The Details of the Detailed Design: National Energy Guarantee and Qualifying Contracts

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What will be the practical impact of the National Energy Guarantee (NEG) on retailers? When we first discussed the NEG, the nuts-and-bolts hadn’t been filled in[1]. However, with the release of the draft ‘Detailed Design’ (the draft design) in June, the picture for retailers is becoming a lot clearer.[2]

Detailed Design National Energy Guarantee moving lights

By Dr Drew Donnelly, Regulatory Specialist, Compliance Quarter.

Unfortunately, nearly all of the media attention thus far has been focused on political squabbles rather than the real-world implications for energy businesses. Furthermore, various important aspects of the NEG have changed between the last consultation round, on the ‘high-level’ design, and the current round. As the consultation on the draft design will end very shortly (13 July 2018), it’s worth taking a look at a NEG element which may impact more on retailers than any other; which contracts will ‘qualify’ for satisfying the Reliability Obligation?

Background to the Detailed Design: National Energy Guarantee

At the same time the Draft Detailed Design of the National Energy Guarantee: Consultation Paper (the draft consultation paper) was released many other accompanying documents were released including:

These are all available at http://www.coagenergycouncil.gov.au/publications/energy-security-board-–-draft-detailed-design-national-energy-guarantee-consultation.

So, what, in short, does the NEG amount to? It requires, market participants (retailers, generators and some large users) to meet dual reliability and emissions obligations. There are a range of goals for the NEG including system reliability, reduced prices for consumers and meeting international carbon emissions targets. The focus today is on the Reliability Obligation which requires retailers and generators to contract to ensure a certain amount of electricity will be available at some future point (whether through generation or demand response).

NEG Contracting for the Reliability Obligation

The NEG provides a mechanism for a future ‘reliability gap’ to be forecast. In response to a forecast gap, market participants will be expected to respond through contracting capacity to fill that gap. However, if the forecast gap is not met voluntarily by market participants, the Reliability Obligation ‘triggers’, market customers will be required to ‘contract’ to meet the gap. The NEG proposes that this be achieved through the existing hedging practices of market participants. Through this, generators and market customers contract with each other to ‘hedge’ the volatility of wholesale spot prices. At first it might seem strange to connect the Reliability Obligation and hedging; hedge contracts do not contract for specific quantities of electricity that could be used to satisfy the Reliability Obligation (like, say, a Power Purchase Agreement can). What the hedge contract market does, however, is incentivise generation. Generators who have sold contracts are incentivised to have dispatchable generation available to ‘defend’ their contracted position and earn income from the spot market to fund the pay-out on their hedge contract.

Qualifying Contracts in the High-Level Design

At an earlier stage of policy development, when the ‘high-level design’ was consulted on, it was proposed that only a restricted class of ‘contracts’ would qualify.[3] These were: contracts settled on centrally cleared trading platforms and/or contracts reported to centralised trade repositories. The rationale was two-fold: to enhance transparency around the wholesale cost of electricity and to ensure liquidity in the market. However, this did cut out quite a range of financial products that are actually used by market customers (primarily retailers) to hedge.

Contracting in the Detailed Design

In response to feedback on the high-level design, the Detailed Design has opted for a less prescriptive ‘framework’ approach. It provides that qualifying contracts will be “any wholesale contract with a direct link to the electricity market which a liable entity uses to reduce exposure to high spot prices”.[4] Under this framework, a range of swap, cap and options contracts will qualify. So too would internal contracts between the retail and generation arms of a ‘gentailer’. As a point of contrast, ‘weather derivatives’ based on certain weather events occurring would not qualify as they do not have a ‘direct link to the electricity market’.

Next steps

The Detailed Design is still in draft form. You can submit on any matters contained in it, including those relating to qualifying contracts by 13 July 2018.  All submissions should be sent to info@esb.org.au.

Remember also that the Regulatory Impact Statement, which analyses the various impacts of the NEG, is open for consultation until 20 July 2018.

If the Council of Australian Governments (COAG) agrees to the NEG in August, it is likely that a bill enacting the NEG will be introduced to federal parliament later this year.

Should you have any questions or want to discuss this, or any aspect of energy retail, please click here to contact Compliance Quarter.

 

[1] See https://www.compliancequarter.com.au/national-energy-guarantee-mean-energy-industry/.

[2]  See https://www.compliancequarter.com.au/national-energy-guarantee-draft-framework-released/.

[3] See http://www.coagenergycouncil.gov.au/sites/prod.energycouncil/files/publications/documents/High-level%20design%20National%20Energy%20Guarantee%2020%20April%202018%20Final.pdf, p43.

[4] Draft Consultation paper, p39.

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