National Energy Guarantee – A Cap And Trade Scheme

By Stacey Vacher, Edge Managing Director

The Energy Security Board (ESB) released a new version of the proposed National Energy Guarantee (NEG) following feedback from a variety of interested parties. The ‘Draft Detailed Design of the National Energy Gurantee: Consultation Paper’was released 15 June 2018. Also included was a paper by the Federal Government setting out the proposal for key areas of legislation which will be set at a Federal level. To support the papers a number of technical working papers were released to explore key aspects of the NEG.

The new version remains focused on reducing emissions in line with Australia’s commitment under the Paris Agreement and ensuring reliability. In addition to these key priorities, a third priority was to ensure that electricity remained affordable going into the future.

In regard to emissions, the largest change from the original version is a voluntary decoupling of the electricity contract written and the emissions levels. A retailer will still need to purchase contracts to keep emissions below a set threshold, however the emissions will no longer have to come from the same contracts that they have purchased electricity from. In theory, a retailer can purchase the output of a coal fired power station however not take on the emissions. That retailer would then be exposed to the emissions at the spot market which could be met through a separate contract with a renewable generator for only the emissions component.

In practical terms, the current proposed NEG is for all intents and purposes a cap-and-trade scheme. A retailer will be provided a cap on emissions. If they exceed that cap, they will have to purchase emissions credits from a low emitting source. If they are under the cap, they can sell their over commitment to other retailers. There will be the option to carry forward a limited amount of a previous compliance year’s over-achievement, for use in a later compliance year.

Reliability will come from AEMO’s forecast of supply adequacy. Each year, AEMO estimates supply adequacy for the following 10 years. If a material gap is identified, AEMO will notify liable entities (likely to be retailers and large users 5MW or greater) that there may be a reliability obligation. If the material gap is still present 1 year out, AEMO may start procuring demand response or additional generation. At this stage all liable entities must disclose their contract position to the AER. If a period with a projected reserve gap has demand above a one-in-two-year event, AER will monitor compliance against the reliability target. Each liable entity must demonstrate that they have procured sufficient qualifying contracts (such as fixed price contracts of a suitable nature, demand side management, or firm generation) to cover their position during peak demand.  It is proposed that a reliability gap will also trigger liquidity obligations for vertically integrated retailers to make financial contracts available to the market via the central exchange.  Furthermore, it is proposed that large users may transfer their reliability obligation to their retailer, but will have to ensure that their Electricity Sale Agreement addresses this. If a liable entity has insufficient qualifying contracts, penalties may apply. The level of penalties is undecided however a suggestion has been made to link to AEMO’s cost of procuring responses.

As with anything, the cost of both the emissions and the reliability components
of the NEG is likely to be passed on to consumers.

Modelling done to justify the introduction of the NEG assumes that the certainty brought by the NEG will reduce the risk premium of new power stations and cause more trading to occur. Both these factors would likely bring down energy prices (compared to business as usual). However, if the market does not see this as a much more stable investment environment, a reduction in wholesale prices is unlikely to materialise.

The NEG will expose consumers to both emissions and reliability costs. In terms of the emissions component, for most consumers this will be another pass-through cost added to their bills. Any trigger of a reliability gap could drive the cost of acquiring qualifying contracts (such as financial contracts) much higher in the relevant period. Whilst the liquidity obligation aims to counter this, we have concerns around how this will be enforced. It is critical to protecting against extortionate costs under this component. The current version of the NEG discusses a number of ways of addressing this and the ESB recommends creating a new repository for contracts as well as a market liquidity obligation. The repository would be able to report on all over-the-counter (non-exchange traded) products including volume and price. This may only be reported in aggregate for the market instead of identifying the parties to the deal. Very little detail is provided regarding the register.  The market liquidity obligation would require large vertically integrated retailers to make contracts available where there is a reliability gap. The retailers must offer to buy and sell contracts at a maximum spread so that prices can’t be set too high for buyers and too low for sellers. As with the repository there are few actual details on the liquidity obligation.

The emissions component has the potential to be highly variable from retailer to retailer. Each retailer will look at the generation they have produced and what emissions contracts they have purchased. If they haven’t purchased sufficient contracts for their entire load, they will assume to have procured the rest at spot. The spot emissions is calculated as the total emissions intensity of all generation less the generation volume already contracted in the emissions registry. A retailer or consumer is unlikely to know in advance how much will be forward sold and therefore the emissions costs can be highly uncertain. The retailer is likely to pass through this cost directly to the consumers, who ultimately wears the risk.

It is critical for all consumers who are agreeing electricity contracts with their retailers to understand how things such as the NEG are managed by their retailer and passed through. For the more sophisticated purchasers there is an opportunity to proactively manage some of this exposure themselves.

The Federal Government will continue to make laws regarding three key areas of the NEG. The key areas are:

  • Setting emissions targets
  • Treatment of emissions-intensive trade-exposed industries; and
  • The role of external offsets

 

There is a separate paper exploring these issues. The emissions targets are proposed to be expressed in tonnes of CO2-e/MWh. The target will be to meet a 26% reduction on 2005 levels by 2030. This is the target which was set at the Paris Agreement. There has been some criticism that if electricity only meets their proportion of the reduction, all industries will have to make the same reductions. The criticism is that it is much more economical to meet a greater share of the obligation from the electricity sector where alternatives to carbon emissions are cheaper than in other sectors.

The Federal Government is proposing to keep emissions-intensive trade-exposed industries exempt from the NEG obligations. This is to maintain international competitiveness.

This means that the rest of the electricity market will be required to purchase
additional volume to make up for the exemptions.

The paper also discusses the role of external offsets including the Australian Carbon Credit Units (ACCU) which are currently part of the Federal Government’s safeguard mechanism. They have also opened up to the possibility of allowing a limited number of overseas certificates be used for surrender.

There are still some large outstanding issues with both the ESB and the Federal Government’s papers. The ESB is pushing ahead to get a decision from the COAG Energy Council in August 2018. To facilitate this date, the turn-around time for comments are limited. The Federal Government is seeking comments by Friday 6 July 2018 and the ESB wants their comments by 13 July 2018. The commencement date of the NEG is due to be 1 July 2020.

If you would like to understand more about the NEG and the potential impact it may have on your energy portfolio moving forward, please visit www.edgeenergyservices.com.au or alternatively you can call one of our team directly on 07 3905 9220 or on 1800 EDGE ENERGY.