The National Energy Guarantee: Our new technology-neutral energy policy

Australia's new energy policy: the National Energy Guarantee

Prime Minister Turnbull has announced the adoption of a new energy policy, known as the National Energy Guarantee (NEG). The NEG is intended to address Australia's "energy trilemma" by:

• ensuring the security of the National Electricity Market (NEM);
• reducing emissions; and
• reducing electricity prices.

The policy announcement also flagged that the Turnbull Government would not be implementing the Clean Energy Target (CET), which was the emissions reduction mechanism proposed in the Independent Review into the Future Security of the National Electricity Market conducted by Australia's Chief Scientist, Alan Finkel (the Finkel Review). However, the current Commonwealth Renewable Energy Target Scheme was unaffected by the announcement - it will remain in place until its scheduled expiry in 2030.

The design of the NEG is based on advice from the independent Energy Security Board (ESB Advice). The Energy Security Board (ESB) was established by the COAG Energy Council in accordance with a recommendation of the Finkel Review.

The NEG has two limbs. It will require electricity retailers and other wholesale electricity purchasers to simultaneously meet a "reliability guarantee" and an "emissions guarantee":

• The reliability guarantee is intended to ensure there is sufficient dispatchable energy (from generation sources such as coal, gas, pumped hydro and batteries) to meet demand in each State and Territory which participates in the NEM. Dispatchable energy is energy which can be switched on or off, or ramp up or down, in response to changing demand for energy.
• The emissions guarantee is intended to ensure Australia meets its international emissions reduction obligations.

Prime Minister Turnbull has made it clear in his media release on the NEG that a foundation block of the NEG is that it is technology neutral: "Unlike previous approaches, we are not picking winners, we are levelling the playing field. Coal, gas, hydro and biomass will be rewarded for their dispatchability while wind, solar and hydro will be recognised as lower emission technologies but will no longer be subsidised".

An overview of the NEG (based on the details in the ESB Advice and the Government's publication on the NEG: "Powering Forward: A better energy future for Australia") is set out below.

Reliability guarantee

In order to satisfy their obligations under the reliability guarantee, retailers and affected wholesale electricity purchasers will be able to:

• invest directly in new dispatchable generation capacity;
• enter into forward contracts with dispatchable generators; or
• contract with other retailers and wholesale electricity purchasers which have exceeded their reliability guarantees,

to cover a predetermined percentage of their forecast peak load.

The amount and type of energy to be contracted for in each region of the NEM will be set by the Australian Energy Market Commission and the Australian Energy Market Operator.

Emissions guarantee

In order to satisfy their obligations under the emissions guarantee, retailers and affected wholesale electricity purchasers will be able to:

• invest directly in new lower emissions generation capacity;
• enter into contracts with existing generators for the generation of a specified amount of electricity to be delivered at a particular emissions level; or
• contract with other retailers and wholesale electricity purchasers which have exceeded their emissions guarantee (ie., have a surplus of low emissions generation),

to meet a defined emissions level based on the total amount of electricity used over a specified compliance period (possibly 12 months).

Although the ESB Advice suggested that retailers and affected wholesale electricity users could also meet their obligation by the purchase of eligible international carbon units or Australian Carbon Credit Units (ACCUs) issued for greenhouse gas abatement activities undertaken as part of the Government’s Carbon Farming Initiative, the Government's publication is silent on this option.

The target to be met by the emissions guarantee will be set "to contribute to Australia's international commitments" according to the Government's publication but it remains to be seen whether this will be in line with Australia's international emissions reduction commitments, which currently require 26-28% reduction in emissions below 2005 levels by 2030 under the Paris Agreement.

Impact of the NEG

Given the lack of detail about the operation of the NEG which has been provided to date (especially in relation to how and at what levels the reliability and emissions targets will be set at any given point in time), it is likely this new policy will create significant regulatory uncertainty in the NEM for some time.

At this early stage there is insufficient detail to accurately assess the impact of the NEG on the NEM and its participants, although we have some early thoughts on possible impacts. We will provide further updates as the detail emerges.

The Government has indicated that it believes the energy guarantee will result in lower emissions over time, consistent with Australia's international commitments. According to the ESB Advice, under the NEG it is expected that renewables (including hydro and solar PV) would comprise 28-36% of electricity generation by 2030.

However, some industry experts have been critical of the NEG's emissions reduction mechanism, suggesting:

• 28-36% renewable energy penetration in the NEM is not sufficient for Australia to meet its emissions abatement obligations under the Paris climate agreement without complementary policies to reduce emissions in other sectors, such as industry, transport and agriculture; and
• the variability of the reliability and emissions targets will mean that the NEG will not be capable of providing the long-term certainty required to stimulate the required investment in renewable energy in Australia.

Indeed, Prime Minister Turnbull has indicated that there is significant opportunity for the burden of reducing emissions to be "back-ended" so that the heavy lifting in relation to emissions abatement is achieved in the later years of the Paris commitment period. In that context, if the emissions guarantee is to drive investment in renewable generation in Australia there will need to be long-term transparency about our emissions reduction trajectory under the NEG.

Placing a price on carbon

In a significant departure from the CET, the emissions guarantee under the NEG is not a certificate-based scheme. Instead, the NEG will rely on the market (led by electricity retailers) to achieve their reliability and emissions guarantees by choosing how they invest in, and contract with, electricity generators. According to the Government, the intention is that the lowest cost range of technologies will be used to meet the overall targets imposed by the NEG.

While there has been widespread conjecture that the secondary market created by the ability for retailers and wholesale electricity purchasers to contract with each other in order to meet their emissions guarantee will effectively "put a price on carbon", the Government's deliberate move to exclude any mechanism which creates credits in which the liable entities can trade makes it difficult to label the NEG an emissions trading scheme.

However, if retailers can make good on any excess emissions over their emissions guarantee by purchasing eligible international carbon units or ACCUs, the market price of those units will effectively set the carbon price in Australia. The omission of any reference to this option in the Government's publication is a clear indication of its concern to avoid any suggestion of the NEG creating a carbon price.

Implementation of the NEG

The NEG is designed to work within the existing regulatory framework of the NEM. The proposed approach to implementing the NEG is through amendment to the National Electricity Law (NEL), which regulates the NEM. The NEL is State-based co-operative legislation, meaning that each State or Territory participating in the NEM has control over whether (and how) the NEL applies in that jurisdiction.

On that basis, it will be important for the Commonwealth Government to garner support for the NEG from each of the State and Territory Governments in the NEM (being Queensland, NSW, the ACT, Victoria, SA and Tasmania). Early indications from the key Labor states have been negative or ambivalent, with each indicating it will need more information about how Australia's emissions reduction obligations will be met under the emissions guarantee mechanism.

If the NEG is implemented in line with the current proposed timeline:

• the reliability guarantee mechanism will come into effect no later than 2019; and
• the emissions guarantee mechanism will come into effect from 2020.

What's next?

The Government has requested that the ESB undertake detailed modelling on the operation of the NEG based on the following criteria in relation to the emissions reduction target:

• a 26% reduction on NEM emissions in 2005 by 2030 (which is the lower end of the range of Australia's commitment under the Paris Agreement);
• both a linear trajectory and an optimised non-linear trajectory from business as usual emissions in 2020 to the 2030 target (noting this will be a policy decision for the Government); and
• a constant post-2030 target.

In addition, the modelling results will reflect the impact of the NEG in relation to retail and wholesale electricity prices, as well as the expected generation and capacity mix compared to a business as usual scenario.

This work is to be completed by 13 November 2017, ahead of the next meeting of the COAG Energy Council later this month where the NEG will be discussed.

Related Insights

• The National Energy Guarantee: what does it mean for your business?
• The renewables debate shifts a gear: Finkel Review proposes Clean Energy Target
• AEMO chimes in on energy security measures