12 September 2014 Electricity Market Review Project Office Public Utilities Office Department of Finance Locked Bag 11 Cloisters Square WA 6850 BY EMAIL: electricitymarketreview@finance.wa.gov.au Dear Energy Market Reform Steering Committee Western Australia - Electricity Market Review Discussion Paper Origin Energy (Origin) appreciates the opportunity to provide comment to the Electricity Market Review Steering Committee s (Committee) Discussion Paper on the structure and performance of the South West Interconnected System (SWIS) and the Wholesale Electricity Market (WEM). Origin welcomes the Minister for Energy s decision to initiate a broad based review of the WA electricity market. While the scope of the review is broad, it is important that in undertaking its assessment, the Committee adopts a holistic approach that accounts for the interdependencies of each element of the supply chain and considers how reforms in one sector impact the success or failure of reforms in other sectors. In this context, Origin has focused its comments on the areas of reform that it considers can deliver the most value for WA. Industry structure reform and the introduction of full retail contestability (FRC) for electricity customers are key priorities that are fundamental to promoting effective competition and development in the WA electricity sector. Separating Synergy into three generating entities and a number of retail entities will deliver a market structure than can deliver competitive outcomes, encouraging innovation and product diversity. Complemented by structural separation, FRC is generally the best means of delivering goods and services to customers at prices that reflect efficient costs. Key preconditions for FRC include the introduction of cost reflective pricing, operational scalability and a customer protection framework. Reform to the existing capacity market design is necessary given its current tendency to overdeliver investment at a high cost for customers; this is not sustainable in the long term. However, we seek to dissuade the Committee from considering a fundamental wholesale market design change at a time when regulatory stability and investment certainty will be critical for timely and effective structural industry reform and electricity retail competition. This review does provide a timely opportunity to reduce the complexity of the current market mechanism. Detailed responses to a number of the Committee s discussion questions are provided as an attachment. Should you have any questions or would like to discuss this information further, please contact Hannah Heath (Manager, Retail Regulatory Policy) on (02) 9503 5500. Yours sincerely, Keith Robertson Manager, Wholesale & Retail Regulatory Policy Origin Energy Electricity Limited ABN 33 071 052 287 Level 45, Australia Square, 264-278 George Street, Sydney NSW 2000 GPO Box 5376, Sydney NSW 2001 Telephone (02) 8345 5000 Facsimile (02) 9252 9244 www.originenergy.com.au
Attachment 1. Industry Structure 1.1 Do you see regulating Synergy to mitigate its market power as a superior or inferior option to structural separation into two or three sets of assets? Origin supports structural separation of Synergy as the preferred approach to mitigate its market power. In our experience, market forces are more effective at delivering competitive and efficient outcomes compared to regulation. Effective competition is best achieved where the market structure encourages innovation and market rivalry that drives technology and efficiency improvements, leading to improved and cost competitive product offerings for customers. Regulation will almost always be an imperfect substitute for competition because, among other things, it can distort incentives for businesses to compete and innovate. 1.2 In developing competitive electricity markets, how important is the structural separation of Synergy into several generators and retailers? Diluting the current concentration in both the generation and retail sectors is a critical precondition for facilitating effective competition in the SWIS and encouraging its future development. The Government can achieve this by structurally separating Synergy into a number of generator and retailer entities. Origin agrees with the Committee that splitting Synergy into three generation entities will reduce market concentration while also introducing competitive tension to both the capacity and balancing markets. This structure helps facilitate effective competition, which can support and encourage new entry in the SWIS. In determining the composition of the assets for each generation entity, structuring each with a balanced mix of base, intermediate and peaking plant can help reduce concentration risk and support the new entities competing across each segment. This portfolio combination can allow market forces to drive efficient contracting outcomes and prices, which can place retailers in an effective position to negotiate supply contracts and encourage facilitation and development of a secondary financial market. Bundling supply contracts with generation assets will be an important consideration to help ensure the newly formed generation entities are able to compete with one another on comparatively equal footing from a fuel cost perspective. For example, Synergy has just executed a 20 year gas supply contract from 2015, 1 which can provide a degree of fuel supply and cost certainty for the gas plants. The level of effective competition between the independent generation entities will be, in large part, dictated by access to affordable coal and gas contracts. Ensuring access to fuel contracts and where relevant the necessary transport from source to plant can enhance the prospective value of the generation entities. We consider the options for retail market structure below, in the context of full retail contestability. 2. Achieving Full Retail Contestability 2.1 Should the retail electricity market be opened to FRC and should all retailers also be able to retail gas? 2.2 In moving to a market that can accommodate FRC, how should TAP and TEC be handled? Origin supports the introduction of full retail contestability for all electricity customers in the SWIS. Promoting effective competition in the retail sector is a key enabler for efficient investment decisions in the generation sector and innovative and economically efficient customer product offers in the retail market. Where competition is effective, it generally 1 Electricity Market Review Steering Committee, Discussion Paper, 25 July 2014, p.33.
provides the best means of delivering the goods and services that consumers demand at prices that reflect efficient costs. Some key preconditions and considerations for introducing FRC include: reduced market concentration; cost reflective retail pricing; operational scalability; a customer protection framework; and dual fuel competitiveness. Reduced market concentration As discussed above, addressing Synergy s market concentration in both the generation and retail sectors is necessary for promoting an effective electricity market in the SWIS. Structural separation of Synergy can achieve this. From a retail perspective, Synergy s segregated retail entities and any new or existing retailer must be able to compete on equal footing. Cost reflective retail pricing Equal footing requires removing the existing SWIS tariff subsidies and adjustments from the retail sector. FRC will not operate effectively while the existing Tariff Equalisation Contribution (TEC) and Tariff Adjustment Payment (TAP) subsidies remain in their current form. In Origin s view, it is not a long term solution to continue to levy the TEC on customers in the SWIS. In the event that the WA Government considers an equalisation policy remains a priority, this subsidy should be funded through consolidated revenue and paid directly to the relevant market (i.e. the Northwest Interconnected System or NWIS). Removing this cross-subsidy between the SWIS and the NWIS can help promote more cost-reflective retail pricing in the SWIS. Origin would also recommend incorporating the TAP into network tariffs to allow nondiscriminatory competition in the retail sector. This would enable the disaggregation of the retail sector and would allow new entrants to compete for customers based on the competitiveness of their charges. In incorporating the TAP into network tariffs, it may be timely to review the structure of network tariffs to ensure the direction of retail market reform and network tariff structures are aligned and complimentary. To encourage growth in this emerging competitive market, it will be important for the WA Government to consider and define a transitional path towards cost reflective prices. A clear plan will provide existing participants and prospective investors with a greater degree of confidence around the Government s commitment to ongoing market development. The introduction of full retail competition is an important step towards price deregulation, which can further enable the SWIS to achieve the full benefits of a competitive retail sector. Operational scalability For prospective investors in the WA retail sector, operational scalability will be a key consideration. Establishing appropriate minimum customer bases for the Synergy retail entities will be an important starting point. Looking for synergies between retail operating procedures and systems infrastructure in the National Electricity Market and the SWIS can assist in reducing the initial operational costs for prospective new market entrants. When combined with retail operating systems that facilitate active customer switching, this can increase the incentives for market entry and support the development of a competitive retail market. Customer protection framework When implementing FRC, a robust customer protection framework is important for promoting customer confidence and active and informed participation in the competitive retail market. Dual fuel competitiveness The introduction of FRC in the SWIS creates an opportunity for retailers to offer dual fuel products to customers. In considering how to allocate Synergy fuel contracts as part of industry separation, there may be merit in considering new retailers ability to access gas in order to develop customer offers. The Synergy retail entities may find themselves at a disadvantage post FRC given the current moratorium has prevented them from building up a gas retailing position both supply and transport. Dual fuel offerings can be a valuable product offering and ensuring Page 3 of 5
new retailers are in the best place to engage in effective competition is likely to deliver benefits to SWIS customers. 3. Market Trading Mechanism Current Mechanism or NEM Gross Pool The Committee s Discussion Paper covered a broad spectrum of market reforms. In terms of which reforms could deliver the most value, Origin would recommend putting industry structure reform and the introduction of full retail contestability at the top of the Government s priority order. That perspective provides relevant context for considering what wholesale market reforms could best facilitate and support these key initiatives delivering value for WA. Origin would agree that the existing capacity plus energy mechanism has delivered significant over-investment in generation in the WEM. We would also agree that the current design is not sustainable in the long term. However, a fundamental change like introducing to a NEM-style gross pool would introduce a high degree of regulatory and market uncertainty. This could undermine the success of effective structural industry reform and the introduction of full retail contestability; existing and prospective market participants and investors will place significant value on regulatory stability and investment certainty during this time. There are more moderate reforms to the current capacity market design that can address its shortcomings. These developments can complement the broader structural and retail market reforms and provide a framework for ongoing development as the emerging market matures. In particular, this review provides an opportunity to reduce the complexity of the current market mechanism. Instituting operational simplicity should be front of mind for the Committee. The next section discusses possible modifications in more detail. 4. The Capacity Mechanism 4.1 Could alternative capacity mechanisms work within the current industry structure? 4.2 Are there other ways to provide the market with sufficient reserve at lower cost? There are two issues associated with the effectiveness of the current capacity mechanism. First is the issue of investment in excess capacity above the capacity requirement. Second is the issue of whether the existing mechanism is setting an efficient capacity requirement and capacity price. The Discussion Paper highlights that the cost of excess capacity in 2015-16 is forecast at $67.8m. The highest cost of excess capacity was $221.3m recorded in 2012-13. 2 However, while these costs may be inefficient, the material drivers of high wholesale energy costs appear to be the capacity requirement and price (and lack of competition). Under the current mechanism, the level of reserve capacity is determined by the level of investment in response to the offered capacity price. The cost of the invested capacity is recovered as an uplift charge spread out over all energy supplied in the market. The capacity price is administratively determined and as a result may not be consistent with actual market conditions or provide efficient investment signals. Meeting the capacity requirement To resolve the first issue, the Committee may want to consider removing the current practice of awarding capacity credits to all qualified suppliers as this appears to be a key driver of excess reserve capacity. Instead, the value of capacity credits could be set so as not to exceed the capacity requirement set by the Independent Market Operator (IMO). This approach could eliminate excess capacity costs and also remove the need for the IMO to apply a de-rating formula. 2 Discussion Paper, p.26. Page 4 of 5
Setting the capacity requirement and capacity price To establish the capacity requirement, Origin recognises that there is often a high degree of uncertainty around expected or forecast peak demand. The current methodology, however, adopts an overly optimistic approach to the value of the inputs into the de-rating formula. There may be merit in reviewing the current reserve margin to ensure it reflects a level of reliability that customers are willing to pay for. In terms of establishing the appropriate price for a capacity credit, there may be merit in investigating the benefit of a non-discriminatory market based approach. Adopting a market based approach may be more likely to result in the cost of capacity credits being set at the lowest cost supply offer. There are a number of market based mechanisms in operation, most notably the auction based capacity markets in Spain, Chile and Argentina. While Origin is not predisposed to any one form of market mechanism, it encourages the Committee to evaluate the benefits of a market based approach as a means of achieving the most economically efficient cost of capacity. Page 5 of 5