ACCC wants changes to the National Electricity Market

In brief

The ACCC recommends changes be made to the structure of ownership of generation assets and incentives in place regarding bidding and generation investment. We examine the operation of the National Electricity Market, why the ACCC is concerned about market concentration, and their recommendations for reform.

How does the NEM work?

The National Electricity Market (NEM) covers five regions: NSW, Victoria, Queensland, Tasmania and South Australia. Prices are set in the NEM by bidding generators. At each five-minute increment, generators bid to offer their electricity for dispatch to the market. The Australian Energy Market Operator dispatches the cheapest bid first, the next cheapest bid after that, and so on. The price of the final bid dispatched is the 'dispatch price'. The spot price is currently set at 30-minute increments (moving to five-minute increments in 2021) by taking the average of the six dispatch prices over that 30-minute period. The spot price is paid to generators for the electricity that they dispatch during that period, regardless of their individual bid values. The lower the generators' bids, the lower the dispatch price and spot price will be.

The NEM is intended to incentivise new investment in generation capacity when spot prices are higher. When the spot price is consistently high, it will incentivise investment in generation capacity. Where capacity greatly exceeds demand, the spot price will be lower and higher cost generators will exit the market.

What are the ACCC's concerns about the NEM?

The NEM relies on price signals to ensure that there is optimal capacity over the medium term. The ACCC is concerned that those price signals are distorted or fail to operate effectively in the NEM because of market concentration, government intervention and high barriers to investing in new capacity. In the ACCC's view, the combination of these factors is at least partially responsible for the higher wholesale electricity prices since 2012. The ACCC labels 'the current wholesale market structure' as 'not conducive to vigorous competition'.

The ACCC is concerned with particular types of generator behaviour. It suggests that Stanwell Corporation, one of two state government-owned generators in Queensland, bid in a manner that raised the wholesale price in Queensland in the lead up to July 2017. Although the Queensland Government directed Stanwell Corporation to change its bidding behaviour, and this led to lower wholesale power prices, the ACCC has raised concerns about this approach. It introduced a degree of uncertainty into the market place and affected those who had already hedged their positions on electricity prices. The ACCC's contention is that the NEM works where competition exists. Government directions to wholly-owned generators do not resolve the structural causes of problematic bidding behaviour.

Those structural causes include relatively high barriers to investment in new capacity. New projects often require a large capital investment, which involves significant risk and therefore difficulty in obtaining finance, particularly when the project is proposed by a new entrant that does not have an established downstream customer base. Although some financing has occurred on the basis that downstream users will purchase electricity from the proposed project for a period of time, many customers are unwilling to purchase electricity over the long-term period necessary to make the project economically viable.

What is the ACCC proposing?

The ACCC is proposing four changes.

Firstly, it has recommended the introduction of a 20 per cent cap on market share in each NEM region or the NEM as a whole, applying to new acquisitions. Where owners or controllers of generation capacity currently exceed that cap, they would not be forced to sell down their assets, nor would the cap apply to investments in new capacity. The ACCC gave some consideration to introducing divestment mechanisms, but decided that a prospective cap on acquisitions, in combination with the other recommendations, was sufficient to restore the effective functioning of the NEM.

Secondly, the ACCC has recommended that the Queensland Government create a third government-owned electricity generator and that it sell at least two of these three generators, or operate all of its generators on a commercial basis. The ACCC hopes this will provide a competitive constraint on bidding behaviour.

Thirdly, a new market-manipulation rule has been proposed prohibiting behaviour that manipulates the proper functioning of the wholesale market. Investigatory powers would be introduced to facilitate the enforcement of this rule, along with appropriate remedies. The ACCC has said that the market-manipulation rules applying to the gas supply market present a good model for such a regime. The ACCC, for the time being, has rejected the idea that a market power mitigation rule should be introduced, suggesting that wholesale power price increases are less a factor of misuse of market power than a lack of competitive constraints.

Finally, the ACCC has recommended that the Australian Government enter into low, fixed-price energy offtake agreements for the later years of new capacity projects, so that the owners can obtain debt financing to build the projects. The ACCC has suggested that eligible projects would have at least three customers who will buy electricity for the first five years of the project, not involve any existing retail or wholesale generator with a significant market share, and have enough capacity to serve a number of large customers. This will incentivise new generation capacity, particularly from new entrants to the market, and result in greater competition in the NEM.