Reforming the NEM: Key recommendations
Australia’s energy transition depends on a resilient, efficient and investment-ready National Electricity Market (NEM). We appreciate the time the Review team has taken to develop a straightforward set of potential market-based reforms going forward, and the opportunity to provide feedback on the Draft Report of the NEM wholesale market settings review.
Reform must be built on strong policy principles: clearly identify the problem, explore all potential solutions, and weigh costs and benefits. Without this foundation, reforms risk addressing symptoms rather than tackling the underlying challenges.
One of the most pressing issues is the current spot market design. The existing regional pricing framework distorts signals for investment and operation, and these distortions will become more severe as renewable energy and storage expand. International evidence strongly supports locational marginal pricing (LMP) as a proven mechanism to improve efficiency, avoid unnecessary transmission build, and reduce long-term costs. We recommend a progressive transition to LMP with a clear roadmap, alongside the development of new hedging tools that allow market participants to manage risk.
Concerns about liquidity in derivatives markets also require closer attention. We believe that low liquidity is more likely a symptom of deeper problems concerning risk and uncertainty – such as uncertainty around coal plant closures, shifting policies, or market power – rather than a failure in itself. Resolving these areas of risk and uncertainty, to the extent possible, will be more efficient than forcing improved liquidity. At the same time, we support efforts to develop new hedging instruments tailored for renewable generation, storage, and inter-regional trades.
The Draft Report also raises the idea of an Electricity Services Entry Mechanism (ESEM) to bridge the so-called “tenor gap” in contract durations. However, we are not convinced this gap reflects a true market failure. More often, it reflects natural differences in planning horizons across investors and consumers. Before creating new institutions, key sources of uncertainty in the future path of prices and the drivers of that uncertainty should be identified, such as the closure schedule of coal-fired power plants. Where governments have control over those sources of uncertainty, action should be taken to help mitigate the risks stemming from these sources of uncertainty. It may be that offering financial contracts that provide insurance against those events is a more efficient policy response.
Taken together, these steps would move the NEM towards a design that reflects the locational value of electricity and provides modern risk management tools. This will help support a more efficient, reliable and low-cost transition to renewable energy. We stand ready to work with the Review team to help shape the NEM of the future.
Authored by: A/Prof Darryl Biggar, A/Prof Gordon Leslie, A/Prof Andrew Rendall. Prof Guillaume Roger, Shreejan Pandey (Contributor) Dr Veronika Nemes (External reviewer)