Australia’s Energy Security Board (ESB) has proposed a ‘reliability mechanism’ to complement the existing National Electricity Market (NEM). It would work alongside an ‘emissions reduction mechanism’ as part of the proposed National Energy Guarantee (NEG). This Working Paper describes how such a reliability mechanism might be designed.

The need for a reliability mechanism arises from concern that scarcity pricing in an energy-only market may not deliver adequate investment to meet future demand. This concern increases with more intermittent energy. Wind and solar have high capital costs but effectively zero marginal costs; once the facility is built, the energy produced is free. The resulting highly volatile spot prices become politically and financially unacceptable, making it less likely that new investment in generation will occur.

Appropriate contracting may occur organically, or can be encouraged through a reliability mechanism. Any mechanism should complement rather than replace the current spot market. It would not replace the need to deliver ancillary services such as frequency control and inertia for grid stability.

The mechanism should integrate with the existing market to ensure electricity is available when needed, by encouraging appropriate generation and demand-response capacity and availability. Various mechanisms are used around the world. They range from strategic reserves to capacity mechanisms, which themselves could be delivered as auctions run by a central buyer or through a decentralised obligation model.

The reliability mechanism proposed by the ESB is a decentralised obligation model. In advice to the COAG Energy Council in November 2017, the ESB proposed an obligation on retailers to maintain an adequate level of dispatchable electricity. Retailers would contract for such resources to fulfil that obligation. The details are still being developed.

A retailer obligation would create incentives for investment to deliver adequate future capacity, and could integrate with the NEG’s emissions obligation as well as the current spot, derivative and ancillary services markets.

A retailer obligation could involve a central agency setting future requirements for market participants and then managing delivery. Or market participants could ensure adequacy and delivery, with big penalities if they fail to do so. The design trade-off is between certainty and cost.

On balance, we support a well-designed retailer obligation utilising commercial market drivers. But there are risks. The next steps must involve comprehensive stakeholder consultation on design details to avoid unintended consequences and address identified risks.