By Louis Chiam King & Wood Mallesons’Melbourne office.

The Australian energy markets are in a state of turmoil. The regulatory and governance arrangements in electricity and gas that have served us well for two decades are facing a host of challenges. From sudden increases in electricity and gas prices and a spike in unplanned outages, through to the increasing calls for more action on carbon emissions and the rise of disruptive new technologies, it seems pressure is everywhere.

The energy crisis of 2017

1. Electricity in 2017

Radical changes in the national electricity market have led to a fraught demand-supply relationship in 2017. Closures of major thermal generators such as the Hazelwood Power Station, and the announced closure of the Liddell Power Station, contribute to a dispatchable capacity shortfall sorely felt in times of high electricity demand.[1]

During peak temperatures in February 2017, with faults in two key gas-fired power stations and interconnector overloading, Australian Energy Market Operator (AEMO) directed TransGrid to shed load at an aluminium smelter in NSW for an hour’s time. The well-documented ‘Black System’ on 28 September 2016 in South Australia caused far more widespread outage for around eight hours for most South Australians. The SA outage was triggered by a combination of factors, including simultaneous storm damage to three transmission lines in South Australia, but also a ripple effect isolating South Australia due to automatic trips in the system designed to protect electricity infrastructure from surges.

In the 2015–16 financial year, three major outage incidents hit the National Energy Market (NEM): load shedding occurring in Tasmania in August 2015, a trip of the Heywood interconnector in November 2015 and a Basslink outage from December 2015 to June 2016. These examples illustrate the impacts that intensity and frequency of weather events can have on electricity system security. Looking forward, AEMO predicts demand-supply instability for the 2017–18 summer, especially in Victoria and South Australia, unless urgent mitigation is put in place.[2]

At the same time, rising electricity prices became a regular feature of headlines around the country. Between June 2011 and March 2017, the ABS reported a 39 per cent increase in the electricity prices paid by consumers, while commercial and industrial customers saw their electricity costs rise significantly.[3] Electricity was suddenly a major cost of living issue — and a major political headache.

2. Natural Gas in 2017

In the meantime, the East Coast gas market is experiencing a boom that has swept away decades of market dynamics and practice, thanks to the unprecedented development of coal seam gas production in Queensland and three very large LNG export projects at Gladstone designed to process and export that gas. The figures are staggering by any measure.

With a capital cost of around AUD 70 billion, the three LNG export projects will have a total nameplate capacity of 25 million tonnes per annum, which represents about 30 per cent of Australia’s total LNG export capacity. And they have driven a rapid growth in coal seam gas exploration and production in Queensland, where proved and probable (2P) coal seam gas reserves in the Bowen and Surat basins grew from 3,400 PJ in 2005 to 42,700 PJ in 2015.[4]

The Office of the Chief Economist estimates that the value of Australia’s LNG exports is forecast to increase from AUD 22 billion in 2016–17 to $35 billion in 2018–19, driven by higher export volumes and, to a lesser extent, higher prices, while LNG is forecast to overtake metallurgical coal as Australia’s second largest resource and energy export in 2018–19.[5]

While this expansion allowed East Coast natural gas producers access to the lucrative export market, it had a very significant knock-on effect in the domestic gas market, where commercial and industrial gas contract prices rose from historic levels around AUD 3 to 4 per GJ to as high as AUD 10 to 16 per GJ.[6]This has flowed through to higher gas prices for consumers and industry as well as higher prices for gas-fired power generation.

3. How Did We Get Here?

It is hardly controversial to say we are living with energy regulation that was designed in another era. As those around for the market reforms of the 1990s will recall, they were heady times. Following close on the heels of their successful financial market liberalisation, the Hawke and Keating Governments brought radical change to the energy sector. The Hilmer reforms opened up energy markets and infrastructure, while key state governments split up their electricity and gas utilities, in some cases privatising the assets and ushering in a new era of energy markets.

These signature reforms in electricity introduced a competitive market for wholesale electricity, the National Electricity Market, while mandating open access and regulated pricing for electricity transmission and distribution networks.

In the gas markets, open access (and tariff regulation) was introduced to a number of key transmission pipelines and distribution networks, while disaggregation of gas utilities heralded a new era of retail market competition.

The reforms of the 1990s were a success on many fronts. They soaked up significant over capacity in the market, drove operating efficiency and brought the rigour of competition to many sections of the market. In real terms, average electricity prices Australia-wide fell by 19 per cent between 1990–91 and 2003–04 (although most savings were gained by business and commercial electricity users).[7]

4. Energy Regulation Today

The key regulatory arrangements introduced in the 1990s are still with us today. A high level summary includes:

(1) National Electricity Law

A prime example of cooperative federal legislation, the National Electricity Law (NEL) was established by agreement among the Commonwealth, Queensland, New South Wales, the Australian Capital Territory, Victoria, Tasmania and South Australia. It is enacted by South Australia as the lead jurisdiction,[8] and then adopted by reference in the other participating jurisdictions.[9]

The NEL establishes the National Electricity Rules (NER), which include the key rules governing the National Electricity Market, as well as access to and pricing for electricity transmission and distribution networks.

There are three key regulatory bodies.

The NER, are administered by the Australian Energy Market Commission (AEMC), which is an independent commission responsible for making rule changes.

The crucial role of the independent market operator is performed by AEMO, which is owned by a combination of Australian governments (60%) and industry participants (40%) and operates with a separate board.

Transmission and distribution tariffs are regulated by the Australian Energy Regulator (AER), an independent entity created under the Competition and Consumer Act 2010 (Cth) and comprising three members.

By a similar mechanism, the National Energy Retail Law and the National Energy Retail Rules apply in most jurisdictions.[10]

(2) National Gas Law

The National Gas Law, established under a similar cooperative regime,[11] governs access to (and pricing for) gas transportation on certain gas pipelines. The National Gas Law does not establish a national market for buying and selling gas. Instead, this is left to a combination of the wholesale contract market and, for entities seeking to supply gas into Melbourne, Sydney, Adelaide and Brisbane, a mandatory gas spot market in each location.

AEMO is responsible for operating each of the spot markets, while the AER determines tariffs for regulated pipelines.

Conclusion

While the need for change is more than evident, it is hard not to be a little overwhelmed by the sheer pace and scale of energy reform today. It is crucial that we reform our energy markets, but at a price that our institutions can cope with and in a way that is sensitive to our democratic institutions and the legitimate expectations of participants.

Who knows, perhaps in 20 years we will look back at the period around 2017 as the heady days that established a robust and effective energy regulatory regime that set Australia up to take advantage of both new technologies and its own natural resources.

[1] With apologies to Western Australian and Northern Territorian readers, this paper, like the energy crisis it describes, is focused on the Eastern States.

[2] AEMO, “Electricity Statement of Opportunities” (September 2017) pp 17–18.

[3] Australian Bureau of Statistics, “Consumer Spending Patterns and Price Change: How Does Electricity Compare?” (ABS cat. no. 6401.0) (2 June 2017).

[4] Office of the Chief Economist, “The Impact of LNG Exposure on Australia’s Eastern Gas Market” (April 2016).

[5] Office of the Chief Economist, “Resources and Energy Quarterly” (September 2017).

[6] ACCC, “Gas Inquiry 2017–2020: Interim Report” (September 2017).

[7] Productivity Commission (Commonwealth), “Review of National Competing Policy Reforms” (2005) p 56.

[8] National Electricity (South Australia) Act 1996 (SA).

[9] See, for example, Electricity – National Scheme (Queensland) Act 1997 (Qld).

[10] See National Energy Retail Law (South Australia) Act 2011 (SA).

[11] The lead legislator is South Australia, National Gas (South Australia) Act 2008 (SA).