Electricity Market Review

Submission September 2014 Electricity Market Review Department of Finance Public Utilities Office Contact Benjamin Hammer b.hammer@cmewa.com The Chamber of Minerals and Energy of Western Australia Level 10, 2 Mill Street, Perth, Western Australia Locked Bag N984, Perth WA 6844 p +61 8 9220 8500 f +61 8 9221 3701 e chamber@cmewa.com w cmewa.com

Contents About CME... 3 Recommendations... 3 Context... 5 The Electricity Market Review... 5 Industry Structure and Regulation... 5 Encouraging competition in wholesale and retail markets... 5 Introducing full retail contestability... 7 Improving incentives for efficient investment in networks... 7 Addressing fuel cost pressures... 8 Market Mechanisms and Institutional Arrangements... 9 Amending the current market mechanism or adopting an energy only market... 9 Changes to the Reserve Capacity Mechanism... 11 Improving the operation of market institutions... 12 Conclusion... 13 Appendices... 14 Appendix I Submission on wholesale gas spot market design options... 14 Page 2 of 16

About CME The Chamber of Minerals and Energy of Western Australia (CME) is the peak resources sector representative body in Western Australia funded by its member companies, which generate 95 per cent of the value of all mineral and energy production and employ 80 per cent of the resources sector workforce in the state. The Western Australian resources sector is diverse and complex, covering exploration, processing, downstream value adding and refining of over 50 different types of mineral and energy resources. In 2013, the value of Western Australia s mineral and petroleum production was $113.8 billion, accounting for 91 per cent of the state s total merchandise exports and thus representing the majority of Western Australia s 43 per cent contribution to Australian merchandise exports. Furthermore, royalty payments to the State Government are forecast to total $6.1 billion in 2013-14. Recommendations Industry Structure and Regulation Encouraging competition in wholesale and retail markets o Synergy should be structurally separated into several utilities to foster competition and limit the power any one utility could exercise in the market. o A clear pathway should be established for the timely privatisation of all utilities resulting from structurally separating Synergy. o A clear pathway should be established for the timely privatisation of Western Power. o Proceeds from the privatisation of Western Power and the utilities created from Synergy should be reinvested into productive infrastructure to continue driving the state and national economies and to qualify for the Asset Recycling Initiative. Introducing full retail contestability o Progress to fully cost reflective retail tariffs, at the efficient cost of supply, should be expedited to enable competition and to reduce the subsidy the State Government pays. o Barriers to retail competition should be removed by enabling all utilities to serve customers in the franchise electricity market and retail gas market. o If some degree of subsidisation for off-swis customers is to continue, the tariff equalisation contribution should be funded from State Government consolidated revenue. Improving incentives for efficient investment in networks o Full retail contestability and cost reflective tariffs should be supported by allowing competition in metering services and the implementation of time of use metering. o Any changes proposed to the access code arrangements should be supported by further industry consultation and the development of appropriate timeframes and transitional arrangements for market participants to plan for changes. Addressing fuel cost pressures o All energy sources, including alternative and emerging sources, should be able to compete on their merits and policies supporting their development should be evidence based. Page 3 of 16

Market Mechanisms and Institutional Arrangements Amending the current market mechanism or adopting an energy only market o There should be further consultation with market participants, including publishing existing studies as the basis for consultation, to gain a fuller understanding of electricity cost drivers. o The existing market mechanism should be modified to improve the market outcomes without decreasing system reliability, introducing additional risks to investors, or incurring sizeable costs associated with a fundamental change in the mechanism. o If any substantial changes to the market mechanism are proposed, these changes should be phased in over a period of several years to allow market participants to plan and adjust their business decisions. Changes to the Reserve Capacity Mechanism o Changes to the Reserve Capacity Mechanism should be developed in consultation with market participants to more rapidly diminish the incentive to invest in capacity beyond the reserve requirement and to establish arrangements to transition to an alternate mechanism for the procurement of lowest cost capacity, such as an auction. Improving the operation of market institutions o The cost of administration for the current market operator, cost of any transferral of responsibilities and cost of establishing any new agencies must be considered, and a model of least cost to market participants determined. Page 4 of 16

Context The Electricity Market Review CME welcomes the opportunity to provide input to the Electricity Market Review, which focuses on options to reform the electricity markets in Western Australia s primary electricity network, the South West Interconnected System (SWIS). Energy is a critical input to, and export from, Western Australia s resources sector operations. Affordable energy supplies are important for ensuring the sector can continue to deliver economic benefits to the state and national economies. Many of the state s resources sector operations are located in regional and remote areas and powered by private, off-grid electricity generators. However, the remaining resources sector operations are SWIS connected. CME also represents electricity market participants that provide electricity and other services to resources sector companies in the SWIS. While supportive of the Electricity Market Review Discussion Paper as a basis for stakeholder consultation, CME is concerned by the limited timeframe in which to consider and respond, particularly given the holistic nature of the review. The discussion paper references a substantial amount of unpublished information used as the basis for addressing key questions posed. This information has not been made available for review and interrogation by stakeholders ahead of the deadline for submissions. CME therefore encourages further industry consultation and, to the extent possible, the release of the reports and modelling used to improve the quality of consultation for the review. Industry Structure and Regulation Encouraging competition in wholesale and retail markets Efficient markets are essential for providing price signals and encouraging private sector investment. CME strongly supports efforts to encourage open and competitive electricity markets in Western Australia. The government owned, vertically integrated electricity utility, Synergy, currently dominates the state s electricity markets through a combination of former Verve Energy generation contracts and Synergy retail contracts. CME opposed the merger, effective 1 January 2014, of Verve Energy and Synergy as a move away from facilitating competitive and efficient electricity markets, open to greater levels of private sector participation. CME welcomes the consideration in the discussion paper of again disaggregating Synergy. The Independent Market Operator (IMO) has forecast the SWIS will not require any new capacity until 2023/24. 1 Synergy s market share will therefore not be reduced by private sector participants introducing new capacity to the market. Synergy should be structurally separated into several utilities to foster competition and limit the power any one utility could exercise in the market. The utilities created from Synergy should be a combination of electricity generators, retailers and vertically integrated companies and the number created should be sufficient so as to ensure no single utility can exercise sustained market power. Due consideration would need to be given to existing contractual commitments Synergy has to ensure no existing supplier or customer is disadvantaged. 1 Independent Market Operator (IMO), SWIS Electricity Demand Outlook, June 2014, p. 3. Page 5 of 16

This structural separation is critical to reforming the state s electricity sector and the key action to be implemented as a precursor to, or concurrently with, the other recommendations in this submission. Ownership of the utilities created from Synergy should also be considered in conjunction with the reform process. Private sector companies, operating in competitive markets, are typically more effective than government owned entities in driving efficiencies and innovating, applying downward pressure on costs. While critical to ensure the market mechanisms, regulatory environment and initial disaggregated structure are first established, a plan for the State Government to divest the utilities created from disaggregation should be developed concurrently. The Productivity Commission, in its inquiry into public infrastructure, recently recommended state and territory governments privatise their government owned electricity generation, network and retail utilities, provided appropriate processes are in place to protect the public interest, such as structural separation, regulation, sale conditions and community service obligations. 2 Similarly, the Economic Regulation Authority (ERA), in its microeconomic reform inquiry, suggested, on the basis of a preliminary review, Synergy would be suitable for structural separation and privatisation, subject to a formal review of the costs and benefits of the privatisation. 3 A clear pathway should be established for the timely privatisation of all utilities resulting from structurally separating Synergy. In addition to generation and retail utilities, the efficiency benefits of privatisation would also be expected for transmission and distribution utilities, many of which are now privately owned or operated in the National Electricity Market (NEM). The Productivity Commission recommended government owned network utilities be privatised after finding governments imposed requirements on these utilities that mean they are typically less efficient than those privately owned. 4 The ERA also suggested Western Power would be suitable for privatisation, subject to a full review of the costs and benefit. 5 A clear pathway should be established for the timely privatisation of Western Power. The Australian Government s Asset Recycling Initiative provides incentive for the divestment of State Government owned assets. Under this initiative, states and territories receive from the Australian Government up to 15 per cent of the asset sale price when the sale proceeds are used to fund new investment in productive infrastructure. Proceeds from the privatisation of Western Power and the utilities created from Synergy should be reinvested into productive infrastructure to continue driving the state and national economies and to qualify for the Asset Recycling Initiative. It is acknowledged there are competing priorities for the State Government at the current point in time and the extent of reinvestment in productive infrastructure will need to be considered in the context of the broader fiscal policy and balancing the net debt position. 2 Productivity Commission, Public Infrastructure: Productivity Commission Inquiry Report Volume 1. No. 71, May 2014, p. 89. 3 Economic Regulation Authority (ERA), Inquiry into Microeconomic Reform in Western Australia: Final Report. June 2014, pp. 170-173. 4 Productivity Commission, Electricity Network Regulatory Frameworks Volume 1. No. 62, April 2013, p. 24. 5 ERA, op. cit., pp. 165-169. Page 6 of 16

Introducing full retail contestability In order to attract private sector investors to the utilities created from Synergy, reforms to other regulatory aspects of the market must also be implemented. Cost reflective tariffs are an important component of improving the effectiveness of the electricity market and CME notes the discussion paper provides limited consideration of cost reflectivity. Market related pricing methods are essential for rewarding private sector risk and providing price signals to consumers. Artificially low tariffs act as a barrier to private sector market entry by providing a comparative advantage to government owned retailers and contributing to the substantial subsidy the State Government currently pays. Progress to fully cost reflective retail tariffs, at the efficient cost of supply, should be expedited to enable competition and to reduce the subsidy the State Government pays. The franchise electricity market currently acts as an artificial barrier to competition. While the franchise market was established to protect residential and small business consumers from increasing price pressures, these consumers, as with all other consumer segments, can be better served by the market forces of competition, in an effectively functioning market. Similarly, the gas market moratorium acts as an artificial barrier to competition in the state s gas retail market. Barriers to retail competition should be removed by enabling all utilities to serve customers in the franchise electricity market and retail gas market. Removal of these barriers to competition and progress to cost reflective tariffs are predicated on there being a sufficient number of retail market participants operating in the franchise electricity and retail gas markets so no retailer is able to exercise sustained market power. For the removal of the gas market moratorium, structural separation of Synergy and effective competition are important preconditions. Synergy would otherwise have information on all SWIS customers, through its electricity retail business, which would not be available to existing gas retail market participants. The subsidisation of off-swis customers currently serviced by Horizon Power is the result of State Government social policy objectives, not a cost incurred in generating, transmitting and retailing electricity in the SWIS. This cost should not be imposed on consumers in the SWIS. If some degree of subsidisation for off-swis customers is to continue, the tariff equalisation contribution should be funded from State Government consolidated revenue. However, the costs incurred through this subsidy should also be considered in the context of the State Government s broader fiscal position, particularly given the state s net debt and the downgrading of the credit rating by two rating agencies in the past year. Improving incentives for efficient investment in networks The SWIS has a demand profile characterised by substantial peaks occurring for only a few hours per year. 6 These peaks are supplied by comparatively costly peaking generation. Allowing electricity retailers to compete in the provision of metering services and offer more flexible and varied tariffs would assist consumer price discovery on the true cost of generation at peak times and allow them to modify use in accordance with their willingness to pay, reducing the network peak. 6 IMO, op. cit., p. 25. Page 7 of 16

The ERA has recommended further investigation be undertaken into introducing flexible electricity tariffs, in addition to progressing towards fully cost reflective tariffs in the franchise market. 7 Full retail contestability and cost reflective tariffs should be supported by allowing competition in metering services and the implementation of time of use metering. Competition amongst private sector retailers would also foster innovation in the development and deployment of smart grid and communications technologies, providing additional opportunities for flexible product and service offerings. Demand side aggregators provide a further option for consumers by compensating electricity users that elect to reduce their use during peak demand periods. Changes to the electricity network access code to move to constrained access arrangements could lead to more efficient use of the system and network capacity, and reduce the future burden on the state s balance sheet by minimising the risk of inefficient network investment. However, market participants have made investment decisions based on existing access arrangements and policy changes may introduce risk for these participants. Any changes proposed to the access code arrangements should be supported by further industry consultation and the development of appropriate timeframes and transitional arrangements for market participants to plan for changes. Addressing fuel cost pressures The state s energy mix should use all available energy resources to assist with security of supply and allow for competitive tension amongst fuel supplies. In addition to its gas and coal reserves, Western Australia has excellent renewable energy resources and other alternative energy resources. Gas supply and demand The IMO recently sought submissions on high level design options for the potential development of a regulated wholesale gas spot market in Western Australia. CME s submission to the IMO was supportive of efforts to further develop liquidity and transparency in the state s gas market, and of the guiding principles to be considered for any potential design options proposed. However, the submission also reiterated market development should be industry led, and any wholesale gas spot market design should minimise costs imposed on market participants, with options to leverage existing platforms considered in the first instance. A copy of CME s submission to the IMO on the wholesale gas spot market design options has been included at Attachment 1. Coal supply and demand Collie coal is an important primary fuel in Western Australia, with coal fired generation comprising around half of all generation in the SWIS. The state s coal resources at Collie are substantial. The state s existing coal mining companies continue to seek increased efficiencies and benchmark against similar open cut coal mining operations in Australia. However, as the resource becomes more complex and is mined from deeper reserves, the extent these resources can be converted to economically extractable reserves is dependent on the price paid. 7 ERA, op. cit., p. 122. Page 8 of 16

Alternative and emerging energy supply CME supports a technology agnostic approach to energy supply. Utility scale wind energy generators and residential and commercial scale solar photovoltaic systems are now well established in the state. There are several other prospective energy sources in the state, including other renewable energy technologies such as geothermal, solar thermal, marine and biomass energy, and other resources such as shale and tight gas, waste to energy and uranium. While beyond the scope of the review, CME considers it important for government and industry efforts to create a policy environment conducive to open and informed discussion about future development opportunities for these energy resources and technologies. The discussion should include consideration of nuclear energy, particularly given the development of innovative reactor technologies. Energy policy should enable proponents to develop nuclear energy projects should there be a business case to do so and should appropriate environmental and planning conditions be met. The prohibition on nuclear energy through the Australian Radiation Protection and Nuclear Safety Act 1998 (Cth) should therefore be removed. CME supports the State Government working with the Australian Government to that end. All energy sources, including alternative and emerging sources, should be able to compete on their merits and policies supporting their development should be evidence based. Market Mechanisms and Institutional Arrangements Amending the current market mechanism or adopting an energy only market Costs of the current market mechanism The discussion paper poses the key reform question of retaining and amending the current market mechanism in the Wholesale Electricity Market (WEM) or moving to an energy only market, specifically a non-interconnected region of the NEM. The primary case proposed in support of moving to a NEM region is to eliminate the excess capacity cost component from the wholesale and retail costs of electricity in the WEM. However, the discussion paper indicates excess capacity appeared to comprise less than 10 per cent of wholesale and retail costs of electricity in the WEM in 2013/14. 8 The Brattle Group estimates the cost of capacity in the WEM to be 17 per cent for 2016/17, while the cost of excess capacity, or payments in excess of the established reliability requirement, is estimated to be only two per cent for the same year. 9 The Public Utilities Office, in its preliminary findings from an investigation into cost drivers in the WEM, classified excess capacity as having a negligible impact in the increasing cost of electricity. 10 It should also be noted the Australian Energy Market Operator has forecast the NEM will, similarly to the WEM, not require any additional capacity until 2023/24. 11 The discussion paper also identifies the high bilateral contracts between the former Verve Energy and Synergy and the lack of competition between generators in the market as other 8 Public Utilities Office (PUO), Electricity Market Review Discussion Paper, July 2014, pp. 14-15. 9 The Brattle Group, Resource Adequacy in Western Australia: Alternatives to the Reserve Capacity Mechanism, August 2014, p. 1. 10 PUO, Public Utilities Office: Energy Policy Priorities and Direction, presented at Energy in WA Conference, Perth, 21 August 2013. 11 Australian Energy Market Operator, Electricity Statement of Opportunities, August 2014, p. 1. Page 9 of 16

cost drivers leading to the substantially higher cost of wholesale electricity in the WEM compared to other Australian networks. 12 However, the cost drivers presented in the discussion paper provide a limited exploration of the reasons for the comparatively high costs of energy. The discussion paper does not appear to consider in detail other potential cost drivers in the WEM compared to the NEM, such as the efficiency of generators, the appropriateness of the fuel mix to the load profiles, the cost of intermittent generation (particularly the network and balancing costs of residential solar photovoltaic systems), and fundamental inputs such as labour and materials. Several of these factors were considered in the preliminary findings of the Public Utilities Office s cost drivers investigation; however, neither the findings of this investigation, nor the consultants studies underlying the wholesale and retails costs presented in the discussion paper, have been disseminated. The wholesale electricity cost in the WEM, reported in the discussion paper to be around $180 per megawatt hour in 2013/14, and overall State Government subsidy, reported to be over $600 million for the same year (including the subsidy paid to Horizon Power, which is not within the review scope), therefore need further transparent investigation to ascertain the breakdown of these costs. There should be further consultation with market participants, including publishing existing studies as the basis for consultation, to gain a fuller understanding of electricity cost drivers. Improvements to the current market mechanism can then be developed based on a more transparent understanding of the true cost drivers. Preconditions for an efficient energy only market Houston Kemp identified the following market conditions necessary for an energy only market to deliver efficient outcomes to consumers: 13 o Enough generators to ensure none can exercise substantial market power and so as to ensure competition between generators. o A sufficiently high price cap to allow cost recovery for investment in new generation capacity. o No barriers to market entry or capacity expansion. o Restrictions on co-ownership of generators and retailers in the event the market is small enough to prohibit a liquid hedging market developing. o Sufficient public information to allow independent forecasting of market conditions. o A market sufficiently sized so market entry does not place substantial downward pressure on wholesale electricity prices, creating an entry barrier. Several of these conditions are unlikely to be met in moving to an energy only market in the WEM, increasing the risk of the market not delivering efficient market outcomes and preferred system reliability levels. Further investigation is necessary to consider how many generators and retailers would be needed from a separated Synergy to facilitate sufficient competition between generators, given the relatively small size of the WEM and the market share each could hold from the existing generation assets in the portfolio. Wholesale prices in an energy only market also need to be able to rise substantially higher than possible in the WEM to allow for market participants to make their returns on 12 PUO, Electricity Market Review Discussion Paper, p. 15. 13 Houston Kemp Economists, Necessary Conditions for an Effective Energy-Only Market in Western Australia, July 2014, pp. 22-23. Page 10 of 16

investment. In the NEM, prices are currently capped to protect consumers; however, this cap is around twenty times more than in the WEM. Given the relatively small size of the WEM, consumers may need to be exposed to more volatile prices than the NEM to provide appropriate returns for investment in generation capacity, when required. NEM regions comparable in size or smaller than the WEM also benefit from interconnections with other NEM regions, allowing for electricity to be imported and reduce the risk of insufficient supply and exposure to high prices in peak periods. The relatively small market size can also act a barrier to market entry or capacity expansion, as utilities need to consider the business case for installing larger, typically more efficient generators, against the downward effect on prices from the relatively large increase in electricity supply from such a generator entering a small market. The overall costs involved in making the fundamental change to join the NEM need to be quantified and considered. These will include costs incurred through changes such as market institutions, legislation and regulations, and operating systems. Fundamental changes in market design could also introduce risk to market participants that have made investments in response to the established mechanism and based on expectations of a stable policy environment. The existing market mechanism should be modified to improve the market outcomes without decreasing system reliability, introducing additional risks to investors, or incurring sizeable costs associated with a fundamental change in the mechanism. If any substantial changes to the market mechanism are proposed, these changes should be phased in over a period of several years to allow market participants to plan and adjust their business decisions. Changes to the Reserve Capacity Mechanism The Reserve Capacity Mechanism in the WEM aims to provide a preferred level of system reliability and facilitate market entry for private sector investors. However, in its current form, elements of the capacity mechanism appear not to have provided investment signals for appropriate volumes and types of generation capacity. 14 Forecasting capacity requirements has been challenging in recent years. There has been an unexpected decline in residential demand (driven by solar photovoltaic uptake, energy efficiency improvements, and in response to tariff increases), and proposed magnetite mining projects in the state s Mid West, requiring a large load relative to the small market size, have not yet commenced operations. Several options are available to reform the existing capacity mechanism to provide more efficient price signals for investment in new capacity. The Lantau Group, in its report for the IMO s Reserve Capacity Mechanism Working Group, proposed several changes to the capacity mechanism including the implementation of a steeper decline in the administratively determined demand curve for capacity beyond the reserve capacity requirement. 15 This change would decrease the incentive to invest in additional capacity beyond the reserve requirement. The Brattle Group similarly recommended changing the demand curve, suggesting it decline more rapidly beyond the reserve requirement than the curve proposed by the Lantau Group. 16 14 ERA, 2012 Wholesale Electricity Market Report to the Minister for Energy, April 2013, pp. 31-32. 15 The Lantau Group, Review of the RCM: Issues and Recommendations, September 2011, p. 13. 16 The Brattle Group, op. cit., p. 31. Page 11 of 16

Moving to an auction mechanism for all capacity, rather than only in circumstances where capacity commitments do not meet the reserve requirement, would more closely align with the principles of allowing the market to determine the lowest cost capacity. Such a mechanism would be required in the event of moving to a substantially steeper demand curve to protect capacity providers from being required to supply below cost in the event of an incorrect capacity forecast. 17 Changes to the Reserve Capacity Mechanism should be developed in consultation with market participants to more rapidly diminish the incentive to invest in capacity beyond the reserve requirement and to establish arrangements to transition to an alternate mechanism for the procurement of lowest cost capacity, such as an auction. Changes to the market mechanism again require the structural separation of Synergy and effective competition as preconditions to ensure no single generator is able exercise sustained market power when offering capacity for auction. Improving the operation of market institutions The IMO currently operates in the roles of both proposing and approving rule changes and the IMO board and executive are appointed by the Minister for Energy. Under the current arrangements there is a potential conflict of interest between the State Government s ownership of utilities operating in the market and its function as, ultimately, the endorser of rule changes. While proposed rule changes are subject to input from the Market Advisory Committee, which contains industry representation, there is not any formal requirement for consideration of the committee s advice in approving rule changes. Greater independence could be achieved through the separation of the rule proposal and approval functions by transferring the latter to an independent agency such as the Economic Regulation Authority or a newly established agency. However, the costs and benefits of these reforms should be transparently quantified and the costs of the IMO in its current remit should be reviewed and compared to similar operators to ensure the market is administered at least cost to participants. The cost of administration for the current market operator, cost of any transferral of responsibilities and cost of establishing any new agencies must be considered, and a model of least cost to market participants determined. 17 Ibid. Page 12 of 16

Conclusion CME welcomes the opportunity to provide input to the Electricity Market Review and looks forward to further industry consultation in developing detailed designs of selected reforms and implementation arrangements. If you have any further queries regarding this submission, please contact Benjamin Hammer, Policy Advisor Infrastructure & Economics, on (08) 9220 8527 or b.hammer@cmewa.com. Authorised by Position Date Signed Nicole Roocke Deputy Chief Executive 23/09/2014 Document reference K:\Infrastructure\Projects & Issues\Energy\WEM Review\140821-INF-Electricity Market Review Submission v0.1.docx Page 13 of 16

Appendices Appendix I Submission on wholesale gas spot market design options 28 August 2014 Ms Kate Ryan Group Manager, Development and Capacity Independent Market Operator PO Box 7096 Cloisters Square, Perth WA 6850 Via email: market.development@imowa.com.au Dear Ms Ryan CME feedback on options for a wholesale gas spot market in Western Australia The Chamber of Minerals and Energy of Western Australia (CME) is the peak resources sector representative body in the state. CME is funded by its member companies, which generate 95 percent of the value of all mineral and energy production and employ 80 percent of the resources sector workforce in Western Australia. The state s resources sector is diverse and complex, covering exploration, processing, downstream value adding and refining of over 50 different types of mineral and petroleum resources. In 2013, the value of Western Australia s mineral and petroleum production was $113.8 billion, accounting for 91 per cent of the state s total merchandise exports and thus representing the majority of Western Australia s 43 per cent contribution to Australian merchandise exports. Furthermore, royalty payments to the State Government are forecast to total $6.1 billion in 2013-14. Energy is a critical input to, and export from, the state s resources sector operations. Affordable energy supplies are important for ensuring the sector can continue to deliver economic benefits to the state and national economies. CME congratulates the Independent Market Operator (IMO) for its efforts to support the development of efficient energy markets in Western Australia, and welcomes the opportunity to comment on the draft report investigating high level design options for a regulated wholesale gas spot market in the state. CME also notes the release on 13 August 2014 of the government s Electricity Market Review discussion paper, which similarly seeks feedback on the benefits of developing a gas supply hub. Feedback obtained through this consultation process should be considered in conjunction with feedback on the discussion paper. Gas market development in Western Australia The domestic gas market in Western Australia has historically been developed through long term bilateral contracts between gas producers and consumers (including the state), which have underwritten investment in gas production projects and supporting infrastructure, such as pipelines and, recently, gas storage. Gas spot markets have also been developed by the private sector. Page 14 of 16

CME supports this industry led market development, which will soon see Western Australia move to seven domestic gas processing facilities as the Gorgon and Wheatstone projects, currently under construction, join the operational North West Shelf, Varanus Island, Devil Creek, Red Gully and Macedon projects. The capacity from the increasing number of domestic suppliers, through these new and recently commissioned projects, will be important for meeting the state s future domestic gas demand. Improving transparency and liquidity assists entry for new market participants, fostering further competition and leading to improved economic outcomes for the state. To this end, CME supports efforts to develop the state s gas market through the provision of supply, demand and price information to participants. However, government led policy interventions in the state s energy markets should only be considered where there is quantifiable evidence of market failure or net public benefit. For a proposed wholesale gas spot market, the benefits for participants need to be quantified and considered against any costs or administrative requirements imposed on participants. In 2013, the government launched the Gas Bulletin Board and Gas Statement of Opportunities with the aim of improving transparency in the gas market. While CME supports the policy objective, it remains concerned by the equity of the cost recovery model and overall costs associated with the administration of the Gas Bulletin Board. CME therefore supports the guiding principles outlined in the draft report for the development of any regulated wholesale gas spot market design in Western Australia, and reinforces the need for any design to minimise costs for participants and apply a user pays cost recovery mechanism. Independent and transparent governance arrangements, with industry oversight of the process, are also important for ensuring participants have confidence in the development and operation of a wholesale gas spot market. It is not desirable to have the government acting as the market rule maker, whilst also being a participant in market development through policy positions on primary energy, infrastructure development and exploration. Design options for a wholesale gas spot market CME supports, in-principle, the consideration of design options for a wholesale gas sport market in Western Australia. CME considers an incremental approach to market development, such as that outlined in the base design, to be an appropriate model with which to begin industry consultation for the development of a wholesale gas spot market. Such an approach also reduces the risk for market participants by minimising the extent of change required to existing arrangements. Additional features such as expanded hub locations, longer term forward products and pipeline capacity products, which are options outlined in the extended model, may improve market outcomes, albeit at an increased cost and administrative requirement for participants. As a wholesale gas spot market matures, additional features could be considered for inclusion, subject to a rigorous cost benefit analysis and supported by industry consultation on the implications of any changes. The IMO may be well placed to operate a wholesale gas spot market from its experience as administrator of the Wholesale Electricity Market and Gas Bulletin Board. However, the IMO should be seeking a low capital and operational cost model, which may be best delivered by adapting an existing platform available in Australia. Private sector participants have established such platforms and government led interventions should not undermine the capital investment made by the private sector. If existing platforms cannot be leveraged, the costs and benefits of any custom designed model need to be quantified. It is also important to note the possibility of a change in remit for the IMO, subject to the recommendations for reform resulting from the Electricity Market Review. Page 15 of 16

Conclusion CME welcomes the opportunity to provide input towards improving the state s energy markets and looks forward to further discussion on the potential development of a wholesale gas spot market in Western Australia. Should you wish to discuss this further, please contact Benjamin Hammer, Policy Advisor Infrastructure and Economics, on 08 9220 8527 or b.hammer@cmewa.com. Yours sincerely Reg Howard-Smith Chief Executive Page 16 of 16