WA Electricity Market Review - Government says 'yes' to Contestability, but 'no' to privatisation

In brief

The WA State Government has rejected recommendations for significant and transformational structural changes to the state's electricity market in response to the recently released Electricity Market Review Options Paper, opting instead for measured and incremental change. Partners Andrew Pascoe and Ben Farnsworth comment on the announced policy agenda, its 'winners and losers' and what we can expect from here in relation to electricity market reform in Western Australia.

Background

In our Focus: Significant review of WA electricity market, we reported on the WA Government's Electricity Market Review launched on 6 March 2014. The review was conducted during 2014 and involved the issue of a Discussion Paper in August 2014 and the receipt of 51 written submissions in response to the Discussion Paper. In December 2014, the Steering Committee delivered the Options Paper to Government. The Options Paper formed the final report (and conclusion) of the first phase of the Market Review. The Government released the Options Paper (on an unedited basis, according to the Minister for Energy) on 24 March 2015.

The Market Review had three objectives:

• reducing the costs of production and supply of electricity and related services;
• reducing Government exposure to energy market risks; and
• attracting significant private sector investment and participation in the electricity market.

Options Paper recommendations

The Options Paper identifies three major reforms needed to reverse the current market conditions of high and rising costs: reducing the market dominance of Synergy; introducing full retail contestability; and reforming the wholesale market mechanisms (particularly the reserve capacity mechanism). The Options Paper presents 14 recommendations to address these three major reforms. For ease of comment, we have categorised these recommendations into the following five groupings:

1. Restructure and privatisation of Synergy (Recommendations 1 – 3)
   The Options Paper recommends that the generation assets of Synergy be restructured or divested to establish three competing generation enterprises with a blend of baseload, mid-merit and peaking generation assets. Under this recommendation, one or two of those generation businesses would be established as a gentailer (ie a combined generator and retailer of electricity). Once the reformed market is operating effectively, this restructure should then be followed by a full or partial privatisation of the asset portfolios.
2. Retail contestability (Recommendation 4)
   Full retail contestability should be introduced as soon as practicable. This recommendation includes the facilitation of dual retailing of both gas and electricity (including by Synergy).
3. Subsidies and concessions (Recommendations 5 -7)
   The Options Paper makes several recommendations in relation to the range of subsidies and concessions paid to or through Synergy, including the Tariff Adjustment Payment and the Tariff Equalisation Contributions. The recommendations include the phasing out of the retail subsidy and the payment of other subsidies and concessions directly to relevant customers, rather than through Synergy.
4. Market for generation fuels (Recommendation 8)
   No change is recommended to the Government's current approach of facilitating commercial outcomes in the market for generation fuels.
5. Wholesale Electricity Market arrangements (Recommendations 9 – 14)
   The Options Paper makes a number of recommendations in relation to the reform of the electricity market arrangements:
• The wholesale electricity market arrangements of the National Electricity Market (NEM) should be adopted, including the adoption of the network regulation arrangements and retailing rules applying in the NEM under the National Electricity Law and the National Electricity Rules. (We note that the retail rules now sit in the National Energy Retail Law and the National Energy Retail Rules.)
• Regulatory barriers to Western Power's substitution of stand-alone electricity systems in place of network services in regional areas should be removed, subject to adequate consumer protection measures.
• Initiatives by EnergySafety to introduce best practice regulation through the proposed Electricity (Network Safety) Regulations should be supported. Advanced meters should be rolled out across the South West Interconnected System (SWIS) to foster competition and innovation in the retail market and more efficient pricing and retail services.
• The Economic Regulatory Authority should retain responsibility for setting electricity tariffs.

Government response

The Government has announced the establishment of a new steering committee to oversee Phase 2 of the Market Review, which aims to implement the Government's response to the recommendations. The Minister for Energy, Dr Mike Nahan, outlined the Government's response to the recommendations in a speech delivered on 24 March 2015. Rather than addressing each recommendation specifically, the Government has identified four 'workstreams': Network Regulation; Market Competition; Institutional Arrangements; and Wholesale Electricity Market Improvements. Phase 2 of the Market Review will involve an initial stage of detailed reform design, followed by implementation decisions. Implementation is expected to occur progressively from next financial year.

Following is a summary of the key response areas presented by Dr Nahan in reference to our categorisation of the key recommendations from the Options Paper. Our comments are in brackets.

1. Restructure and privatisation of Synergy
   The Government will not be privatising Synergy. Nor will it be restructuring Synergy to create one or more 'gentailers'. The Government will consider specific asset sales. Although the assets were not specifically identified, previous comments suggest generation assets may be identified for sale.
2. Retail contestability
   The Government supports full retail contestability and will implement this recommendation once the Government subsidy for the electricity market is reduced to zero – this is expected to occur within the forward estimates (four years). Full retail contestability will include the gas market, enabling Synergy to compete in the retail gas market. The Government's response includes a commitment to the 'removal of all barriers to entry in the retail and wholesale market'. In response to the recommendation in relation to advanced metering, the Government will seek to apply Chapter 7 of the National Electricity Rules in regulating metering in the SWIS. This will involve a review of who can provide metering services and how the costs of metering services can be recovered. (We note that Chapter 7 of the National Electricity Rules is currently the subject of consultation on proposed Rule changes to introduce competition in metering services and facilitate deployment of smart metering.)
3. Subsidies and Concessions
   The Government expects the subsidies to be reduced to zero within the forward estimates. Approximately $500 million of subsidy savings were reported in the December mid-year Financial Projections Statement. Further savings are expected to be announced in the May budget.
4. Wholesale electricity market arrangements
   The Minister made the following comments in relation to market reform:
• There will be reform to the current capacity charge structure, perhaps moving towards an energy structure. The aim of this policy response is to reduce the amount of surplus generation capacity in the market, and its associated costs. (It will be interesting to see how the Government addresses any compensation issues that might arise from taking surplus capacity out of the system.)
• The Steering Committee will look at the introduction of 'facility bidding' to promote greater competition between generation facilities.
• System management (currently undertaken by Western Power) will be folded into the role of the Independent Market Operator.
• The regulation of the Western Power network, including price, connection and access, will be transformed along the lines of the national regime, with adaptations to suit the specific circumstances of the Western Australian market. The network connection and access rules will transition from the current unconstrained model to a constrained network model.
• Retail tariff and other regulatory functions currently undertaken by the ERA will be transferred to the Australian Energy Regulator.

• The Minister indicated that the Government would be announcing its policy in relation to renewable energy later this year.
• Full retail contestability will include giving retail customers the option of selecting one of a range of electricity retail suppliers, or none at all. In other words, people can opt to move off the grid completely. (These comments fell short of guaranteeing that no charges will be incurred by such people – there are issues involving back up power, the cost of electricity infrastructure being accessible by such people.)

Conclusion

Overall, the Government's response to the Option Paper can be described as measured and incremental. There is very little in the way of bold market reform, or short-term changes to drive competition. There is little or no prospect of any significant privatisation transaction, at least in the retail and generation sectors. Critics of the Government's response might say that the failure to confront the industry structure and the market dominance of Synergy, whether by way of vertical separation and/or privatisation, means that one of the three key structural reforms recommended by the Review has been largely ignored.

The response certainly represents a move forward in terms of improving the electricity market in this State. The proposed reforms should, in time, drive a greater level of price signalling, which in turn should deliver innovation and efficiencies.

It is too early to comment on the full impact of the Government's announcement on 24 March. Following are some initial comments:

• There will be no significant structural change and no major privatisation proposal involving Synergy in the current (or even next) term of government, other than the sale of discrete assets.
• There was no formal mention of a sale of the poles and wires assets, although reports in the media indicate that the Government is not considering a poles and wires transaction at this stage.
• There are longer-term consequences for existing gas retailers such as Alinta and Kleenheat facing competition from Synergy, which holds the competitive advantage of its existing retail platform.
• The market for retail contestability will create opportunities for current market participants and new entrants to leverage off existing retail platforms to develop an electricity retail business – provided the Government implements the full range of recommendations relevant to contestability, including in relation to metering and other barriers to entry.
• Market participants will need to consider their existing contractual arrangements to determine the implications of the proposed market restructure. Existing contracts have been established on the basis of a market structure driving particular economic outcomes. If the restructure causes fundamental changes in the economic outcomes for participants, then the contractual arrangements may need to be reviewed and tested.
• It seems the SWIS will move towards a NEM-like energy-only system (as opposed to the current capacity plus energy market). If an energy market model is adopted, will there be effective competition in the market, given that Synergy currently supplies 80 per cent of all energy delivered to the market?
• Consideration will need to be given to the compensation payments (if any) if capacity is restricted or other structural changes are implemented to the detriment of existing market participants who have invested on the basis of the existing market architecture. There is currently 2300 MW of excess capacity in the SWIS.
• If the Government sells generation assets, what performance guarantees (if any) will be provided, and will these guarantees simply be another form of subsidy?
• If the Government moves to join the NEM as an unconnected region, there may be opportunities for innovative financial products to drive more efficient outcomes in the SWIS – the stable and well understood market conditions that operate under the NEM would be conducive to ongoing private sector investment in the SWIS, which in turn would drive efficiencies and innovation.
• The decision not to pursue a power privatisation strategy at this time presents some interesting long-term challenges for the State:
  • As the Government recognises, new technologies in electricity generation, distribution and storage will continue to have a disruptive effect on the operation of the market in Western Australia. In other words, demand is not expect to increase in the near term, and may continue to decline. This means the public assets may have a decreasing value over time.
  • Western Power needs to invest significant capital in upgrading its transmission assets.
  • Australian power generation and transmission assets are currently the subject of review and interest from prospective local and international investors. Now might be a better time to try to realise full value for such assets, rather than deferring to some future time.