How the National Energy Guarantee could work better than a clean energy target

The Turnbull government has announced its new energy policy, called the National Energy Guarantee (NEG). The NEG contains two new obligations on electricity retailers. The first is to ensure we have enough electricity generation available to meet our needs (the Reliability Guarantee). The second is to drive down the sector’s greenhouse emissions (the Emissions Guarantee).

No, it’s not Chief Scientist Alan Finkel’s Clean Energy Target. But it is a policy that will drive down emissions in the electricity sector after 2020 and can be adapted by the Labor Party to hit the emissions-reduction target of any future Labor government.

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In other words, the NEG can offer the previously elusive prospect of a bipartisan and credible emissions reduction policy, of the kind that industry has been crying out for.

What is the Emissions Guarantee?

Under the Emissions Guarantee, retailers will be required to buy or generate electricity with a set level of emissions intensity – the tonnes of carbon dioxide emitted per megawatt hour – each year. The allowable level of emissions intensity will be reduced each year, to stay in line with Australia’s Paris climate target.

To meet this obligation, retailers will probably build or purchase their own generation assets, or sign contracts with other generators. Over time, retailers’ portfolios will become cleaner and cleaner, as new low-emission generators are built and more high-emission generators are shut off.

There are several benefits to this scheme. Australia’s emissions targets for the electricity sector should be met. And the scheme can theoretically be ramped up to meet more challenging targets over time, simply by lowering the emissions intensity limit for retailers.

It should also be reasonably cost-effective. Rather than the government imposing quotas or limits for various types of technology, retailers will be given a free hand to pick the cheapest mix of generation that will meet their emissions obligations. It is genuinely technology-neutral.

This makes the Emissions Guarantee superior to Finkel’s Clean Energy Target. The CET would have acted as a mechanism to push clean energy technologies into the system, but it would not have cared which generators left the market as a consequence.

Under a CET, a black coal generator could leave the market instead of a higher-emitting brown coal generator, if the black coal generator produced more expensive electricity. Then even more low-emission generation would have to be built to meet the target.

The Emissions Guarantee overcomes this problem. The important outcome is that the mix of generation meets a level of emissions intensity. This can be achieved by pushing in low-emissions generation and/or by pushing out high-emissions generation. The outcome will be similar to that of an emissions intensity scheme: lower levels of renewables than under other schemes, but a cheaper way to reduce emissions.

There are downsides to this approach. First, like an emissions intensity scheme and the CET, the Emissions Guarantee is not linked directly to the absolute emissions that need to be abated if Australia is to meet its Paris targets. But this problem can be overcome if the mechanism allows some flexibility around the setting of the emissions intensity target – which it appears to do.

Nor is the scheme integrated fully with the wholesale energy market – the National Electricity Market (NEM). As a result, it could produce some perverse outcomes in the NEM, where some regions have too much of particular types of generation.

What is the Reliability Guarantee?

This is where the other part of the policy comes in. Under the Reliability Guarantee, retailers will be required to contract (or own) a certain amount of “dispatchable” generation – electricity that can be switched on at will – to meet demand in each state.

The Reliability Guarantee appears to be a type of “capacity mechanism”, aimed at ensuring that generation can always meet demand. It appears to be consistent with the “retailer capacity obligation” proposed in a Grattan Institute report last month.

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Many of the precise policy details are yet to be worked out – not least the precise definition of “dispatchable generation” under this scheme. But the hope is that it will ensure all NEM states have sufficient electricity supply. Avoiding any repeat of last summer’s blackouts and shortages has become a political imperative.

While reliability might be guaranteed under the new policy, it should be remembered that capacity mechanisms tend to be both complex and costly. The devil will of course be in the detail. But the fact the government has chosen to impose the obligation on retailers suggests the market will be given the opportunity to find the least-cost solutions to our reliability needs.

A way forward?

So the retailers will now be responsible both for delivering our emissions reductions and for making sure that the lights stay on. These obligations will strengthen the incentives for retailers to own their own generation assets, rather than being hostage to wholesale prices. The issues raised by ACCC boss Rod Sims relating to the power of the big gentailers now have increased importance.

The National Energy Guarantee is not the best policy solution. A carbon price imposed on electricity generators may have avoided the need for either of the two “guarantees” contained in the NEG. But the political reality is that a carbon price of any sort is not going to be adopted in Australia any time soon.

So this is not a perfect solution, but it is better than what we have now. And importantly, it is supported by all members of the newly formed Energy Security Board. Opportunity knocks for this nation’s politicians.