An AEMC threat to renewables?

Our previous article provided a brief overview of the Optional Firm Access (OFA) model currently being considered by the Australian Energy Market Commission under the Transmission Frameworks Review.  In this article we explore what the implications of this model might be for renewable generators.

Under the OFA model, dispatchable renewables (such as hydro, geothermal and solar thermal with storage) could find benefits similar to those for fossil-fired generators. They would have the option to purchase firm access, which could increase financial certainty, reducing contracting risk and decreasing financing costs.

In general, variable renewable generators (such as wind and solar photovoltaics) are expected to purchase a relatively small quantity of firm access. Given their variable nature, these technologies are unlikely to find it cost effective to acquire firm access for their full capacity, instead choosing to be non-firm, or perhaps covering only a small percentage of their capacity (10-30 per cent). This would mean that under the OFA model, variable renewable generators would be required to make compensation payments when constraints bind that they are not required to make at present.  These could be substantial, possibly in some periods reducing the price they receive  from close to the market price cap ($12,900/MWh at present) to close to zero (their own short-run marginal cost, which could be setting the relevant local marginal price in that period).

Many are surprised to discover that all generators in the NEM make a very significant proportion of their annual revenues during a small proportion of the highest priced periods, and variable renewables are no exception to this. Analysis of historical prices indicates that wind and solar generators receive 20‑70 per cent of their annual revenues in the highest priced 20 days of the year.

The incidence of binding constraints is likely to be somewhat correlated to the incidence of high prices (since these both relate to periods when the system is under stress). Therefore, a significant proportion of renewable generator revenue could be under threat if the OFA model were implemented*. 

Even more importantly, the transitional arrangements proposed for the initial introduction of the OFA model are likely to be highly problematic for the renewables industry. In order to smooth the entry of the OFA model and prevent significant market disruption, the AEMC has proposed that the existing network capacity should be allocated for free to incumbent generators.

Each incumbent generator would receive a share of access to the existing network, in proportion to the level of firm access they would need to have unfettered access to the regional reference node.  This would be scaled back over time to around 70 per cent, and retained at that level for the entire residual life of the generator. Generators could trade this access if desired. 

The issue for the renewables industry is that they form the bulk of new entrants expecting to enter the NEM in the coming decades. Under these proposed transitional arrangements, unlike incumbents, new entrants would not receive any network access for free but instead would be required to purchase it (either from incumbents, or from the network service provider, at the incremental cost to upgrade the network sufficiently to provide that access). This creates a fundamental difference in cost structure between incumbents (who would have firm access for most of their capacity, for the remainder of their economic life) and new entrants (who would need to commit to substantial ongoing payments to procure network access, or face potentially significant compensation payments).

These proposed transitional arrangements are conceptually difficult.

In essence, the majority of the existing network, which has been entirely paid for by consumers, is being “gifted” to the incumbent generators at no cost. Incumbents obtain significant value from this (in the form of a competitive advantage compared to new entrants). Furthermore, the process of deciding how much capacity each incumbent should get is likely to be fraught with rent seeking behaviour.

To address this issue, access on the existing network could instead be auctioned, such that market participants procure only the level of access they require (and are prepared to pay a fair market price for). Auction revenues could be returned to consumers in the form of reduced TUoS payments over time. Arrangements of this type have been proposed by the Clean Energy Council in its submission to the AEMC.

Most importantly, the renewables industry cannot afford to let the Transmission Frameworks Review go unscrutinised, since the outcomes of this process could have dramatic implications for the future of renewable energy in Australia.

* At present, most renewable generators are supported by a long term Power Purchase Agreement (PPA), since retailers have an interest in acquiring Large-scale Generation Certificates (LGCs) under the Large-scale Renewable Energy Target (LRET).  However, beyond 2020 the LRET target no longer increases, and retailers will not have an incentive to sign additional PPAs.  New renewable generation will need to be supported by market revenues alone (possibly underwritten by more conventional types of contracts for a proportion of their capacity).

Dr Jenny Riesz is a Senior Consultant in the Energy Strategic Advisory team at AECOM, a global provider of professional technical and management support services to a range of industries and clients worldwide. Jenny's focus is on renewable energy and climate policy.