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The Energy Security Board (ESB) has released a draft plan for a capacity mechanism which would see fossil fuel energy providers paid to have power supplies available during peak times as Australia transitions to renewable energy.

The National Electricity Market (NEM) is going through a transformation as Australia moves towards net-zero emissions by 2050. 

This transition will see ageing fossil fuel plants that once made up most of the NEM replaced with new, clean energy resources and a more responsive demand-side. 

Coal generators, which currently account for over half the NEM’s generation output, are ageing, and several have announced early retirement dates.

Most market participants consider the Australian Energy Market Operator’s (AEMO) Step Change scenario to be the most likely – which implies 14GW of coal-fired generation may retire by 2030, and all coal-fired generation will cease generating by 2043.

At the same time, AEMO has forecast that electricity demand could at least double by 2050.

The ESB said a capacity mechanism, in which providers of capacity are paid to have their capacity available during certain periods, will help reduce the risk of a disorderly transition. 

The ESB said it is a more direct, more certain way of ensuring we have the right amount and the right mix of capacity that we need, to deliver affordable and reliable power as our system decarbonises.

In arriving at this conclusion, the ESB noted that the vast majority of electricity markets around the world already explicitly value capacity and pay for it directly.

Australia is one of very few ‘energy only’ markets remaining. Even in Australia, the bulk of resources built by the private sector have been underpinned in some way by government policies. 

The practical reliance on the energy-only market to drive investment in dispatchable capacity has been limited.

According to the ESB, from an investor’s point of view, a capacity mechanism would reduce reliance on wholesale market outcomes that are becoming increasingly difficult to predict. 

The ESB said it would provide an alternative revenue source that would be potentially more predictable and secure, rewarding the capacity service that the market needs. 

The plan proposes that all resources contributing to capacity should be eligible to participate in the capacity mechanism.

The ESB argued that the capacity mechanism should not exclude existing resources in order to ensure reliability through mixed resources, avoid over-building new capacity and discourage premature exit of existing capacity before alternative resources are in place.

Participating capacity providers will need to meet capacity certificate requirements in return for the payment as part of the draft plan.

Under a centralised procurement approach, AEMO would hold capacity auctions, award contracts, and make payments to capacity providers. It would then need to allocate these costs to consumers – either through networks or retailers.

The ESB said that cost allocation through retailers using actual demand is the preferred approach. 

Calls for alternative action to energy crisis

Community group Solar Citizens has condemned ESB’s plan to implement a capacity market that would include payments to ageing coal and gas power stations. 

Deputy Director at Solar Citizens, Stephanie Gray, said Australian homes and businesses are already paying the price for reliance on expensive and unreliable fossil fuel generators. 

“The current energy crisis is the result of sky-high coal and gas prices, breakdowns at multiple coal units, and price gouging from big energy corporations,” Ms Gray said.

“We’re in this mess because, after a decade of national energy policy failure, we haven’t built enough renewable energy backed by storage to replace ageing fossil fuel generation. 

“Paying big coal and gas companies to keep them operating for longer is the opposite of what we need to do to address the energy crisis.

Ms Gray said paying coal and gas to be available will simply add another price burden to consumers at a time when the cost of living is already hurting many homes and businesses.

“We’re calling on state and territory energy ministers to rule out a capacity mechanism that will fund coal and gas,” Ms Gray said.

“Instead, they should be urgently rolling out renewable energy and battery storage so that Australian homes and businesses are less exposed to inflated global coal and gas prices.

“State governments should also increase support for vulnerable households to access solar and storage, particularly those who face barriers to getting solar, including renters and social housing tenants. 

“The new Federal Government has been handballed an energy system in disarray. It’s now up to them to clean up the mess of the previous government by planning coal closures and accelerating the rollout of renewable energy and storage.

“We recommend the Federal Government to implement a storage target, similar to the successful national Renewable Energy Target, which has now effectively come to an end.”

AEC supports “technology-neutral” approach

The peak body for power generators and retailers, the Australian Energy Council (AEC) has voiced its support for the ESB’s work on the capacity mechanism.  

The AEC’s Chief Executive, Sarah McNamara said the AEC welcomes the emphasis on any capacity mechanism being technology-neutral so it can deliver the best outcomes.  

“The AEC believes any capacity mechanism needs to support existing plants, as well as new plants. Our preference remains for neutrality between the two, but we will consider the draft proposal,” Ms McNamara said.

“We would be concerned if there are jurisdictional carve outs to the mechanism, which could lead to it being much less effective in supporting the energy transition.  

“The AEC’s position is strongly against lowering the energy market price cap as it is contrary to the ESB and COAG’s previous position on the energy market itself remaining the main investment signal. 

“Whilst capacity mechanisms exist in many places, there have been many challenging issues, arguments and repeated adjustments. Introducing one into a 25-year-old energy-only market will be anything but straightforward.”

Environment Victoria rejects strategy

Environment Victoria has rejected the proposed capacity mechanism as an effective strategy to maintain reliable energy supply.

Environment Victoria’s CEO, Jono La Nauze, said the notion of paying fossil fuel generators to stay open is a backward looking idea.

“The only people attached to this idea appear to be the ESB and the coal and gas industry,” Mr La Nauze said.

“Across the board, stakeholders from environment groups to big business have rejected this idea as have energy ministers of every political persuasion.

“When energy ministers emerged from their recent crisis talks it was clear that – at a ministerial level at least – a new era of sensibility and cooperation had arrived.

“Too much unreliable coal in the NEM has caused this problem. 

“Paying to keep it in the system would be a kick in the guts to households as inflation takes off. We must use this as an opportunity to thoroughly reform the NEM to make it genuinely – and cleanly – fit for purpose in the future.”

Other experts weigh in

Lead analyst at Institute for Energy Economics and Financial Analysis, Johanna Bowyer, said the capacity payments would be paid for by the end energy user, via their retailers. 

“It could put upward pressure on electricity bills at a time when bills are rising in many states,” Ms Bowyer said.

“The proposal includes payments to existing coal and gas generators, which could keep high emissions capacity in the system for longer, delaying the transition to a low emissions electricity system.”

Clean Energy Finance Director, Tim Buckley, said there’s no point enacting a new capacity mechanism without explicitly considering the cost of carbon.

“A technology-neutral solution with no carbon price fails to address the key issue of climate science,” Mr Buckley said.

“A capacity payment scheme designed by the previous energy minister is highly unlikely to be part of the optimal solution, particularly if there is any suggestion of yet more costs being imposed on consumers to bailout or further subsidise the fossil fuel industry.”

Climate and Energy Program Director at The Australia Institute, Richie Merzian, said, “A capacity mechanism is an imperfect tool and what we need is an overarching plan for how we transition our grid to 100 per cent clean energy.”

To read the Capacity Mechanism Project High-level Design Consultation Paper, click here.

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