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In order to support the changing energy industry in Australia, the Energy Security Board (ESB) has released a draft plan for a capacity mechanism to stabilise the energy grid, with gas and coal providers to be paid as back-up suppliers. 

The capacity mechanism would have fossil fuel energy providers paid to have power supplies available during peak times.

The National Electricity Market (NEM) is going through a transformation as Australia moves towards net-zero emissions by 2050. 

This transition will see ageing fossil fuel plants that once made up most of the NEM replaced with new, clean energy resources and a more responsive demand-side. 

Coal generators, which currently account for over half the NEM’s generation output, are ageing, and several have announced early retirement dates.

Most market participants consider the Australian Energy Market Operator’s (AEMO) Step Change scenario to be the most likely – which implies 14GW of coal-fired generation may retire by 2030, and all coal-fired generation will cease generating by 2043.

At the same time, AEMO has forecast that electricity demand could at least double by 2050.

The ESB said a capacity mechanism, in which providers of capacity are paid to have their capacity available during certain periods, will help reduce the risk of a disorderly transition. 

The ESB said it is a more direct, more certain way of ensuring we have the right amount and the right mix of capacity that we need, to deliver affordable and reliable power as our system decarbonises.

In arriving at this conclusion, the ESB noted that the vast majority of electricity markets around the world already explicitly value capacity and pay for it directly.

Australia is one of very few ‘energy only’ markets remaining. Even in Australia, the bulk of resources built by the private sector have been underpinned in some way by government policies. 

The practical reliance on the energy-only market to drive investment in dispatchable capacity has been limited.

According to the ESB, from an investor’s point of view, a capacity mechanism would reduce reliance on wholesale market outcomes that are becoming increasingly difficult to predict. 

The ESB said it would provide an alternative revenue source that would be potentially more predictable and secure, rewarding the capacity service that the market needs. 

The plan proposes that all resources contributing to capacity should be eligible to participate in the capacity mechanism.

The ESB argued that the capacity mechanism should not exclude existing resources in order to ensure reliability through mixed resources, avoid over-building new capacity and discourage premature exit of existing capacity before alternative resources are in place.

Participating capacity providers will need to meet capacity certificate requirements in return for the payment as part of the draft plan.

Under a centralised procurement approach, AEMO would hold capacity auctions, award contracts, and make payments to capacity providers. It would then need to allocate these costs to consumers – either through networks or retailers.

The ESB said that cost allocation through retailers using actual demand is the preferred approach. 

Calls for alternative action to energy crisis

Community group Solar Citizens has condemned ESB’s plan to implement a capacity market that would include payments to ageing coal and gas power stations. 

Deputy Director at Solar Citizens, Stephanie Gray, said Australian homes and businesses are already paying the price for reliance on expensive and unreliable fossil fuel generators. 

“The current energy crisis is the result of sky-high coal and gas prices, breakdowns at multiple coal units, and price gouging from big energy corporations,” Ms Gray said.

“We’re in this mess because, after a decade of national energy policy failure, we haven’t built enough renewable energy backed by storage to replace ageing fossil fuel generation. 

“Paying big coal and gas companies to keep them operating for longer is the opposite of what we need to do to address the energy crisis.

Ms Gray said paying coal and gas to be available will simply add another price burden to consumers at a time when the cost of living is already hurting many homes and businesses.

“We’re calling on state and territory energy ministers to rule out a capacity mechanism that will fund coal and gas,” Ms Gray said.

“Instead, they should be urgently rolling out renewable energy and battery storage so that Australian homes and businesses are less exposed to inflated global coal and gas prices.

“State governments should also increase support for vulnerable households to access solar and storage, particularly those who face barriers to getting solar, including renters and social housing tenants. 

“The new Federal Government has been handballed an energy system in disarray. It’s now up to them to clean up the mess of the previous government by planning coal closures and accelerating the rollout of renewable energy and storage.

“We recommend the Federal Government to implement a storage target, similar to the successful national Renewable Energy Target, which has now effectively come to an end.”

To read the Capacity Mechanism Project High-level Design Consultation Paper, click here.

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