The Reserve Capacity Mechanism and eligibility criteria 6 min read
The Federal Government's Capacity Investment Scheme (CIS), introduced in late 2023, is now underway in WA. The WA Government has entered into a Renewable Energy Transformation Agreement (RETA) with the Federal Government to accelerate the buildout of renewable projects in the Wholesale Electricity Market (WEM), which sees federal CIS funding allocated to WA in return for the State Government creating favourable conditions for renewables investment in WA. The Australian Energy Market Operator (AEMO) is currently evaluating Stage A bids for Tender Round 2, which aims to procure 500MW of clean dispatchable capacity to connect to the South West Interconnected System (SWIS), WA's primary electricity network, which supplies the WEM.
While the terms of Tender Round 2 are largely based on the pilot round for clean dispatchable capacity in Victoria and South Australia, they have been adapted to accommodate the Reserve Capacity Mechanism (RCM)—Australia's only capacity market and a unique characteristic of the WEM that aims to ensure there is sufficient capacity to meet peak demand in the SWIS.
In this Insight, we explore how the CIS will operate in WA alongside the existing RCM and what projects need to do to meet the eligibility criteria for participating in the CIS Tender Round 2 and future annual rounds in the WEM, with respect to the RCM.
Key takeaways
- For a WA project to participate in the CIS, it must also participate in the RCM.
- The terms for the first WA tender round differ from those for the National Electricity Market tender rounds, as several key features, including bid variables, are tied to the Capacity Credits held by the project.
- Capacity Credits can help make a project bankable.
- A facility must be certified to participate in the RCM. Capacity Credits are awarded two years in advance of when the obligation to provide capacity is enlivened.
- Factoring in the lead time for certification should inform your project schedule.
How does the RCM interface with the CIS?
The RCM plays a central role in the operation of the CIS in the WEM. Primarily, it determines eligibility: participation in the CIS requires that a project participates in the RCM.
Reliability assessment
Unlike the National Electricity Market (NEM), where CIS tender bids are evaluated based on a focused reliability assessment, AEMO will rely on the reliability assessment already conducted for the project as part of the relevant RCM tender round when evaluating bids in WEM tender rounds.
Obviously, the RCM assessment is tied to the four-year RCM cycle, whereas a Capacity Investment Scheme Agreement (CISA) may have a term of up to 15 years. To address this, the draft CISA allows the Federal Government to immediately terminate the agreement if the project does not obtain Peak Capacity Credits for two consecutive Capacity Years. If terminated, the project is also required to pay an early termination fee.
As a result, under the CISA, the project assumes the risk of failing to participate in the RCM at any point during the CISA term.
Bid variables
A unique feature of the WEM CIS tender is that some contract terms are tied to the Capacity Credits held by the project.
Most notably, the revenue floor and ceiling (CISA bid variables, explained in our previous Insight) are tied to the financial value of Capacity Credits: the revenue floor and ceiling 'float' from year to year to the extent the financial value of Capacity Credits fluctuates.
In addition, the annual support payments under the CISA are aligned with the project's allocation of Capacity Credits under the RCM each Capacity Year.
Reserve Capacity Mechanism in more detail
What is it?
The RCM is crucial for maintaining the stability and reliability of the geographically isolated SWIS. It is becoming increasingly important in light of recent developments, such as the WA Government's plan to retire its coal fleet by 2030 and AEMO's forecast of a capacity shortfall from 2027 onwards.
Operating on a four-year cycle, the RCM requires AEMO to procure capacity from market participants two years prior to when it is required. For example, in 2025, AEMO will be securing capacity for the period from October 2027 to September 2028 (Capacity Year), as demonstrated in the diagram below.
This forward-looking model allows new facilities to participate in the RCM before they are operational through the 'Early Certified Reserve Capacity' process.
What are Capacity Credits?
The RCM operates by awarding tradeable Capacity Credits to projects in return for capacity being made available in a given Capacity Year, thereby ensuring enough capacity to maintain grid reliability in the SWIS at times of peak demand. Capacity Credits represent the notional amount of capacity (in MW) that a facility must provide in a given Capacity Year. Market Participants are incentivised to obtain Capacity Credits, which are financial products tied to their ability to make capacity available.
Capacity Credits can be managed through the Capacity Credit Allocation and WEM settlement process. For more details, visit AEMO's Assignment of Capacity Credits.
How are Capacity Credits allocated?
Facilities seeking Capacity Credits must either submit an expression of interest (EOI) or complete an indicative facility class assessment. While submitting an EOI is not mandatory, it can affect a facility's priority during its Network Access Quantity assessment.
The allocation of Capacity Credits depends on several factors, including:
- Certified Reserve Capacity: an assessment of the physical capabilities of a facility, its level of commitment for a new facility (eg whether the market participant has entered an access contract with Western Power) and trade nominations.
- Network Access Quantity (NAQ): limits that may be imposed on a facility to provide capacity due to network constraints.
New market participants who intend to participate in the RCM should be aware that, unless an exception applies, existing capacity providers have priority for NAQ when Capacity Credits are allocated. This means network constraints could limit Capacity Credits for new facilities if there is limited capacity in that part of the network.
What rights and obligations attach to Capacity Credits?
Holding Capacity Credits comes with obligations, including making capacity available (depending on the facility type) and complying with outage planning requirements. Non-compliance can lead to refunds being payable or a reduction in assigned Capacity Credits.
Capacity Credits can be traded in two ways:
- Offtake agreements: market participants can trade Capacity Credits at a commercially agreed price through off-market mechanisms (ie offtake agreements). Consumers purchase Capacity Credits from generators to meet their allocated RCM costs (known as the Individual Reserve Capacity Requirement). This trade occurs through the Capacity Credit Allocation process.
- Market settlement: AEMO purchases Capacity Credits at an annually determined Reserve Capacity Price. For the Capacity Year 2025-26, the Reserve Capacity Price is $251,420 per Capacity Credit. This payment is part of the WEM weekly settlement process.
Do Capacity Credits enhance project bankability?
Certification by AEMO can enhance a Project's bankability by indicating an additional revenue stream to potential financiers. Market participants must meet the eligibility requirements, such as obtaining a generation license, and provide security once early certification is granted.
Facilities that do not trade their Capacity Credits can opt to be a 'Fixed Price' facility, setting the Reserve Capacity Price paid by AEMO for a five-year period. This option provides price certainty for market participants and their financiers.
Actions you can take now
WEM CIS tenders will be conducted annually. The EOI process for the 2025 Capacity Year will open in early 2025. Projects intending to participate should ensure they align with this timetable.
Early stage projects intending to participate in the WEM CIS should consider starting the Early Certified Reserve Capacity process for the RCM. This allows AEMO to certify a project's reserve capacity at any point before the Capacity Year it intends to participate in the RCM. Existing facilities should consider the benefits of submitting an EOI for its NAQ-assessment priority, as compared to undergoing an indicative facility class assessment.
Participating in the RCM in the early stages of a project can have significant benefits for project bankability and obtaining project finance, as this additional revenue source will be attractive to investors.
Projects that obtain Capacity Credits and are successful in a WEM CIS tender should be aware of their ongoing obligations under the CISA to participate in the RCM and hold Capacity Credits.