As a result of existing and anticipated climate change mitigation policies, the pattern of generation investment in Australia's energy markets is changing. Increasingly, lower carbon-intensive generation is being connected to the grid. These generation systems tend to be relatively small in size and located remotely from existing networks. Connecting them in a way that minimises total system cost is unlikely to result from the existing market framework; it will require investments in network augmentation and generation that are more forward-looking and co-ordinated than has traditionally been the case.

These issues were canvassed in the Australian Energy Market Commission’s (AEMC) Review of Energy Market Frameworks in Light of Climate Change Policies, which recommended strengthening energy market frameworks to ensure they will accommodate these new generation sources.

A new energy framework

In this context, the Ministerial Council on Energy (MCE), in early 2010, requested a rule change to introduce a new framework for the efficient connection of clusters of new generation to the shared network over a period of time.

The framework is called a scale efficient network extension (SENE), and would prevent the inefficient duplication of connection assets. A SENE could be an extension to the network or an increase in the capacity of a terminal station. The MCE's rule change request included a proposed Rule.

One of the key issues associated with any rule about SENEs arises from the forward-looking nature of the required investment: namely, who should underwrite the risk that the spare capacity associated with building a SENE (ie that which is above the capacity needed to service the first generator, in anticipation of future generator connections) is not utilised by subsequent generators (the asset stranding risk)?

The MCE's proposed Rule required consumers to underwrite the cost (and risk) of spare capacity, to be paid back through generator charges if all generation were to be connected as forecast. A regulatory oversight mechanism was included in the proposed Rule, to reduce the asset stranding risk to consumers.

Will it succeed?

In 2010, the AEMC held extensive consultations on the proposed Rule, which were extended on numerous occasions, due to the Rule's complex nature. It also published an Options Paper on 30 September 2010, to test with stakeholders several potential solutions to the issues associated with the Rule change, and found 'highly divergent views among stakeholders'.

The AEMC published its Draft Rule Determination and Draft Rule on 10 March 2011, which proposes a solution that is different from both the originally proposed Rule and the options presented in the Options Paper. It proposes to allocate the asset stranding risk to the entities best able to manage that risk (market participants/investors) as opposed to those who are unable to do so (consumers).

The only change to the National Electricity Rules (NER) that the Draft Rule proposes to effect would relate to the undertaking of location-based studies into the design and costing of a SENE. The purpose of such studies would be to reveal to the market potential opportunities for efficiency gains from the co-ordinated connection of expected new generators in a particular area.

The Draft Rule would require the relevant transmission network service provider (TNSP) to undertake such a study upon the request of any person. The costs, scope and timeframes of the study would be negotiated between the proponent and the TNSP, and the agreed costs must be borne by the proponent. Upon completion of a study, the TNSP must publish a report on its website.

Commercialising SENEs

Once a study is published, it would assist potential investors to make an informed commercial decision about whether to fund, construct, operate and connect to a SENE, but these decisions will be made by market participants and investors within the existing framework for connections under the NER.

A SENE may be funded by any entity that considers that the opportunity for capturing scale economies and earning a risk-adjusted return outweighs the risk of the forecast generation not materialising. Possible funding entities could include the TNSP (or another TNSP), a generator, a government or another third party.

The Draft Determination envisages that SENE funding would be repaid via generator charges for the use of the SENE. However, the Draft Rule does not make provision for such arrangements, which the Draft Determination indicates would be the subject of commercial negotiations between the relevant parties.

The Draft Rule does not regulate charges for use of the SENE or compel generators to connect to a SENE. Rather, if a SENE is built, the terms and conditions of connection to the transmission network (as augmented by the SENE) would be negotiated between the TNSP and the generator, subject to the existing rules governing connections.

The broader issue

Broader issues regarding access rights and connection will be considered holistically as part of the AEMC's ongoing Review of Transmission frameworks. The AEMC considers that its Draft Rule, by remaining silent on connection issues, will minimise the risk of potential inconsistencies being introduced into existing frameworks and avoids some of the complexity associated with the MCE's proposed Rule and the five options canvassed in the Options Paper.

More generally, the AEMC's main reason for the Draft Rule departing from what was previously proposed is that it provides for a more efficient allocation of asset stranding risk.

The benefits that the Draft Rule seeks to achieve come from the improved transparency of information about potential opportunities and risks associated with SENEs and to facilitate commercial investment decisions. The AEMC also notes that the Draft Rule may assist in overcoming the first mover disadvantage in circumstances where the first generator is able to negotiate a connection charge that is lower than that which might apply in the absence of a SENE (for example where it is likely that other generators will connect soon after and so the asset stranding risk is relatively low).

The AEMC makes an interesting comment about its role, in the context of submissions by stakeholders, to the effect that a more interventionist approach is required to ensure that Australia will meet its renewable energy target. It reiterates that it is obliged to assess all proposed Rule changes against the National Electricity Objective, which is to promote efficient investment in and use of electricity services in the long-term interest of consumers. This, according to the AEMC, requires it to make rules it considers will promote efficient outcomes within the context of the legislative and policy environment within which the market operates, but not to ensure that other government policy objectives are met.

Crunch time

The final Rule Determination on SENEs is due to be published on 30 June 2011. Meanwhile, the AEMC's analysis and development of policy proposals in relation to connection (and other transmission) issues is ongoing in the context of the Transmission Frameworks Review. A final report of that Review is due to be submitted to the MCE by 30 November 2011.

Arrangements for connecting renewable energy generators to SENEs, and to the network in general that are more favourable to the renewable energy industry could yet be secured as a result of the Review's work. However, given the AEMC's comments concerning its objective and role in the context of its proposed arrangements for SENEs, renewable generators may not be holding their breath.