The Nelson Review has unveiled its proposals to bring the National Electricity Market up to speed and capable of handling new technologies, but has chosen to focus on tweaks to the existing system rather than wholesale changes such as the introduction of a capacity market.
The four-member panel led by respected energy economist Tim Nelson says its focus is on bringing transparency to the market, and setting up protocols that will allow market settings to rapidly evolve to foster the transition from a centralised fossil fuel system to a decentralised market based around renewables and storage.
Nelson says the draft recommendations will pave the way for market signals to be visible for the bulk energy (wind and solar), shaping (bidirectional trade and storage), and firming capacity (batteries and other dispatchable generation) needed over the short, medium and long term.
The most striking and substantial of the nine draft recommendations is for AEMO Services to conduct tenders for contracts for bulk energy, shaping and firming.
Nelson says this will be delivered through the Electricity Services Entry Mechanism (ESEM), that would be written into the market law, and will address the fundamental issue of “tenor” – the problem that developers have in getting some certainty over revenues for the long term that is essential to land finance for their projects.
“The physical world has changed …. we need financial contracting that underpins how the National Electricity Market works, keeps up with it,” Nelson told Renew Economy.
Issue of tenor
The recommendations have been published by the government following a more than six month review from a panel comprising Nelson, former Australian Energy Regulator Chair Paula Conboy, energy expert Ava Hancock who helped design the NSW Energy Roadmap and former Boston Consulting energy practices lead Phil Hirschhorn.
“If we get the right market settings in place, we can deliver a secure, affordable, low-emissions electricity system that works better for everyone,” Nelson said in a statement.
“Our draft report makes nine major recommendations aimed at re-establishing the NEM’s core strengths: efficient markets to guide investment decisions, efficient dispatch, manage financial risk, and deliver the affordable and reliable energy consumers deserve and expect.”
“We are confident that the pathway we’ve set out – one that strengthens markets, supports investment, and puts consumers first – is the right one.”
See this op-ed from the Nelson panel: Our approach is not to throw out the market – but to reinforce its strengths
Nelson has effectively decided to keep the structure of the current market – which may disappoint some, particularly those who argued for major change such as a distinct capacity market.
But he argues that the recently introduced emissions component into the National Electricity Objective (it was struck out by John Howard when the NEM was created in the late 1990s and reinstated by Labor) will help. And making tweaks to the existing system will be a lot easier than redesigning the whole lot.
“All we’re really doing is taking the existing spot and forward market, making sure it’s up to date with the real kind of evolution of the physical system, so that the medium term management or the risk management function is consistent economically with the long term investment signal,” Nelson told Renew Economy.
“We are not revolutionising it, we are just pivoting the existing stuff that’s already stood up.”
Nelson gave the example of a wind farm developer who signs up a customer for five or seven years, which is normally not long enough to lock in cost effective finance. But the option of a contract, obtained through a reverse auction similar to the current Capacity Investment Scheme, will add greater certaintly.
It’s just a pivot
“The beauty of using these contracts, rather than revenue underwriting, is that as you roll into the future, those contracts can be sold back to the market, so that you’ve created a closed loop whereby, if you’re a retailer or an end user, those products will be available to you in the future to manage your risk of operating in the spot at that point in time.”
“We think that by standardising the contract type through that industry led process, we think it would reduce the complexity. It would reduce a lot of the compliance costs, because it wouldn’t require bespoke negotiation. It would literally be, this is the contract. It becomes simpler. Everyone can get their head around it.
“And then the other key elements that we see that this is, again, transparency. So because its buying these contracts, it will need to sell them back, therefore, it will be disclosing what those contract prices look like.
“And with transparency in place, you might actually find that some of the larger customers sign longer term deals. And so you might start breaking down the tenor gap, because of that transparency.”
Nelson says the panel believes the proposed modifications will endure and provide the long term certainty missing from the market. And this will apply as much to energy users as suppliers.
“The system will need bulk energy. It will need shaping, and it will need firming by defining them as services, not technologies, that allows the technology to evolve.
“So, whether it’s a battery, whether it’s pumped hydro, whether it’s some type of shifting of load, you can value the service that’s provided by using these standardised contracts.
“And that’s where what we heard from some of the demand side players. So think of them as your larger industrial and commercial players.
“Let’s say I’m manufacturing widgets. I want to I’ve got an opportunity to alter my widget making factory line to maximize the benefits of flexible energy consumption, but it’s a 15 year project or a 10 year payback period.
“It’s hard for me to justify doing that, because I have no certainty around what the economics of that look like. So we think that this type of approach should incentivize all different types of technology, both supply and demand, but also large and small scale.
“We think that it’ll create an environment of innovation that will lead to lower costs over time and again, it allows the market to continue to manage the risk that exists in the spot market.”
The Nelson panel has also recommended a two year review from the regulator and industry to ensure that the contracts being traded remain up to date with technology change.
It also wants regulator to look at the transparency and competition issues that could emerge around auto-bidding software, the lack of visibility over battery state-of-charge, and the impact of unplanned transmission outages on market efficiency.
It also urges more visibility from virtual power plants that aggregate consumer energy resources such as rooftop solar, household batteries and EV charging (and discharging), and it recommends funding for CER, especially for batteries, be targeted toward installations that can participate in the market and support the grid.
Unlocking consumer energy
“Complementary reforms would focus on establishing technical standards, improving consumer protections, and enabling data-sharing to support safe and reliable operation,” the panel says.
“These changes aim to unlock the full benefits of consumer energy resources for households and the wider system, including lower energy costs and improved system resilience.”
So, does the panel anticipate any pushback from the industry, and particularly those industries that did not succeed in having the market tweaked in the image of their business plans?
“I think that the key challenge for all stakeholders is to see it as a package of reforms,” Nelson says. “We think that this will be the first time that you’ll have an investment signal, a medium term derivative, risk management signal and a spot market signal.
“They’re all economically consistent. That’s a critical step forward, we think, for the market, because it gives everyone confidence that that it’s internally consistent, and those three timeframes.”
The early response from energy market experts was positive.
“The Review has aligned to what the market needs: accelerating investment signals and valuing the increasingly important consumer contributions in the clean energy transition,” said Nexa Advisory CEO, Stephanie Bashir.
Anna Freeman, the acting chief policy officer for the Clean Energy Council, said the lobby group was pleased that the Nelson Review has recognised the importance of helping investors to strike long-term contracts.
“The proposal put forward in the Nelson Review for competitive tenders for new long-term, tradeable contracts for ‘bulk zero emissions energy, shaping and firming’, facilitated by government but traded in the market, is a creative and novel solution,” she said.
You can read Nelson’s op-ed on the review’s findings here: Our approach is not to throw out the market – but to reinforce its strengths
Plus: Weather dependent and energy constrained: Nelson urges millions of home batteries to be “scheduled”
Note: Tim Nelson and the review panel will be appearing on Renew Economy’s Energy Insiders podcast this week.
Full list of recommendations
Recommendation 1: Maintain the real-time regional energy-only spot market as the core market for efficient dispatch and rewarding the provision of physical energy services
The NEM’s spot market continues to manage the supply of electricity by sending strong, transparent price signals based on real-time supply and demand. However, the conditions under which the spot market operates are shifting as renewable generation plays a bigger role and demand becomes more flexible.
The Panel recommends keeping the core design but seeks targeted updates to improve efficiency, and better integrate emerging technologies.
Recommendation 2: Energy ministers should require a broader range of price-responsive resources to be visible or dispatchable to participate in price formation
As more households and consumers install behind the meter technologies (e.g. rooftop solar and batteries or large loads), there is more opportunity to get our energy system running for less and more efficiently. Operationally, they need to be visible to the market and system operator. Right now, these resources are largely acting behind the scenes, making it harder to forecast demand and increasing system costs.
The Panel proposes reforms to make participation for consumers in the broader market easier and more attractive, starting with voluntary mechanisms, and over time moving toward requiring large (individual or aggregated) resources to participate transparently. For example, a portfolio of household batteries could join a retailer’s virtual power plant which would eventually be required to bid into the market, helping AEMO more accurately forecast supply and demand.
Recommendation 3: Governments should focus reforms and support for consumer energy resources on facilitating market participation to enable consumers to benefit from being price-responsive
The Panel recommends that public funding for consumer energy resources, especially for batteries, be targeted toward installations that can participate in the market and supporting the grid.
Complementary reforms would focus on establishing technical standards, improving consumer protections, and enabling data-sharing to support safe and reliable operation. These changes aim to unlock the full benefits of consumer energy resources for households and the wider system, including lower energy costs and improved system resilience.
Recommendation 4: Market bodies should use the rule change process to ensure the efficient and competitive functioning of the real-time energy-only spot market
New operational challenges are emerging in our grid. These include the increasing use of autobidding software into the market, lack of visibility over battery state-of-charge, and the impact of unplanned transmission outages on market efficiency.
The Panel recommends that market bodies investigate these issues further and, where appropriate, work to preserve market efficiency and support fair competition.
Recommendation 5: The Reliability Panel should consider adjusting the form of the market price settings
Market price settings, such as the “market price cap” and “cumulative price threshold”, play a critical role in balancing investment incentives with consumer protections.
Given the changing generation mix and growing role of flexible technologies, the Panel recommends such settings adopt a forward-looking, 15-year perspective. This would better support viewing and engaging with risk on a long-term horizon, giving the sector more certainty to therefore invest in new technologies such as batteries and demand response.
Recommendation 6: Energy ministers should establish an always-on market making obligation (MMO) in the National Electricity Law/National Electricity Rules (NEL/NER) for a small number of key derivative contracts in each NEM region, with contract types determined through a co-design process with the AER and industry
The Panel recommends establishing a market making obligation, requiring certain market participants to always offer to buy and sell a few key electricity contracts.
This would help make the contracts market more active, transparent and easier to access, especially for smaller retailers and new players. This would strengthen the market’s ability to manage risk and shield consumers from price volatility.
Recommendation 7: Ensure sufficient market information is available to support longer-term derivatives market (i.e. contract market) liquidity and price discovery
To support the sector to make better forward planning and investment decisions, the Panel recommends expanding the availability of market data to improve long-term price discovery. This would give the sector earlier, more credible signals about future supply-demand conditions and help build confidence in the value and risks of in the long term.
Recommendation 8: Energy ministers should establish an Electricity Services Entry Mechanism (ESEM) within the National Electricity Law (NEL) to facilitate investment in the NEM
The current short term spot and medium term contracts markets are not delivering sufficient long-term investment signals to replace retiring coal generators. In particular, the “tenor gap” – the mismatch between long project lifespans and short contract durations – remains a significant barrier to investment.
The Panel recommends creating a new Electricity Services Entry Mechanism (ESEM) within the National Electricity Law. The ESEM would:
issue standardised financial contracts for energy, shaping and firming services,
progressively sell these contracts back into the market, and
operate on a voluntary, technology-neutral basis aligned with jurisdictional emissions targets.
The ESEM is designed to integrate with existing schemes and financial markets, and to gradually step back as the market matures and begins to deliver these investment signals independently.
Recommendation 9: Governments and market bodies in the NEM should pursue a coordinated suite of reforms to ensure regulatory settings, the innovation ecosystem and existing policies and programs are aligned with the ESEM.
To support long-term investment, the Panel recommends a coordinated suite of complementary reforms that clarify emissions policy, accelerate innovation, and improve access to contracts and markets.
Giles Parkinson is founder and editor-in-chief of Renew Economy, and founder and editor of its EV-focused sister site The Driven. He is the co-host of the weekly Energy Insiders Podcast. Giles has been a journalist for more than 40 years and is a former deputy editor of the Australian Financial Review. You can find him on LinkedIn and on Twitter.