Executive Summary
Background Marsden Jacob Associates (Marsden Jacob) was appointed by the Australian Energy Council (AEC) to undertake an assessment of the current and proposed revenue streams for generators in the Wholesale Electricity Market (WEM) and whether they provide revenue adequacy to support the
industry as it transitions. Recommendations on measures to send the right investment signals are
provided.

Australian commitments to net zero emissions by 2050 will drive the WEM to high levels of intermittent generation sources. This has adverse consequences for inflexible generation plant in the
South West Interconnected System (SWIS) which is experiencing reduced generation outputs, increased cycling, and periods of negative prices in the Balancing Market and Short‐Term Energy Market (STEM). The current generation fleet is not optimal given the current and future load duration curve in the WEM. There is increased variation in both demand (due to behind the meter generation) and supply due to the increased reliance on intermittent generation sources. The current WEM generation fleet of coal and gas is above current requirements with high capacity (MW) and high energy resources (MWh). These additional costs must be absorbed by either customers or generation asset owners. The optimal future electricity system will require flexible and dispatchable energy resources such as storage and OCGT aeroderivative units2 to manage these variations. The likely plant mix will have high capacity but limited energy resources (i.e., energy from storage facilities). In effect, the SWIS is transitioning from a relatively low capacity (MW)/unconstrained energy system (MWh) to a high capacity/limited energy system. Governments are intervening in electricity markets to support this transition to a more flexible generation fleet in the National Electricity Market (NEM) with underwriting of gas generation and storage projects. The WEM is currently undergoing a reform program to encourage flexible technologies while providing some transitional arrangements to support existing generation.

Generator Revenue Adequacy and Market Power in the WEM
Current Revenue Adequacy Over the period 2016/17 to 2020/21, the WEM has provided adequate revenue to permit existingplants to continue operations with positive EBITDA margins.A positive EBITDA does not imply that generators are making financial returns and covering all capital costs, but it does suggest thatgenerators are at least recovering their variable costs and contributing to capital cost recovery.

Analysis and Recommendations The WEM is moving towards high levels of intermittent generation and will require flexible generation and storage to maintain reliability standards. However, our analysis shows that there may not be adequate revenue to encourage flexible generation and storage. The “missing money” is being caused by low and variable capacity prices for new entrant generators. This can be corrected by providing long term capacity contracts with prices that reflect the costs of new entrant (CONE) capacity. Under the new capacity rules in the WEM, the Electric Storage Resources (ESR) Obligation Duration is set at four hours, which means that a storage facility that can provide 4 hours of continuous supply will be accredited for Capacity Credits at 100 per cent of the facility’s nameplate capacity. This means that an 8‐hour storage facility will only get the same capacity market revenue as a 4‐hour battery, even though we expect future requirements for storage will exceed 4‐hours. As highlighted below, average peak demand in the SWIS is around 4‐hours today (4 PM to 8 PM based on Operational Demand that is >90% of peak demand in that year). However, in 2040, average peak
demand will be around 5‐hours (2:30 PM to 7:30 PM). On some peak days in the WEM, peak demand can occur for up to 6‐hours (e.g., in 2022 and subsequent years).

Future Challenges and Ideal Attributes for the WA Power Market Australian private sector and government commitments to net zero emissions by 2050 will drive the WEM to high levels of intermittent generation sources and firming services provided by flexible generation and storage facilities. The future challenge is managing variations in both supply and demand for electricity, using a plant mix that can be characterised as having high capacity (MW) but limited energy resources (MWh). This is very different from the current power system that has low levels of capacity and almost unconstrained levels of energy supply. This chapter looks at the challenges facing the WA electricity system and what are the key characteristics of the future power system that are required to achieve secure, reliable, clean, efficient, and affordable energy supplies.

Overview of the WEM The WEM is a ‘capacity plus energy market’ which relies on authorities to co‐
ordinate long term planning and procurement to ensure that sufficient capacity resources (quantity approach) are available to meet the targeted level of supply reliability. This is very different to the NEM which relies on ‘scarcity’ prices (pricing approach) to drive investment in sufficient capacity resources to meet the targeted level of reliability. Investors typically like capacity markets because revenue risks are lower (guaranteed minimum levels of revenue), but frequently suffer from chronic surpluses of capacity, which requires policy makers and governments to intervene regularly in the market to reduce the surplus. The reverse problem occurs in energy only markets, whereby governments and policy makers intervene in the market to avoid shortages of capacity. There are two fundamental approaches to market design – energy and capacity markets, and energy only markets. We discuss some of the key aspects of each design in meeting market objectives. We also look at how reforms of the WEM are attempting to overcome some of the inherent flaws of the current energy and capacity market design.

The ESR Obligation Duration applying to a Capacity Year will be published in the Electricity Statement
of Opportunities. AEMO will also have the flexibility to change the window of time (but not the length of the window) at shorter notice, by 8.30am on the Scheduling Day, to enable AEMO to respond to changing or unexpected market conditions.

In effect, the ESR Obligation Duration (quantity approach) replaces the price‐based approach used to
determine the dispatch of plant in energy‐only markets such as the NEM. Currently AEMO has determined that the peak period for storage facilities is only 4 hours. However, as more storage is deployed in the SWIS, it is likely that AEMO will have to extend the ESR Obligation Duration to avoid creating new peaks in demand. This can be clearly seen below, whereby the peak period in 2022 is currently 3 hours from 5.30 PM (17.5 interval) to 8.30 PM (20.5 interval), but then changes to 4.5 hours from 4 PM (16.00 interval) to 8.30 PM (20.5 interval) in 2035 (note this could also result from behind the meter storage being dispatched as well). This implies that the 100 MW battery (Facility 1) will have to increase storage by 50 MWh to ensure that it continues to be accredited for 100 MW of Capacity Credits.

Generator Revenue Adequacy and Market Power in the WEM Over the period 2016/17 to 2020/21, revenue from the WEM has provided adequate revenue to permit existing plants to continue operations in the SWIS (EBITDA margins are positive). Based on current WEM revenue forecasts, new entrant coal and OCGT plant is not economic. Flexible generation (OCGT_Aero) and storage (4 hours storage) is marginal (revenue is just sufficient to cover costs), while intermittent generation (wind and solar) is still economic (the latter is only economic if LGC revenue is included). A low‐capacity price forecast contributes to the above results.

Future Revenue Sufficiency in the WEM (Cal 2022 to Cal 2031) The transition to zero net emissions by 2050 is gaining momentum with many market participants in the NEM announcing the earlier retirement of coal fired units.30 To a large extent this is occurring because of reduced grid demand for dispatchable generation and a reduction in utilisation of coal fired units. These same drivers may accelerate the retirement of coal fired units in the SWIS.

Given that coal plant retirements may be an efficient response to declining operational demand, will
there be sufficient revenue to enable new investment in firm generating sources to maintain future
supply reliability? To answer that, we need to consider likely future outcomes in the WEM with new
entrant generator costs. In the following analysis, we have compared the levelised costs of each technology class with levelised revenue over the period 2022 to 2031 for a Base Case Scenario (i.e., ESOO 2021 expected case scenario).

Currently, the WEM is mainly reliant on ex post market power mitigation measures. The ERA monitors the market, investigates possible misuse of market power, and takes regulatory action if a participant’s behaviour is found in breach of the Market Rules. These measures rely on the deterrence provided by enforcement and penalties.

Reforms of the WEM that should be considered to improve revenue adequacy and market efficiency There is “missing money” in the WEM that can adversely impact the investment case for flexible generation and storage in the SWIS that is required as part of the transition to a low emission electricity sector. The fundamental problem is low and variable capacity prices for new entrant generators. This can be corrected by providing long term capacity contracts with prices that reflect the costs of new entrant (CONE) capacity. The WEM is a highly concentrated market, and as such, an appropriate market power mitigation framework needs to be developed that ensures parties are incentivised to behave competitively but does not prescribe outcomes and allows both participants to act commercially and allow markets to clear at efficient price levels.

It has been argued that the minimum STEM price of ‐$1000 per MWh contributesto the missing money
problem in the WEM. However, our analysisindicatesthat in 2021 (the 12‐month period with the highest
occurrence of negative pricesin the WEM), the Balancing Market price did not clear at ‐$1000 per MWh. The lowest price was ‐$90 per MWh. In previous years, the minimum STEM price has occurred due to inflexible plant (e.g., minimum load of coal and gasfired generation) and VRE plant that have “run of plant” Power Purchase Agreements(PPAs) and are not exposed to the spot price. However, the latter issue is not a market design problem but a market imperfection (i.e., contractual error) created by those organisationsthat entered these contractual arrangements. New VRE PPA contracts usually give the off taker the right to curtail the VRE plant if negative prices are likely to occur. As demonstrated in Section 2.2, the occurrence of negative prices could peak at 2000 trading intervals(i.e., 1000 hours) in the WEM by 2030 and then declines post 2030 asinflexible plant isreplaced by VRE and flexible plant and storage.\

However, in the Techtopia and Double Bubble cases considerable upgrades in transmission capacity are required to enable wind and solar farms to dispatch into the SWIS once the capacity of the South West transmission network zone is fully utilised. The big assumption in these two scenarios is that wind and solar resources will be built in this zone, even though there are currently no wind farms in this region. Currently all wind capacity is in the South East transmission network zone (40 MW). We have provided a map of the South West and South East transmission zones below.

The inaugural ISP was developed in 2018 and was refreshed in 2020 and is currently being updated in 2022 The ISP identifies the most efficient locations for the creation of Renewable Energy Zones (REZ) to support VRE generation and the development of transmission capacity investments that are required to ensure that generation from these REZs can meet various load centre requirements.

Source:Energycouncil