Priority area: linking financial incentives with physical needs to deliver reliable supply
Australia must have enough electricity available when people need it, and at the lowest cost. We want to encourage the right amount of investment in the power system’s long-term capacity so the operator isn’t forced to intervene more than necessary because this increases costs for consumers.
Electricity supply must match consumer demand at all times for the power system to stay reliable and secure. To achieve this balance, the market was set up to pay generators for making electricity when customers need it.
There are two key features in today’s national electricity market (NEM) that are making it more challenging to deliver reliable supply – that is, to match demand and supply and reward participants appropriately for their contribution to this.
- As the power system changes, demand and supply are becoming more variable. This makes it harder to predict and then balance demand and supply at all times. This makes it hard for investors to pick the type of kit that will be profitable over the long term, and therefore increases the risk for people wanting to invest in the energy sector.
- In recent years, the link between financial reward and physical need - purposefully put there to help balance supply and demand - has been broken. This has resulted from mechanisms that reward some generators for their contribution to achieving environmental goals, and not for being available when customers or the power system needs the electricity they make.
Financial signals, like spot and contract prices, are key factors that guide investment in the types of generation that can meet the physical needs of consumers. For example, following the closure of a large power station, there will be sustained high spot prices, which are then reflected in high contract prices. These high prices provide and financial incentive to build new generation or demand response capability that will fill the supply gap.
Find out more how spot and contract markets work together to keep the lights on and prices stable.
However, if a generator is being paid just for switching on, then there is no incentive for the seller to generate more or less electricity when customers and the power system need it - that is, when spot prices are high or low.
Without financial signals from the energy market guiding investment in the types of generation the power system needs to stay secure, and meet consumer demand this could lead to a future generation that is unable to deliver reliable supply.
Find out more about what the AEMC has done to encourage the right amount of investment in the power system's long term capacity.
The Commission is prioritising work to restore the link between financial incentives and physical need to provide reliable supply by providing incentives (i.e. new revenue opportunities or regulatory obligations) for generators to generate more or less electricity depending on when customers and the power system need it.
Current AEMC projects
Current AEMC projects which are helping to link financial incentives with the physical needs of the system include:
- Market making arrangements: a number of initiatives are already underway to increase contract market liquidity – in particular the ASX’s voluntary market making scheme and the market liquidity obligation which is part of the Retailer Reliability Obligation. To complement these, the AEMC has proposed additional monitoring and reporting processes in the market, including expanding the market monitoring role of the Australian Energy Regulator.
- Short term forward market rule change: we are examining whether the introduction of a short term forward market would incrementally improve the alignment of financial incentives with the physical needs of the system. By allowing the trading of electricity contracts closer to real time, the platform could give participants greater price certainty and more options to manage financial risks.
AEMC’s system security and reliability action plan
This is part of the AEMC’s broader system security and reliability action plan. We are developing market frameworks which allow continued take-up of new generating technologies while keeping the lights on at the least cost to consumers.