Finkel Review - Renewables: The importance of regulatory certainty for renewables

In brief

In the third of our series analysing the Finkel Review, we look at implications for the renewable energy sector. Two recommendations in particular – the Clean Energy Target (CET) and the Generator Reliability Obligation – raise a number of opportunities and issues for investment in the renewable energy sector. Partner Kate Axup and Associate Danielle Jones report.

Key themes and suggestions

• Certainty and stability are crucial: The establishment of a regulatory framework for the post-Renewable Energy Target (RET) period is fundamentally important for continued investment in the renewable energy sector. Political volatility will destabilise the sector and decrease investment. 
• Base load power shortfall: With the closure of aging coal fired power stations, and as energy companies and banks are increasingly distancing themselves from investment in new coal fired power stations, an opportunity exists for renewable energy generators, coupled with battery storage or other dispatchable capacity, to make up the base load power shortfall. This is consistent with the Generator Reliability Obligation recommended by Dr Finkel.  
• Changing PPA market: We expect to see a shift in market terms for power purchase agreements (PPAs) involving renewable energy generators as the RET comes to an end. The nature of this shift will depend on how the issue of regulatory certainty is addressed (whether it be by implementation of the CET recommendation or otherwise).

Background

The Finkel Report is the product of an extensive examination of all aspects of the future of the National Electricity Market (NEM). [Please see our previous Client Update: Finkel: the solution for our energy future?

The renewable energy sector is a key focus of the Finkel Report due to the increase in renewable energy generators in the NEM and the move away from thermal generators that have traditionally provided base load power. Dr Finkel notes that the security and reliability of the NEM has been compromised by poorly integrated variable renewable electricity generators and the unplanned withdrawal of older coal and gas-fired generators.¹ Further, uncertainty and changing emissions reduction policy has hampered investment in the renewable energy sector.² Accordingly, a key outcome of the Finkel Report is increased security, which is underpinned, in part, by the orderly transition to a low emissions future through an agreed emissions reduction trajectory. 

What did Dr Finkel say about renewables?

Set out below are the key recommendations outlined in the Finkel Report relating to the renewable energy sector. We have also considered opportunities and issues flowing from these recommendations.

The need for a certain policy framework

We know that an unstable policy environment in respect of renewable energy has a significant impact on investment in the sector. From July 2014 (with the repeal of the carbon pricing scheme) to May 2015 (when bipartisan agreement was finally reached in respect of the RET), investor confidence in Australia's renewable energy sector plummeted. Bloomberg New Energy Finance reported an 88 per cent drop in new investment in large-scale renewable energy in 2014 compared with 2013, the lowest level since 2002.³ Further, Australia's global ranking of attractiveness among investors in large-scale renewable energy fell 28 places from 11th to 39th place.⁴  

The tide has certainly turned since May 2015, with the 2017 renewable energy attractiveness index prepared by EY in May 2017 ranking Australia as the 5th most attractive country to invest in for new renewable projects, citing a year of record investment in the sector and a decline in coal for the jump in ranking.⁵ The increase in regulatory certainty for renewables was clearly the force behind this change.

The Government's failure to endorse the CET recommendation (while endorsing all 49 other recommendations) has once again created the possibility of a period of regulatory uncertainty for renewables, which could lead to investors again refraining from making new investments in the sector as the end of the RET gets closer. A lack of investment in new generation capacity will, as Dr Finkel notes, compromise the reliability of the NEM.⁶ While it is true that the Government has not rejected the CET at this stage, it is important for the market to be given clear direction in terms of future regulatory settings in a timely fashion.

Base load power gap

The Finkel Report notes that the past few years have seen the retirement of a significant volume of coal fired capacity from the NEM with no corresponding investment in new generators that can provide the equivalent base load power.⁷ Further, prominent energy companies and banks have publically distanced themselves from coal fired power stations, noting that coal is becoming increasingly uneconomic as the country moves to a carbon constrained future.⁸

However, as the Finkel Report also notes, the reliability of the NEM is dependent on a certain level of base load power that can be dispatched on call.⁹ Renewable energy generators by their nature cannot provide that base load power. Accordingly, a gap exists in the market that will need to be filled by another form of dispatchable generation.

To help address this gap, the Finkel Report's 'Generator Reliability Obligation' recommendation provides that all new variable renewable energy generators should be required to include new dispatchable capacity.¹⁰ The Finkel Report does not specify what the dispatchable capacity must be but includes battery storage, pumped hydro and gas-fired power stations as examples.¹¹

While the Generator Reliability Obligation has the potential to increase the cost of renewable energy projects as a result of the obligation to source new dispatchable capacity and will form part of future project economics, the renewable energy sector appears to be starting to move in this direction anyway. For example, AGL is trialling the world's largest residential virtual power plant in South Australia¹² and Conergy has started constructing Australia's first grid-connected utility scale solar and battery storage project.¹³

Consequently, the implementation of the Generator Reliability Obligation could be a key driver of investment in battery storage technology that could lead to a more rapid roll out and evolution of that technology than may otherwise have happened. If this occurs, renewable energy generators coupled with battery storage could help to fill a base load power gap.

Transition from the RET to the CET

The RET scheme is scheduled to end on 31 December 2030.¹⁴ Currently, many PPAs involving renewable energy generators have a term that expires on that date.

A clear and widely accepted CET (or other new regulatory framework) will allow renewable energy generators to negotiate and enter into longer-term PPAs and will give parties more comfort around risk sharing in respect of changes to the policy framework. This, in turn, will lead to greater investment as parties can get comfortable that their investment will be recovered over time.

In contrast, the lack of a clear pathway post the RET sunset date of 31 December 2030 is likely to cause issues in the negotiation and execution of PPAs in the short term. In our experience, it is unusual for parties to agree to contract for large-scale renewable energy certificates after the RET sunset date, meaning that the term of PPAs is likely to get shorter and shorter to a point where they become unbankable. Further, as the fate of the RET becomes more certain and without a viable replacement, the allocation of regulatory risk as between the parties will become increasingly contentious . Again, this will lead to difficulties in parties executing PPAs, which are often a crucial factor in securing investment in new renewable energy projects.¹⁵