The reforms are largely targeted at reducing the cost of the capacity component of the Wholesale Electricity Market.
In March 2014, the Minister for Energy, Dr Mike Nahan, launched a review into the Wholesale Electricity Market or WEM for the South West Interconnected System (SWIS). The review of the WEM was, in part, driven by increasing electricity prices and the market's reliance on State subsidiaries to the tune of approximately $500 million a year.
Earlier this month, the WA State Government announced some important reforms to the WEM arising out the review. We consider those reforms and how they might impact market participants.
In March 2015, the State Government announced its preferred areas of reform for the WEM in response to the recommendations provided by the Steering Committee selected for the review, categorised into four streams:
- Network Regulation: The transfer of regulation of the Western Power network from the Western Australian regime to the national regime.
- Market Competition: Among other reforms, the introduction of full contestability for the residential electricity market which is currently serviced by Synergy only, and possible removal of the moratorium that prevents Synergy from selling gas to residential customers.
- Institutional Arrangements: The transfer of operational and market functions from the WA Independent Market Operator to the Australian Energy Market Operator.
- WEM Improvements:Reforms to improve the operations and processes of the WEM, including the Reserve Capacity Mechanism, an element of the WEM intended to ensure that sufficient generation capacity is available in the SWIS.
Announcement of WEM reforms and rationale for the reforms
In April 2016, the Minister for Energy announced a number of important reforms to the WEM, in particular a review of the Reserve Capacity Mechanism.
The key reforms announced by the State Government were:
- Adoption of an auction as the basis for generators to procure and price capacity.
- Reducing capacity payments to generators until the auction is implemented.
- Reforming the Demand Side Management program.
The rationale behind these reforms is largely targeted at reducing the cost of the capacity component of the WEM. The WEM is a capacity-plus-energy market, where generation capacity is created through a separate market so as to ensure security of supply. In recent years, the SWIS has experienced an over-supply of capacity. By way of illustration, in 2016-17, the SWIS is projected to have 23% or approximately 1,000 megawatts of surplus capacity, resulting in increased costs being borne by consumers and the WA State Government.
The State Government is aiming for these reforms to result in savings to its bottom line of approximately $130 million.
A detailed explanation of these reforms can be read in the publicly available report, "Reforms to the Reserve Capacity Mechanism".
Implications of WEM reforms
Reserve capacity auction
Implementing an auction for capacity was one of two major market mechanism reforms considered by the Steering Committee for the WEM. The other option was to implement an energy-only market based on the model of the National Electricity Market, considered by the State Government, which was not adopted – this option would have been a significant structural change to the current system.
An auction process changes the WEM structure while retaining the capacity-plus-energy fundamental. It is intended that the capacity auction will result in the prices paid for capacity being subject to a more competitive process.
The auction to acquire generation capacity, which will be introduced by 2021, will be held on a three year forward basis and it will be mandatory for all capacity providers to participate.
Transitional changes to capacity pricing
Until the capacity auction process is implemented, the State Government will reform the formula for determining the Reserve Capacity Price – this is the price paid by the market operator to generators for capacity that is not bilaterally traded between participants.
This revised formula for determining the Reserve Capacity Price during the transitional period is expected to result in a lower Reserve Capacity Price until the capacity auction process is implemented.
Reforming Demand Side Management
The Demand Side Management mechanism effectively pays businesses to be on standby to reduce electricity demand upon request during peak periods.
The changes to the Demand Side Management program include a different pricing mechanism for payments made to participants and increasing the requirements on participants. It is anticipated that the new Demand Side Management pricing mechanism will result in significantly reduced payments made under the program.
The State Government's apparent position on Demand Side Management is that it is not providing value for money given the surplus of capacity in the SWIS. The State Government stated that since 2006, Demand Side Management participants have been paid about $430 million and have only been used for a total of 106 hours. However, supporters of Demand Side Mechanism argue that it is an effective form of providing back-up power and is necessary in the SWIS given its isolation and size.