Significant review of WA electricity market

In brief

The West Australian Government is looking to restructure the WA electricity market and has invited the industry to participate in a significant structural review, which will have a material impact on the Government's privatisation agenda, and the competitive and regulatory environment in which the privatisation of electricity generation or retail assets might occur. The Government has released a discussion paper that raises questions and issues for industry feedback. Partners Andrew Pascoe and Anna Collyer and Lawyer Katherine Glossop report.

Background

On 6 March 2014, the Minister for Energy, Mike Nahan, announced a review of the electricity market in the south west of Western Australia. The review was driven by a concern that the cost of supplying electricity in Western Australia is unsustainably high compared to the rest of Australia.

On 8 May 2014, Dr Nahan indicated in his budget speech that, following the review and implementation of market reform, the Government will consider the sale of individual electricity generation assets.

The objectives of the Electricity Market Review are:

• reducing the cost of supplying electricity without compromising safe and reliable supply;
• reducing Government exposure to energy market risks and having future power generation assets built by the private sector without Government investment or other financial support; and
• attracting to the electricity market private-sector participants that are of a scale and capitalisation sufficient to facilitate long-term stability and investment.

The review is to be undertaken in two stages, with Phase 1 being an assessment of the strengths and weaknesses of the current market and an examination of options for reform; and Phase 2 being the design of a set of reforms and implementation arrangements.
On 13 August 2014, the Minister released the Electricity Market Review Discussion Paper (the discussion paper) in connection with Phase 1. Public submissions on the discussion paper are due by 12 September 2014. It is intended that Phase 1 of the review will be completed by 31 October 2014.

In parallel with this market review process, recent media reports have speculated that the Minister for Energy supports the separation of Synergy, the existing 'gentailer' into two or maybe three separate entities, facilitating the possible sale of one or more of them. The discussion paper raises similar structural policy proposals.

The issues

According to the discussion paper, the cost of electricity generation in Western Australia is significantly higher than in most other regions in Australia. Some of the reasons for this are:

• capacity costs, which are not charged in any other Australian jurisdiction, are high;
• costs embedded in bilateral contracts between the wholesale business unit and the retail business units of Synergy are high and set in an uncompetitive environment; and
• competition among generators is weak.

Synergy owns approximately 58 per cent of all installed capacity in the wholesale electricity market and supplied approximately 65 per cent of the energy sold in the wholesale electricity market in the 2012-13 financial year. Through its bilateral contracts with generators, Synergy also controls around 76 per cent of the capacity credits assigned in the wholesale electricity market. The discussion paper points out that if this monopoly continues, the market is unlikely to function efficiently and competitively. The high cost of electricity has driven up electricity tariffs in spite of the Government subsidising Synergy's operating costs by $495 million in the 2013-14 financial year. The average cost of electricity in the South West Interconnected System is projected to increase by approximately 20 per cent over the next four years, with the annual subsidy by the Government increasing to average around $600 million. Moreover, under the Reserve Capacity Mechanism (which is used to attract and pay for new generation capacity), 'in 2012-13, the market had an average capacity utilisation of just 35 per cent, meaning out of all the capacity that customers pay for on average only one third is being used.'

Options

The discussion paper puts forward a number of options aimed at addressing the above issues. Those options include the following.

Structurally separating Synergy in order to increase the number of generators and retailers

It is suggested that significant benefits would be derived from Synergy being separated into at least three generators and at least two retailers. The separate entities would need to be fully independent, which would involve separate corporate structures with independent boards and different ownership.

Introducing full retail contestability

Introducing full retail contestability would ensure that the benefits of a competitive wholesale market are passed on to consumers. This would involve:

• allowing full competition for small electricity customers, which would increase the attractiveness of the market to both existing and new entrant retailers; and
• repealing the Gas Market Moratorium, which prevents Synergy from supplying gas to customers who consume less than 0.18 terajoules per year. Repealing the Moratorium would allow restructured entities to compete for small gas customers.

Improving incentives for efficient investment in networks

There are aspects of Western Power's network and metering services that could be exposed to competitive pressures. Stimulating competition in this area would allow for more cost efficient meter services; incentivise innovation and reduce the financial burden on the government to fund metering infrastructure.

Addressing fuel cost pressures

There are very few market participants marketing gas for sale or seeking long-term gas contracts. This makes it difficult for new participants to enter the market. Western Australia may benefit from introducing a gas supply hub, similar to the one established by the Australian Energy Market Operator in Wallumbilla under the National Gas Rules. The gas supply hub is an electronic trading platform with standard terms and conditions and a market settlement facility that supports the short-term trading of physical gas and related products.

Amending market mechanisms and institutional arrangements

The discussion paper lists numerous options to reform market mechanisms and institutional arrangements. One option discussed is the introduction of an auction approach to capacity credits which, if competitive, would allow the price to be set at a level reflective of any supply surplus or shortfall of capacity. Another option for reform would involve placing the obligation on retail market participants to source their own capacity. Capacity could be sourced through longer term bilateral contracts and shorter term capacity traded by participants, with the expectation that this would stimulate a secondary market.

Disaggregating Synergy and moving to a gross pool market

Another option would involve the introduction of a NEM-style of gross pool, whereby contracts are kept separate from the pool and all electricity generated must be offered through the pool. Existing NEM designs, systems, legislation, rules and processes could be adopted. This option would not be possible without the disaggregation of Synergy. The generation assets would need to be separated into potentially three asset bundles, and the retail business could also be separated on a geographical basis.

Practical implications

• The review into WA's electricity market is welcome and timely. The current market structure does not encourage competition at the generator or retail level. Nor does it encourage investment in new generation capacity. These represent structural impediments to a more efficient market.
• The discussion paper, although calling for public comment, presents the outline of a reasonably compelling case for structural change.
• The lack of effective competition at the wholesale and retail levels of the market are key impediments to an efficient electricity market in WA.
• The discussion paper notes that the existing market structure, involving caps on Synergy's ability to build new plant, has not (as was hoped) opened the field for private sector generation, principally because there is no current demand for new generation, and no expectation of demand-driven new generation for 'some decades to come'. This means that the only means for creating competition in the generation market is to sell some of the generation assets currently held by Synergy. This, in turn, will assist in opening up the retail market for full retail contestability.
• In addition, the discussion paper notes the importance of current restrictions on metering, which gives Western Power an effective monopoly in the retail sector because it restricts the capacity of other potential retailers to provide a broad range of product offerings (unless they, or the customer, pay for the installation of an interval meter). Other constraints include the cap on the number of requests for customer data (20) that a competitor can submit to Synergy each day. This cap limits the capacity for a competitor to build a viable customer base.
• The identification of these issues, collectively operating as a structural barrier to entry into the retail market, provides prospective market entrants the opportunity to advocate for the removal of these barriers and to promote the broad-ranging benefits of full retail contestability.
• Western Australia has the benefit of being able to review the impact of, and benefits and risks derived from, market restructures undertaken in other similar jurisdictions.
• There may be useful lessons from the New Zealand experience, where three dominant gentailers limited the degree of competition in both the wholesale and retail markets. Accepting that some degree of vertical integration is inevitable, these issues were addressed in part through asset swaps to create greater geographic tension between each entity's generation and retail assets.
• It is interesting that the EMRS is looking to the NEM as a model, while many similar aspects of the NEM are being reviewed, including in relation to competition in metering and firm access to the network, or under scrutiny, such as the impact of the RET on capacity signals in the wholesale market and the approach to network pricing in the context of declining electricity demand.