Transmission Loss Factors) Rule 2020

Australian Energy Market Commission DRAFT RULE DETERMINATION RULE NATIONAL ELECTRICITY AMENDMENT (TRANSMISSION LOSS FACTORS) RULE 2020 PROPONENT Adani Renewables 14 NOVEMBER 2019 Australian Energy Draft rule determination Market Commission Transmission loss factors 14 November 2019 INQUIRIES Australian Energy Market Commission PO Box A2449 Sydney South NSW 1235 E [email protected] T (02) 8296 7800 F (02) 8296 7899 Reference: ERC0251 CITATION AEMC, Transmission loss factors, Draft rule determination, 14 November 2019 ABOUT THE AEMC The AEMC reports to the Council of Australian Governments (COAG) through the COAG Energy Council. We have two functions. We make and amend the national electricity, gas and energy retail rules and conduct independent reviews for the COAG Energy Council. This work is copyright. The Copyright Act 1968 permits fair dealing for study, research, news reporting, criticism and review. Selected passages, tables or diagrams may be reproduced for such purposes provided acknowledgement of the source is included. Australian Energy Draft rule determination Market Commission Transmission loss factors 14 November 2019 SUMMARY 1 The Australian Energy Market Commission (AEMC or Commission) has made a more preferable draft rule to provide the Australian Energy Market Operator (AEMO) with greater flexibility to refine and improve the methodology to determine marginal loss factors. 2 This draft rule complements the recent changes the Commission has made to the National Electricity Rules (NER) on improving the transparency of new generation projects. It also supports AEMO's work to improve the transparency and predictability of loss factors. Together, these changes are in the long term interest of consumers as they will enable better, more informed decision-making for prospective investors of generation assets. Additionally, existing market participants will have more transparency and information for the operation of existing assets. 3 Some stakeholders have been concerned about recent volatility in transmission loss factors as this creates revenue variability, and have suggested that these changes have been difficult to forecast. While the Commission understands these concerns, it also recognises the importance of maintaining clear signals for efficient dispatch and future investment in the market, even in times of change. Consumers should not be expected to shoulder such uncertainties when they have no ability to manage or offset them. 4 For these reasons, the more preferable draft rule retains the existing marginal approach to determining transmission loss factors. A marginal loss factor methodology remains the most efficient way of accounting for physical transmission losses in the national electricity market (NEM). In the absence of a full dynamic, locational approach, continuing to set these loss factors on an annual, forward-looking basis remains the most appropriate approach given the existing broader market design. 5 The recent volatility of loss factors experienced by some stakeholders arises from the market- wide transition that is currently underway. Traditional thermal plants are closing, and more renewable and asynchronous generators are connecting to the power system — often in locations remote from load centres that may be serviced by relatively weak transmission lines. 6 Enabling this market transition to occur smoothly will require significant reforms to the market design of the NEM to make long term, robust improvements to the way operational decisions are made and investment is carried out for the long term benefit of consumers. Such changes are being progressed through a range of actions, including: • the Commission's Coordination of generation and transmission investment (COGATI) review, which includes consideration of the appropriate long-term approach to losses • the Energy Security Board's work to action the Integrated System Plan, which will govern future transmission planning and investment processes • the Energy Security Board's development of a post-2025 market design for the NEM. The rule change requests and Commission's response 7 The Commission has considered two rule changes requested by Adani Renewables. The first i Australian Energy Draft rule determination Market Commission Transmission loss factors 14 November 2019 of these proposed that the intra-regional settlement residue (IRSR) should be shared equally between transmission customers and generators. The second, sought to change the marginal loss factor methodology to an average loss factor methodology. 8 In regard to the allocation of the IRSR, the Commission has decided not to make a draft rule in the manner proposed by Adani Renewables. The IRSR arises as the use of marginal loss factors generally tends to result in an over-recovery of funds from settlement. This is currently allocated to transmission customers through reduced transmission use of system (TUOS) charges. 9 Redistributing part of the IRSR to generators would be likely to result in generation asset owners taking into account the anticipated effect of the IRSR in their bidding decisions. This may impact the order of dispatch of generation units in the NEM, resulting in less efficient operation of the market. It may also dampen the locational signals that marginal loss factors provide to prospective investors in new generation assets, and therefore lead to less efficient investment over the long term. 10 In its rule change request, Adani Renewables suggested that redistributing the IRSR would result in lower electricity prices to customers. However, it is unlikely that any such reductions would fully offset the increased TUOS charges that would also occur under this approach. The current arrangements directly pass the benefits of the IRSR to consumers. As consumers pay for transmission infrastructure, it is appropriate that their transmission costs are reduced. 11 For these reasons, the proposed change to share the IRSR with generators would be unlikely to achieve the national electricity objective (NEO) and be in the long-term interest of consumers. 12 The Commission has also concluded that the use of average loss factors would be unlikely to better achieve the NEO than the current marginal loss factor methodology, nor better achieve the NEO than what is proposed in the draft rule. There are a number of reasons for this conclusion: • The current marginal loss factor methodology provides important locational signals for prospective investors and owners of new generation assets, which are needed to enable efficient decision-making about investment in the generation sector. This is particularly important in the current transformation of the electricity market. • While an average loss factor method to determining transmission loss factors might result in a reduction in the volatility of loss factor values, it would also dampen locational signals for new efficient generation investment needed for the future. This is undesirable in the current climate where it is important that a variety of generation assets are introduced across the whole market. It may also lead to more generation investment in inefficient locations, increasing physical transmission losses further. This would, in the long-run, be likely to lead to higher electricity costs for consumers. • The use of average loss factors to address concerns from some investors about revenue volatility and increases in their cost of capital does not outweigh the reduction in efficient investment signals and dispatch decisions in the NEM. ii Australian Energy Draft rule determination Market Commission Transmission loss factors 14 November 2019 • Continuing to use a marginal loss factor methodology is also consistent with the marginal approach currently used in the NEM for dispatch decision-making and pricing, supporting efficient market operations. • The use of an average loss factor may change the merit order to dispatch generators, resulting in less efficient use of the generation fleet and reducing the efficient operation of the NEM in real time. This may have the effect of wholesale electricity prices being higher than they would using marginal loss factors. 13 In addition, the Commission notes: • An average loss factor methodology would represent a move away from the long term direction of using dynamically set marginal loss factors that is being developed through the COGATI review. This would result in a more significant transition as and when those new arrangements are introduced. • The draft rule retains the benefits of the marginal loss factor approach while providing AEMO, in consultation with market participants, a greater ability to use different calculation techniques within that framework without impacting on accuracy. This aims to enable AEMO to make refinements and improvements to the determination of marginal loss factors consistent with the long term interest of consumers. • While the loss factor values for many generators have materially declined over the last two to three years, other generators have not had this experience. A move to average loss factors would benefit some generators more than others, and would result in some generators being worse off. This is particularly the case for embedded generators located near major load centres and some batteries. For example, the recent indicative loss factors for 2020-2021 published by AEMO in November 2019 show that loss factors are forecast to worsen for some generators, but are expected to improve for many generators, with one of the largest improvements

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