What you need to know about the national energy guarantee and demand response

In brief

Following the Energy Security Board's release of the National Energy Guarantee Draft Detailed Design Consultation Paper, Partner Kate Axup, Associate Mark Leersnyder, and Lawyer Mohamed Khairat consider the challenges and opportunities surrounding demand response as an alternative form of dispatchable capacity in the Australian energy market. This article is part of a series in which Allens examines aspects of the proposed National Energy Guarantee.

Background

According to the Energy Security Board (ESB), the development of demand response products that qualify under the reliability obligation of the National Energy Guarantee (the Guarantee) will 'be central to ensuring the reliability requirement of the Guarantee is met at least-cost'.¹ 

Throughout the Draft Detailed Design Consultation Paper (Draft Design), the ESB makes it clear that demand response is a key alternative to additional generation output in order to enable liable entities to meet the reliability requirement of the Guarantee, provided that these demand response products are 'in-market' and are used by the counterparty to hedge against its exposure to high pool prices. 

What is demand response?

Demand response helps to manage electricity supply by paying energy users to reduce their energy consumption for short periods of time when electricity reserves reach low levels as a result of peak demand.

Periods of peak demand, while relatively infrequent, can have significant consequences. If there is insufficient supply to meet demand, system failure and curtailment can occur. Further, building generation infrastructure to cater for infrequent periods of extreme demand is not a particularly efficient outcome. For example, on extremely hot days, Australians across the eastern seaboard have been recorded using 46 per cent more electricity than average. As such, many gas-fired peaking plants are turned on for as little as 20 hours a year.² 

Demand response can help to address both of these consequences by taking demand out of the system while providing a financial incentive for users to do so.

Why is demand response important to you?

Recent steps taken by Australian regulators have opened up new opportunities for relevant stakeholders to be involved in the demand response market. There are already a number of commercial incentives offered for participation in demand-response initiatives, with regulators seeking public consultation on whether further incentives are needed.

Regulators have also recognised that, while technological strides are being made with dispatchable capacity, demand response can be an efficient, cost-effective mechanism for providing increased reliability in the energy market. Understanding demand response will therefore be important to retailers and large customers who, depending on the final form of the Guarantee, may be subject to the reliability requirement.

With regulation and policy surrounding demand response currently being considered, this is an opportunity for all relevant stakeholders to be involved in shaping this aspect of the future of Australia's energy market.

Demand response around the world

The use of demand response in energy markets is not a new concept, and dates back several decades.

Today, demand response activity is most active in the US, and is quickly gaining traction in South Korea and Japan. Globally, a 2015 report by Navigant Research expects spending on demand response technologies to total $US 6.2 billion in the period 2015 to 2024.³

In the US and South Korea, demand response has been part of legislation for several years. In the US, the Energy Policy Act of 2005  (Pub.L. 109-58), which addresses growing energy challenges, requires the Federal Energy Regulatory Commission (FERC) to conduct an annual survey of demand response in the US.⁴  According to FERC's 2017 annual survey, 28,673 MW in demand response resources were available in 2016 across seven participating regions in the US.⁵ 

Meanwhile, South Korea's demand response program is set to kick off in 2018. As of November 2017, there are 3,580 participating consumers, setting potential power saved in the country at 4.3 gigawatts – 'equivalent to the output of three nuclear reactors'.⁶  Ahead of its rollout, the South Korean Ministry of Trade, Industry and Energy has been considering reforms intended to increase financial incentives for consumers who have volunteered to participate in the demand response program.

What is already happening in Australia?

Demand response is in its infancy in Australia. However, the combination of the ESB clearly signalling the importance of demand response products in the context of the reliability requirement and the developments described below suggest that this will be a growing part of the energy market in the coming years:

• Demand response trial program: In May 2017, ARENA and AEMO announced a trial program to support demand-response projects across Australia. The trial program saw $35.7 million in funding distributed to 10 pilot projects across New South Wales, Victoria, and South Australia, with the aim of delivering at least 200 MW of capacity by 2020.⁷  According to a submission by AEMO and ARENA made to the Australian Energy Market Commission (AEMC) in May 2018, the establishment costs of the trial, including costs such as customer procurement and upfront capital costs, had a weighted average $200,000 per megawatt of capacity, compared to the average capital cost of $1 million for a diesel engine.⁸  Building on this success, ARENA and AEMO announced in the submission that they are exploring the potential for new trials to demonstrate how demand response may contribute to reliability and affordability in electricity wholesale markets.⁹

• Wholesale Electricity Market: In Western Australia, stakeholders can participate in a form of demand response through the Wholesale Electricity Market (WEM). The Reserve Capacity Mechanism (RCM), through a system of credits and oversight from the Independent Market Operator of Western Australia, is aimed at ensuring there is adequate generation and Demand Side Management (DSM) capacity available to meet peak system requirements. The RCM effectively rewards Market Customers for reducing electricity demand upon request from Market Generators during peak periods.¹⁰  Additionally, DSM rewards consumers for not only actually reducing energy consumption during periods of peak demand, but also for just being on standby.

• Ancillary services: Currently, there are eight markets in the National Electricity Market (NEM) for procuring sufficient Frequency Control Ancillary Services (FCAS), which are used to maintain frequency on the electrical system and manage the power system reliably. In 2016, the AEMC made a final rule on 'Demand Response Mechanism and Ancillary Services Unbundling', creating a new type of market participant – a market ancillary service provider – who will not need to be a customer's retailer to offer the customer's loads into FCAS markets.¹¹ As explained by AEMC, in practice, 'this means that while a customer has a retail supply contract with a retailer, a customer may have a separate contract with a market ancillary service provider (who may be another retailer) to provide ancillary services'.¹²  This, therefore, provides customers with an option to participate in demand response by engaging with a market ancillary service provider.

Barriers to increased adoption of demand response

There are a number of challenges and regulatory barriers associated with the implementation of demand response in Australia and around the world. These include:

• Cost: The costs associated with investment in technology and infrastructure required to facilitate demand response is often raised as a barrier to the increased rollout of demand response. This includes costs associated with the upgrade of retailers' billing systems (ie to facilitate demand response) and the creation of smart grid infrastructure.

• Reliability: While demand can be affected by factors such as weather, there are other factors that are random and can be unpredictable. The Independent Review into the Future Security of the National Electricity Market – Blue Print for the Future (the Finkel Review) recognised that, particularly for residential consumers, it is difficult to maintain responsiveness to price signals as evidenced from other countries.¹³  The Finkel Review noted that a solution could be to remove a consumer's requirement to manually respond to demand reduction and instead give power to a service provider who has an agreement with the consumer to automatically curtail that consumer or shift electricity usage.¹⁴

• Transparency: According to the AEMC, one of the most important barriers to demand response is the lack of transparency around how much demand response is occurring in the NEM, making it difficult to determine whether there are sufficient levels of demand response and whether such demand response is efficient and valuable.¹⁵ A number of stakeholders in the energy market, such as Snowy Hydro, AGL and the EEC, agree, and have called for greater innovation in and accuracy of market-demand forecasting, reporting and information provision.¹⁶ The AEMC believes it is important to provide greater transparency, including more information to market participants to allow them to make informed demand-response decisions that may lead to greater efficiency and value.¹⁷ As such, as part of its Reliability Frameworks Review (Reliability Review),¹⁸ the AEMC is currently reviewing a number of potential changes aimed at addressing the challenge of transparency. In addition to steps taken by the AEMC, the Draft Design considers a number of options to support an increased ability to make informed decisions. This includes requiring AEMO to assess its forecasting processes.

• Single financially responsible market participant: In addition to reviewing the issue of transparency, the Reliability Review is also considering changes to  current arrangements in the NEM that only provide for a single financially responsible market participant (FRMP) at a connection point. According to the AEMC, this means that unless 'a customer is willing to directly participate in the wholesale market or has a retailer that is willing to offer demand response (either from itself, or via a third-party aggregator), the customer will not be able to engage in wholesale demand response'.  As part of the Reliability Review, the AEMC is currently considering two options that would allow multiple parties to engage a single consumer behind a connection point without it being contingent on the cooperation of the FRMP.

What's next?

Steps taken by the ESB, the AEMC, and other relevant stakeholders appear to indicate a move towards encouraging the uptake of demand response mechanisms in Australia. Demand response is, for now at least, seen as an important mechanism that can help secure efficient energy supply across Australia.

Interested stakeholders should follow the outcome of the AEMC's Reliability Review, which is set to be finalised in mid-2018, and consider making a submission to the ESB on demand response (noting that submissions on the Draft Design are due by 13 July 2018, with the final Draft Design to be released in August 2018).