energy Security Board (ESB) has proposed a dramatic change to how the east coast electricity market (the National Electricity Market or NEM) will function. As far as we are aware, this proposal for a capacity payment comes without any economic analysis detailing the cost of this regulatory change, why this extra cost is necessary or why it is preferred compared to alternative options.

The ESB’s proposal will require consumers, via their retailer, to provide a large payment primarily to conventional power plants (mainly coal and gas power plants) based on the installed capacity of their generators, irrespective of how often that capacity is needed to generate electricity. By comparison, at present, generators are only paid based on actual electricity generated.

Our analysis, based on experience from the Western Australian electricity market, shows the capacity payment could be in the realm of $2.9 billion to $6.9 billion each year. This would result in an average cost of $182 to $430 per household per year.

This is a massive additional cost

This is a massive additional cost, which could be more than double the impact of the carbon price on a household electricity bill. It will come without any compensating reduction in the energy market price cap or generator bidding controls based on what appears to be recommended in the ESB Post 2025 Market Design Options released in April.

According to the ESB and Minister Taylor, consumers need to provide this new capacity payment to generators to ensure sufficient supply to meet demand, otherwise power blackouts will occur.

However, quantitative analysis indicates that supply is more than adequate to meet demand even if another major coal generator (beyond Liddell) is closed early.

Meanwhile, as the NEM experiences increasing levels of wind and solar in the generation mix, and increasing numbers of battery installations and demand response, it is increasingly important that price signals adjust very quickly to reflect a supply-demand balance that is changing on a shorter timeframe than seen in the past.

A capacity payment is a backward step

A capacity payment is a backward step that will not allow for the increasing levels of flexibility needed in the power system. It requires a central planner to guess the power system’s capacity requirements a year or more in advance, and fails to adequately recognise the large diversity in how quickly technologies can respond to changes in demand. This makes the system more rigid rather than encouraging flexibility. There is a range of reforms that have been or are about to be implemented, which address short time-frame issues around system security and will allow for the increasing flexibility seen in the NEM. The capacity payment is not one of them.

Most stakeholders representing electricity consumers, retailers and renewable energy generators do not support a capacity payment, understanding it is unnecessary. Instead, support is principally from the owners of coal-fired generators.

The reality is that coal-fired power stations are exiting power systems across much of the developed world at a very large scale without harming reliability. This is a necessary outcome for countries to meet the Paris Climate Change Agreement to contain global warming to well below 2 degrees above pre-industrial levels, and preferably to 1.5 degrees.

An additional payment to existing generators risks locking the old legacy system in place for longer

The problem is not that coal power plants will exit, but rather that they might exit abruptly without providing enough notice for investors to respond by building replacement capacity. However, the likelihood of abrupt exit is contained and manageable, as there is an influx of dispatchable generation coming online to replace coal. Almost 6,500MW of new dispatchable capacity is due to be added to the NEM between 2017 and 2027. This is 1.9 times the aggregated capacity of the coal power stations – Yallourn, Callide B and Vales Point B – scheduled to close soon after 2027. Any residual risk of abrupt closure could be reduced with better regulation, that is more targeted and addresses the uncertainty around coal closure directly, rather than through a generalised payment to all fossil fuel and hydro generators in the NEM.

An additional payment to existing generators in the NEM risks locking the old legacy system in place for longer, which may in fact harm reliability. A financial lifeline to these ageing power plants leaves us reliant on supply that will become increasingly unreliable, while exacerbating uncertainty about when they may exit. This uncertainty will deter investment in newer, more flexible and more reliable power plants that make better sense into the future.

Instead of consumers paying extra money to owners of coal generators via capacity payments, the ESB needs to undertake a more thorough evaluation of lower cost alternatives for managing the risks of supply adequacy as coal power plants exit, of which there are several.

It is important that any reform options, particularly ones involving a substantial new cost to consumers, are evaluated based on a thorough, evidence-driven assessment of the problems the market faces. This includes carbon emissions and proper consideration of all available options. We need to avoid a rushed approach that could be driven by threats of certain commercial interests facing financial difficulties, or short-term political motivations.

Press release: Hit to power bills from coal bail-out plan