July 2022 Ontario Electricity Market Update: Lessons From Australia

August 4, 2022
Michael Killeavy

On June 15, 2022 the Australian Energy Market Operator (AEMO) took the unprecedented step of suspending the operation of the National Electricity Market (NEM) because “it has become impossible to continue operating the spot market while ensuring a secure and reliable supply of electricity for consumers …” because of generation shortfalls. “In the current situation suspending the market is the best way to ensure a reliable supply of electricity for Australian homes and businesses. The situation in recent days has posed challenges to the entire energy industry, and suspending the market would simplify operations during the significant outages across the energy supply chain,” according to Daniel Westerman, the AEMO CEO.

The NEM is an inter-state energy only electricity market that includes all Australian states except Western Australia and the Northern Territory.  It serves 10.3 million customers across five states consuming 203 TWh in 2020, which is about 80 percent of the electricity consumed in Australia.  The combined generating capacity in the NEM is 65.2 GW and there are 504 registered participants, including generators, transmission service providers, distribution service providers, and customers.  The NEM was launched in 1998 and was one of the very first competitive electricity markets to be established during a wave of electricity sector reforms that took place in the 1990’s.  The Australian Energy Market Commission (AEMC) provides oversight of the AEMO and sets the market rules, the National Electricity Rules (NER).

In the hours before the suspension the AEMO had issued numerous lack of reserve alerts and 5,000 MW of directions to generators, which is about 20 percent of demand. The AEMC quickly rolled out a compensation mechanism for generators that were forced on.  Consumers were urged to reduce their consumption of electricity.  Supply shortfalls were averted and the market suspension began to be lifted in stages seven days later on June 22, 2022.

What happened? Prior to the market suspension on June 12, 2022, electricity spot prices in Queensland reached a cumulative high price threshold the equivalent of was the spot price being at the market price cap of A$15,100/MWh, continuously, for 7.5hours.  This automatically triggered an administered price cap of A$300/MWh under the NER.  In response to the implementation of the A$300/MWh price cap, generators withdrew from the market causing a supply shortfall.  A warning letter was issued by the AEMO to generators on June 14, 2022, but the supply shortfall continued unabated, which led to the market suspension the very next day.

Is the NEM broken?  Some analysts say that it isn’t broken and that the high spot prices were directly attributable to the energy shortfall created by the February 2022 invasion of Ukraine by Russia.  The commodity cost of coal rose above A$ 500/tonne and the price of natural gas was over A$ 40/GJ, above four of five times the long-term average price.  Roughly 65 percent of NEM energy is coal-fired, and another 6.5 percent is natural gas-fired, making the spot price very sensitive to these input costs.  Despite being a significant producer or coal and natural gas, Australia does not reserve quantities for its own use as critical inputs.  There are also claims that generators were “gaming” the system to force the AEMO to order them to generate, which meant a more generous compensation mechanism than the one they would receive under the price cap.

There was an interesting commentary on the AEMO market by James Fleay, published after the market suspension that claims that this crisis was many years in the making.  Most of Australia’s generation and transmission resources were built and operated by state governments before the 1990’s.  Electricity sector deregulation in the 1990’s changed system planning and investment decisions.  Governments believed that the market would take care of system planning and investment decisions.  They became technology neutral, preferring a market-based decision on what sorts of technology in which to invest, ignoring the fact that the performance of the power system depends on the interaction between these technologies.  Fleay believes that this has led to “increased risks and amplified performance failures.”  Governments offered generous incentives for building wind and solar generation but did not address adequately how the system would need to be operated with increasing penetration of renewables. The upshot was that it was not possible to finance new gas-fired or coal-fired generation, or even sustaining capital, needed to provide generation to fill in the gaps caused by intermittency.  In fact, the retirement of coal-fired assets has hastened resulting in the AEMO scrambling to bring new generation online.  The AEMO’s planning is rooted in economics and as Fleay puts it “the nonsensical nature of the competition due to the absence of engineering principles and good practice, not to mention plain common sense, needs to be examined. Those practitioners who have a deep technical understanding of power networks and generation technologies need to drive fundamental redesign of this market"

The physical nature of the power system is very similar throughout the world, it is the financial and regulatory construct that layers on top that drives investment, real-time (RT) operation, and cost recovery and that framework must consistently adapt to align with broader economic and political objectives.  Ontario's pressing supply needs requires the Ontario regulatory framework to continually adjust to ensure there is a confident investment environment to build adequate capacity that reflect customer preferences.