NATIONAL ELECTRICITY MARKET

A case study in successful microeconomic reform

NATIONAL ELECTRICITY MARKET A case study in successful microeconomic reform

Economic growth and prosperity One of the enduring stories of to a significant degree, involves a microeconomic reform has been the continuing process of structural change. National Electricity Market (NEM). Of employment opportunities moving In celebrating that achievement we from one industry to another, from acknowledge the many hundreds of one place to another. Of investment leaders: politicians across jurisdictions who responding to changing patterns recognised the need and benefits of change of consumer demand and changes and set the direction; officials and people in relative prices brought about by within the sector who worked together innovation, new technologies and the to make it possible; international experts opportunities for improved productivity. who contributed their ideas; and everyone in the electricity industry who helped This process cannot be centrally directed us learn how to make it work in practice. or planned. But that does not mean the process, and its consequences, are not in The NEM has proved to be a sustainable need of being led or managed in order to reform – capable of being built upon and produce sustainable benefits for consumers. a fundamentally important input to the performance of the Australian economy. We know this process as ‘microeconomic reform’. While broader in scope, the In this, the fifteenth anniversary year of ‘reform agenda’ in the 1990s had a NEM commencement, we commissioned particular focus on capital intensive utility KPMG to interview those involved in the services such as energy, communications, market’s evolution in order to identify the transport and water: that is, the non- lessons of their experience. The purpose traded goods sector; the efficiency of then is not so much to focus on the which was seen as underpinning our NEM itself, but rather the people and potential long term growth. A common the processes they led and managed feature of these sectors was that they in order to bring it about. were dominated by publicly owned enterprises often with a monopoly We hope the findings of this case study industry structure. Prices did not will provide lessons and insights for reflect efficient costs and investment dealing with the issues we face today decisions were centrally directed. The in the energy sector and other sectors risks associated with the efficiency of of the economy. the sector were therefore borne by consumers. They also intersected the John Pierce interests and responsibilities of multiple levels of government. Chairman Australian Energy Market Commission

“KPMG was a major participant in the electricity reforms that occurred during the 1990s and early 2000s.”

KPMG was honoured by the Commission’s the electricity industry, or business request to prepare this case study of the (e.g. consumers). We and the Commission establishment of the NEM as an example appreciate that this is only a very small of successful microeconomic reform. proportion of the hundreds of people involved across Queensland, NSW, ACT, KPMG was a major participant in the Victoria, South Australia, and Tasmania electricity reforms that occurred during who brought the NEM and the associated the 1990s and early 2000s. We were industry restructuring to fruition. joint lead advisors to the Victorian State Government for the reform and KPMG hopes that this case study will privatisation of the electricity and gas provide a useful guide on how to develop sectors, and to the South Australian and implement microeconomic reform State Government for the reform and policies in assisting with improving privatisation of their electricity sector. productivity and growing prosperity for More recently, we have advised the NSW the benefit of all Australians. It could also Government across a number of their underpin effective energy policy and State owned assets including helping markets in the future, helping to establish develop a more efficient structure for the basis for financing the investments the electricity distribution businesses. required to drive efficient energy markets.

For this study, we interviewed thirty-one people who played important roles in Michael Bray the reform process from government, KPMG Asia Pacific Energy Leader This report is not intended to be utilised, or relied upon by any person other than Australian Energy Market Commission, nor to be used for any other purpose other than as indicated in the engagement contract with Australian Energy Market Commission, without KPMG’s prior written consent. Accordingly, KPMG and its associated entities does not accept responsibility or liability in any way whatsoever for the use of, or reliance on, this report by any third party. Contents

Executive Summary 2 1 Our approach 8 2 Development of the National Electricity Market 1991 to 1998 12

2.1 The context for electricity reform 12 2.2 Electricity reform had a clear, structured agenda 14 2.3 Role of the jurisdictions and the electricity industry 15 2.4 Strong political leadership drove the reform 19 2.5 Financial incentives were critical to getting some states on board 20 2.6 Role of the National Grid Management Council (NGMC) and electricity industry 22 2.6.1 Importance of an independent chairperson 22 2.6.2 Value of research and the Paper Trial Simulation 23 2.6.3 Clear objectives were set for a competitive electricity market 25 2.6.4 Appropriate resourcing of the NGMC’s reform program 26 2.6.5 Value of industry resources 27 2.6.6 Setting a considered pace for reform – time to “demystify the process” 28 2.6.7 Open and adequate consultation across all stakeholder groups 33 2.6.8 On-going and staged engagement with regulatory bodies like the ACCC 34 2.7 Limitations of the electricity reform process 35 3 Evolution of the NEM Post 1998 period 38

3.1 Introduction of full retail competition in electricity 40 3.2 Change in NEM governance arrangements 41 3.3 Change in industry structure and ownership 43

4 Key lessons for the future 44 Acronym Glossary 48 2

The purpose of this report on the Executive development of the National Electricity Market (NEM) is to identify the key Summary elements and lessons of the process that made it a success. The report has been written with a level of detail intended to address a broad audience of Governments, companies, consumers and industry associations.

Background

The formal process to develop the NEM began in 1991 with a decision by the Council of Australian Governments (COAG) to establish a National Grid Management Council (NGMC) to coordinate the planning, operation and development of a competitive electricity market. COAG took this decision in response to a report tabled in 1991 by the Industry Commission which found that potentially significant increases in Australia’s Gross Domestic Product (GDP) could be realised by:

• a restructuring of the electricity supply industry with the vertical separation of generation and retail from the natural monopoly elements of transmission and distribution; • the introduction of competition into generation and retail by providing access to the transmission and distribution systems on a non-discriminatory basis; • progressively selling publicly owned • the establishment of the National electricity generation, transmission Electricity Code Administrator and distribution assets to the private (NECA) as an independent company sector; and responsible for managing changes to market rules and the network • the enhancement and extension access regime; of the interconnected systems of New South Wales, ACT, Victoria, and • the establishment of the National South Australia to eventually include, Electricity Market Management when economically viable, the power Company (NEMMCO) as the market systems of Queensland and Tasmania. operator and power system operator for the NEM; In the interviews, participants focused on • customer choice in electricity the period 1991 to 1998 which was the supplier across the NEM, initially for period leading up to, and including: large customers, which was a first step in the transition to full retail • the introduction of a uniform single competition and the deregulation wholesale electricity market across of retail pricing. eastern and southern Australia,

• disaggregation of the vertically The diagram overleaf provides a brief integrated electricity sector summary of the major events over into competing generators the period 1991 to 1998. A glossary and retailers, and monopoly of acronyms is provided at the end transmission and distribution of this publication. network service providers, • the passage of a National Electricity Law as cooperative legislation across the participating jurisdictions to enable the NEM to operate with harmonised laws and regulations including a National Electricity Code that defines the rules for the wholesale electricity market and access to the networks; National Electricity Market development time line 1991-1998

‘91- ‘92 ‘93- ‘94

1991 – Industry Commission Energy Generation 1993/94 – NEM Paper Trial and Distribution Report 1994 – NEM market design and Code development 1991 – COAG is formed and establishes National Grid Management Council 1993 – SECV split into corporatised bodies – generation, transmission, distribution/retail

State Electricity Commission of Victoria (SECV) 1994 – VicPool III state based electricity market

1992 – VicPool II trial internal power market 1994 Office of Regulator General established

Electricity Commission of NSW renamed Pacific Power and internally restructured into generation and transmission

1991/92 – Pacific Power Internal Power Market (“ELEX”)

1991 – Queensland Electricity Commission “Key reform agenda (QEC) established with generation, electricity transmission, and industry regulation elements overall: Separation of policy and regulation from industry, industry restructuring, and introduction of

Legend competition.”

National VIC NSW SA ACT QLD TAS ‘95- ‘96 ‘97- ‘98

1995/96 – NEM Simulation Trials NEM systems development

National Electricity Code consultations Applications to ACCC 1996 – National Electricity Law passed Dec 1998 – NEM commences 1996 – National Electricity Code Administrator (NECA) and National Electricity Market 1997 – NEM 1 Stage 1 – VIC wholesale market Management Company (NEMMCO) linked with the NSW wholesale market

1995 to 1997 – generation separated into Dec 1998 – VIC joins the NEM five corporatised generation businesses

Privatisation of distributors, generators and 1997 NEM 1 Stage 1 – VIC wholesale market transmission assets from late 1995 to October 1997 linked with the NSW wholesale market Dec 1998 NSW joins the NEM 1995 – TransGrid established

1995 – 25 Local government electricity businesses 1997 – Separate generation corporation established formed into 6 state-owned distribution/retailers with ETSA – transmission, distribution and supply

1996 – Independent Pricing and Regulatory Tribunal SA Trader participates in NEM1 (IPART) established Dec 1998 SA joins the NEM 1996 – Pacific Power restructured into 3 generation businesses and NSW State Electricity Market commences 1997 – ACTEW joins NSW electricity market

1995 – Electricity Trust of South Australia corporatised 1997 – Independent Pricing and Regulatory with 4 subsidiary companies –transmission, Commission (ICRC) established generation, distribution, and gas supply Dec 1998 – ACT joins the NEM 1996 – SA as Lead legislator passes National Electricity Law 1997 – Queensland industry restructured 1995 to 1996 – ACTEW corporatised into corporations: 3 generation, 1 transmission company and 7 distribution/retailers 1995 – QEC disaggregated into 2 corporatised entities – Queensland Generation Corporation (Joins the NEM in 1999 with separate regional (QGC) and Queensland Transmission and wholesale market) Supply Corporation (QTSC)

Regulatory functions transferred to the 1998 – HEC restructured into generation Department of Mines and Energy (Hydro Tasmania), transmission (Transend) and distribution/retail (Aurora Energy) 1995 – Corporatisation of the Hydro-Electric Commission (HEC) (Joins the NEM in 2005) 6

Findings • In the energy sector, the National Competition Payments1 had three benefits: first, the State This case study presents a summary of the Governments had an incentive key lessons from the NEM reform process. to change as they wanted the Based on interviews with some of the payments; second, there was a key participants, these lessons can be political cost if some payments listed as following. were seen to be withheld; and third, they could use the 1. The material problems were defined payments as an argument to and clear reform objectives were set undertake reform in the face • In embarking on the reform of opposition. Looking to future of the electricity sector, clear reform, there are risks that the objectives for change were incentive becomes payment defined and the change maximisation, rather than approach was transparent. policy optimisation; and the The economic and policy relationship between the implications, commercial and Commonwealth and the states financial impacts, and technical changes from a partnership to a and operational impacts were quasi contract. Incentive payments brought into alignment. This are not a substitute for mutual alignment was maintained commitment to policy outcomes. throughout the process and has underpinned the NEM’s durability. 3. Strategies were developed to enhance confidence in the reforms 2. Reform took high-level political drive; provision of time, energy • Confidence in the proposed and, according to many reform reforms was developed by participants, financial incentives specifying market designs and rules in detail and then taking • Ministers involved in the the time to run trial simulations reform were required to make and model the reforms with the a significant commitment of involvement of the key industry personal time in order to make and government representatives things happen and keep the to iron out design flaws. Reforms process on a consistent path. were implemented at the state level before moving to full national reforms. The learning from these state experiences was invaluable and boosted confidence in the reforms. 4. Strong and appropriate support • The reform was managed so structures were established with that the key things were done key stakeholder participation early, such as setting agreed principles and conceptual design • Reform across the Commonwealth for the market mechanisms. and the States required Ensuring there were incremental significant collaboration and implementation steps and cooperation. Establishment delivery of incremental benefits of appropriate governance helped keep stakeholders structures across federal, engaged on the longer journey. jurisdictional and industry levels was essential to ensure • Identifying the key stakeholders the reform had appropriate and having open and ongoing coordination of policy, technical dialogue helped to build trust design and implementation. and engagement. • It was important to give 6. Getting the industry structures right credibility to the process. was key for effective competition This was enhanced by having an independent, highly regarded • The process highlighted that chair. The people who were competitive markets only involved understood the work well with a competitive commercial realities of the industry structure. businesses and the impacts • It also demonstrated there is an of the reform on them. explicit trade-off between the benefits of a competitive industry 5. The pace of the reform allowed structure and maximising sales for effective consultation across proceeds from privatisation. all stakeholders The gains for the economy of a • It was important to ensure competitive industry structure the time allowed for reform needs to take precedence was manageable and realistic over the fiscal impacts of for all involved. privatisation. To do otherwise poses a risk to the benefits of the reform being sustained.

1  To encourage reform, the Federal Government established a system of payments to States known as National Competition Payments. These payments recognised the benefits to federal government revenues to be gained from the reforms (particularly in electricity and gas), and sought to share them with State Governments that had to make the changes to bring these benefits about. 8

1 Our Approach

› “The history of Australia’s National In suggesting that the history of the Electricity Market provides an NEM provides an example of how major example of how major reforms can reforms can be successfully implemented, be implemented through careful KPMG and the Australian Energy Market market design and management. Commission (Commission) decided The competition reforms of the to test this point of view with a cross 1980s and 1990s represented section of reform participants who a significant structural shift in played a variety of important roles the Australian economy. The in the reform process. process of NEM development and implementation demonstrates how The objectives of this approach were to: careful design and management • Confirm whether reform participants can deliver market systems which agreed with this point of view maximise the benefits of these regarding the reform process; and reforms while minimising costs and disruption to consumers.” • Define in more detail the key elements and lessons from John Pierce, The Australian National Electricity Market: Choosing A New Future, the electricity reform process Fifth Forum on Energy Regulation in summarised in the hypotheses. Quebec City, Canada on 12 May 2012 In this case study participants focused on • customer choice in electricity the period 1991 to 1998 which was the supplier across the NEM initially period leading up to, and including: for large customers which was a first step in the transition to • the introduction of a uniform single full retail competition and the wholesale electricity market across deregulation of retail pricing. eastern and southern Australia; In this case study, we also describe the • disaggregation of the vertically major changes in the retail electricity integrated electricity sector into market and the NEM governance and competing generators and retailers regulatory framework that took place and monopoly transmission and post 1999. These developments were distribution network service providers; not discussed in any detail in the • the passage of a National Electricity participant interviews. Law as cooperative legislation across the participating jurisdictions to Based on participant feedback we enable the NEM to operate with also present a summary of the key harmonized laws and regulations findings from the success of the including a National Electricity NEM reform process. Code that defines the rules for the wholesale electricity market and access to the networks; • the establishment of the National Electricity Code Administrator (NECA) as an independent company responsible for managing changes to market rules and the network access regime; • the establishment of the National Electricity Market Management Company (NEMMCO) as the market operator and power system operator for the NEM; 10

In order to better understand the 9. Steve Edwell perspectives being provided, the (Queensland Treasury, Queensland table below presents the list of people Electricity Reform Task Force) interviewed and what their primary 10. Michael Egan roles were during the 1990s. (NSW State Treasurer) 1. Ken Baxter 11. Sally Farrier (Victorian and NSW Department (Victorian Electricity Supply of Premier and Cabinet, Industry Reform Unit) Chair Baxter Group) 12. Jim Gallaugher 2. Roger Beale (Convener – NGMC’s Market Trading (Associate Secretary, Prime Minister Working Group, Technical Director and Cabinet 1993-96) of Victorian Power Exchange) 3. Dr. Peter Boxall 13. Len Gill (Under Treasurer, South Australia (Victorian Generator Participant, Department of Finance and Treasury) Victorian Market Design Working 4. Vicki Brown Group and Vesting Contracts (ACCC official) Working Group) 5. Ross Bunyon 14. Neville Henderson (Chief Executive – Pacific Power) (National Grid Management Council – General Manager Projects, 6. Dr. Ralph Craven Project Manager NEM Governance (NGMC Paper Trial Project Manager, Reforms 2004/05) Queensland Transmission and Supply Corporation) 15. Russell Higgins (Secretary Department of Resources 7. David Croft and Energy – Commonwealth) (Chief Executive – TransGrid) 16. David Hoch 8. Bernie Delaney (NGMC’s Market Rules Working (BHP, Business Council of Australia, Group, Victorian Generator Member of NGMC’s Market Participant, Victorian Market Steering Committee) Design Working Group and Vesting Contracts Working Group) 17. Graham Holdaway 26. Brian Spalding (KPMG Partner – Victorian Electricity (TransGrid, Program Manager Supply Industry Reform Unit) NSW State Electricity Market) 18. Michael Lambert 27. Tim Spencer (Secretary NSW Treasury) (Queensland Premiers Department and South Australian Treasury) 19. John Landels (National Grid Management 28. Alan Stockdale Council – Chairman) (Victorian State Treasurer) 20. Ted Matthews 29. Geoff Swier (Head – Electricity Reform Task (Victorian Electricity Supply Force, Department of Resources Industry Reform Unit) and Energy – Commonwealth) 30. David Swift 21. Robert Milliner (South Australian ETSA and (Partner Mallesons Stephens Electricity Reform Unit) Jaques – Legal Advisor to NGMC 31. Roger Wilkins and Victorian Government) (Director General NSW Department 22. Dan Norton of Premier and Cabinet) (National Electricity Market Management Company Chairman) Peer review: Drew Clarke 23. Stephen Orr (Secretary Department (Victorian Generator Participant, of Communications) Victorian Market Design Working Group and Vesting Contracts Working Group) 24. John Pierce (Chief Economist Pacific Power and Deputy Secretary NSW Treasury)) 25. Rod Sims (Deputy Secretary, Department of Prime Minister and Cabinet) 12

2 Development of the National Electricity Market 1991 to 1998

In order to understand the development › “There was a loose but extended of the NEM over the period 1991 to 1998, alliance of politicians and senior it is important to understand the: officials who felt Australia had to move past post-war protectionism, • broader context for electricity reform subsidies and wage fixing. These in the period prior to the 1990s, protectionist policies meant • other reforms that were being Australia kept having inflation undertaken during the 1990s issues when activity picked up.” • elements of the electricity market reform process. In the early 1980s there was gradual change in trade reform as tariff quotas During the participants’ interviews, were phased out and some very high a number of key process elements tariff levels were lowered. were identified. This section has In 1983 the Australian dollar was floated, been structured to reflect these which, together with winding back process elements, alongside some of industry protection, progressively commentary from participants made the business community more regarding the process and the key economically savvy. lessons both positive and negative. The greater exposure to international competition created pressures for more efficient delivery of utility services. 2.1 The context In the 1960s, 1970s and early 1980s Consequently, in the mid to late 1980s, for electricity Australia had a somewhat insular, there was increasing focus at the highly regulated economy, with many reform Commonwealth level and in some public sector monopolies, relatively State jurisdictions on aligning prices of low productivity growth and poor government business enterprises (GBEs) comparative economic performance. more closely to actual costs and on improving productivity. › “Realisation in business community › “It is easy to focus on this as a reform and government officials (and over process but there is a need to time at political level) that the only focus on the context of reform. The way to enable economic growth electricity industry is voter sensitive, was a full microeconomic reform.” unionised, there are multiple state governments with different factions, From the late 1980s into the early 1990s pressure points and margins and there was some initial reform activity in over staffed – so reform would lead telecommunications, electricity, water, to job losses. An immense inertia is road and rail. However, it was seen built in to the system so that there that the early microeconomic reforms would be winners and losers. Losers begun since the late 1980s were being are smart enough to be able to progressed on a sector-by-sector mobilise. The government relied basis without the benefit of a broader on dividends. When you overlay this, framework covering both economic this is a very complex environment principles and political governance. to undertake reform.”

Furthermore, those reforms had shown Competition in the generation segment that the Trade Practices Act 1974 (which of the electricity industry in England preceded the current Competition and and Wales was introduced in 1990 Consumer Act, 2010) was too limited in with the privatisation of non-nuclear its application, with legal coverage linked generating assets. At privatisation there to ownership or corporate form. were 7 companies participating in the generation market of England and Wales. By the late 1980s electricity utilities had The introduction of competition in the progressed administrative reform, but supply of electricity to industrial and a step change was required to further commercial customers began in 1990. increase productivity and efficiency. › “The UK experience with power sector reform and privatisation gave both central agencies and ministers a greater degree of confidence in the feasibility of competition reforms in Australia.” 14

2.2 Electricity › “The Industry Commission study was crucial to the process. That reform had a clear, was important, not only because structured agenda of the study but through COAG to get some States on board. While In May 1990, the Commonwealth there was reluctance, everyone Treasurer, Paul Keating, requested the could see the size of the prize. Industry Commission inquire into the As a comparison, 1.25% of GDP generation, transmission and distribution doesn’t sound like much but the of electricity and the transmission and major tax reform at the time only distribution of gas. had 0.5% GDP benefits. So it was big and worth pursuing.” › “One of the major motivations in a number of jurisdictions The 1991 Industry Commission’s (certainly this was the case in report recommended that potentially NSW) for supporting the reform significant Gross Domestic Product was the very strong desire to avoid (GDP) improvements (around 1.25% any government involvement of GDP) could be realised by: in decision making on the next • a restructuring of the electricity increments of generating capacity. supply industry with the vertical This was a concern to avoid the separation of generation and retail clear mistakes of the 1970s and from the natural monopoly elements 1980s over expansion in capacity.” of transmission and distribution; In their 1991 Energy Generation and • the introduction of competition Distribution report, the Industry into generation and retail by Commission found that the electricity providing access to the transmission and natural gas supply industries had not and distribution systems on a been performing to their full potential. non-discriminatory basis; Poor investment decisions leading to • progressively selling publicly owned excess capacity and gross overstaffing electricity generation and electricity during the 1980s provided the most transmission and distribution assets striking evidence that electricity and gas to the private sector; and had not been supplied at least cost. • the enhancement and extension of the interconnected systems of New South Wales, ACT, Victoria, and South Australia to eventually include, when economically viable, the systems of Queensland and Tasmania. At a Special Premiers Conference in 1991, 2.3 Role of the the Australian Commonwealth, State and Territory governments reached agreement jurisdictions and the on the need for a national competition electricity industry policy. An independent Committee of Inquiry into a National Competition Policy Electricity reform started in Victoria for Australia was later commissioned and and NSW before there was extensive reported in August 1993. (This report led Commonwealth involvement and a to the Hilmer competition policy reforms fully developed concept of a National endorsed by COAG in 1995.) Electricity Market. In 1991, the Electricity Commission of NSW was renamed Pacific › “The 1991 Industry Commission Power and internally restructured into report established a baseline for six business units – which consisted of microeconomic reform in the three generating groups, a pool trading electricity sector that identified unit, a transmission network business potential efficiency gains and and a services unit. Pacific Power also convinced politicians that reform established ELEX, an internal power was necessary. This data-driven, market in 1991/92. In 1992, the State evidence-based review convinced Electricity Commission of Victoria Stockdale at the state and Keating commenced VicPool II which was a trial at the national level that the effort of an internal power market. These power to reform was worth it.” market trials were a critical confidence building exercise that competition in generation supply was feasible.

As part of the reform process, the jurisdictions were responsible for: restructuring of their state owned electricity industry, local trials of competitive markets, setting up an independent economic regulator and supporting the legal and regulatory changes. The reforms in each state had the following common features:

• vertical separation of generation, transmission and distribution; • separation or ring-fencing of retail supply from electricity distribution; 16

• ring-fencing of transmission and the The history of these events merits a power system control functions; separate case study for each jurisdiction. Victoria and NSW were the first to • corporatisation of electricity entities; restructure their electricity industry. This • use of ‘vesting’ contracts for the was followed by the other jurisdictions for sale of electricity to retailers from their respective electricity industries. In generators to minimise the risks this section we present a summary of the to generators and retailers/ common process elements that occurred. consumers in the transition to a competitive market; › “It is fair to say that the reform • gradual unwinding of cross-subsidies program nationally, and in other between consumer groups; jurisdictions, benefitted greatly from the work taking place in • establishment of special electricity Victoria and NSW on market design, reform units to manage the the network access regime, industry process; and restructuring, and the development • establishment of independent of regulatory frameworks. Each regulatory agencies responsible state that followed Victoria and for the economic regulation of the NSW were able to learn from them sector and in particular electricity in terms of process, issues to be transmission and distribution addressed etc. This also laid the network businesses. foundation for the transition to the NEM and governance under › “Difference with electricity was that NEMMCO, NECA and the ACCC.” no-one in Commonwealth knew anything about electricity. They The electricity reform process knew the other areas: road, rail etc. was organised along similar lines Independent Commission report in each jurisdiction: gave it credibility at a national level. Needed the COAG imprimatur, • A strong Minister was supported but COAG was not able to make by a core team with a strong Project it happen. Needed the states Manager in a Reform Unit with to drive reform.” industry representatives and key external advisors (legal, market design, etc.). • The Electricity Reform unit (this While competition reform in electricity is a generic term – each jurisdiction had a level of consistency across the had different names for this jurisdictions, there was a need for each entity) was set up (usually under jurisdiction to understand how to Treasury) to manage reform and manage local special issues (e.g. legacy to co-ordinate jurisdictional inputs power supply contracts with smelters, into the national process. retail tariff policy and community service obligations.) • There were clear accountabilities between government and industry. › “In NSW Egan was a reformer – Government set policy based on when things got tough, he banged economic and technical advice the table.” provided by industry. • The jurisdictional reform working Each jurisdiction undertook an analysis groups consisted of the best talent of impact of the competition reforms in mixed with industry, government electricity (e.g. Victoria Status Report 1993, officials, and external advisors. NSW 1995 Electricity Reform Statement, QLD Electricity Industry Structure Task • There was an open consultation Force Report December1996, the process with all stakeholders. Industry Commission Report for South › “If Victoria hadn’t privatised, may Australia 1996). This analysis allowed not have got there in the end. each jurisdiction to tailor the reform for Needed one state to put in the the special features in this jurisdiction political capital to drive it – VIC had excluding the wholesale market trading more at stake than anyone else. design. It also provided everyone some They were prepared to barter and confidence that they knew what the push to get it through. Stockdale local issues were. The development and Kennett were aggressively of each report was prepared with a driving reform policy. If they hadn’t consultation process with industry been privatising, there wouldn’t and other stakeholders. have been the motivation.” 18

› “There was a political imperative to › “The reform units set up in each make it work. There were a lot of jurisdiction were important smart people in the industry back because they provided the NGMC then. Once they understood the and Senior Officials with a single model was changing they had point of contact for the national the capacity to get in and work reform process.” through the development of the model to create the market.” Orchestrating a separate review enabled a neutral assessment of the industry, A good example is Victoria where the minimising the likelihood of preconceived first task of the Electricity Supply Reform ideas clouding the issues. Unit was to prepare with industry a Status Report of 21 areas of the electricity › “If the electricity industry had industry in Victoria including Information been in private ownership, these Technology (IT), Human Resources (HR), reforms would have been very wholesale market design and fuel supply difficult to achieve without issues. The draft report underwent a substantial compensation high-level critique by two consultants being paid to private investors. for each of the 21 areas. This technique In the USA the same degree of drove momentum for reform, engaged structural separation has never with the businesses, showed a level of occurred because the industry is interest in what they thought, flushed predominantly privately owned.” out their views, and used other experts to express views to create tension. This Each State also removed economic and one-off exercise was used to establish technical regulation from the electricity a baseline for reform. industry and reassigned it to either an independent jurisdictional economic regulator for electricity network regulation or technical regulator. In some cases technical regulation was assigned to a government department or agency (e.g. Victorian Office of Electrical Safety).

There was also a staged transition to the NEM from the initial trial markets in Victoria and NSW in 1991/92 through to a live market in Victoria in 1993 (VicPool III), the NSW State Market in 1996 and the joining of the Victorian and NSW markets under NEM1 in 1997. 2.4 Strong political Over this period there was strong political leadership for electricity and other leadership drove microeconomic reforms (e.g. transport, the reform gas). The Prime Minister, the Treasurer and key Ministers in the 1983-1996 Labour › “COAG was driven by the central Government drove the early reforms, and agencies to push competition were assisted by some strong, pro reform reforms, and COAG agreement to Premiers and State Treasurers. The then those reforms was very important Leader of the Opposition, John Howard, – critical to formation of NEM.” also supported many of the Labour Government’s reforms. In a number In May 1992 a Council of Australian of areas he carried forward the reforms Governments (COAG) forum replaced and he benefited from them as Prime the Special Premiers Conferences. Minister from 1996-2007. This bi-partisan During the 1990s COAG drove the consensus for reform also made it difficult electricity reform process; receiving for those wanting to oppose reform. reports and recommendations from the NGMC until the NGMC was wound › “The cooperation at senior up in February 1997. official level was really unique. It was a very results oriented, › “The baton might shift around in cooperative approach. All working terms of who was driving reform on getting an outcome. Positive process hardest e.g. Greiner/Hawke, not negative approach.” Keating/Kennett, then Howard, but always someone was driving The Senior Officials group (known as it at the highest levels.” “the Baxter group”) was a group of senior officials from the jurisdictions and the Commonwealth which formed to provide secretariat support for COAG meetings. It was an important process element as it had key central agencies and groups involved across the Commonwealth and jurisdictions. The Senior Officials Group provided advice on electricity and other microeconomic reforms to COAG. 20

“A lot of shuttle › “There was complexity in this 2.5 Financial incentives diplomacy by exercise because the Commonwealth had no constitutional power so were critical to getting the Feds working Federal Government played a some states on board with jurisdictions facilitating and constructive was important role and not a dictating role.” At the April 1995 meeting of COAG, the Heads of Government agreed to the in getting the While there was strong Federal support implementation of a package of National for reform, the State Governments also NEM up.” Competition Policy Reforms that would relied on key advocates to drive the increase the competitiveness and growth reforms. In the early 1990s, Greiner was prospects of the national economy. actively pushing for reform in NSW. By the mid 1990s, Kennett in VIC was the › “Looking back, many electricity strongest advocate, spurred on by the reform participants have need to improve productivity and address suggested that it was nearly an the state’s debt problems. The role of the impossible task because of the states was significant as they had control various stakeholders who did of the sector, thus they had the most to not want to lose access to gain and the most to lose through reform. the existing monopoly rents (e.g. state governments and › “One of the catalysts with the vertically integrated utilities).” Baxter Group was the Jurisdictional Senior Officials had a degree of Under this package of reforms, COAG authority as a state official and not created a new institution, the National as a Commonwealth official. So Competition Council (NCC), as an the Jurisdictional Senior Officials independent body to assess the progress didn’t come with ‘This is Canberra of all Governments on implementing speaking.’ Dynamics that we had their agreed reforms. with the Commonwealth provided a peculiar set of circumstance that hasn’t been repeated.” › “The Competition Policy Reforms It was the NCC that recommended with incentive payments were to the Federal Treasurer whether the critical to SA, NSW, ACT and QLD State Governments had “earned” their coming on board – not in Victoria payments; whether they had sufficiently (who were nearly bankrupt). The undertaken the agreed reforms, and competition payments were made appropriately assessed other legislation to compensate the states for that restricted competition. the loss of monopoly rents.” These payments were instrumental in To encourage reform, the Federal getting some states to sign up to, and Government established a system of commence implementation of, changes payments to States known as National required to achieve the framework for Competition Payments. These payments a national electricity market. recognised the benefits to Federal Government revenues to be gained from the reforms (particularly in electricity and gas), and sought to share them with State Governments that had to make the changes to bring these benefits about.

› “That incentive … Keating had a famous saying of never stand between a state premier and a bucket of money.”

Far more important than the fiscal significance of the payments was:

• the sense of collaboration they established between the Commonwealth and the States. The Commonwealth taxation system captured the fiscal benefits of the reform which were shared with the States that had to implement them; and • the tool they provided State Treasurers for dealing with internal resistance. 22

2.6 Role of the National of the work evolved, the composition of the Council itself changed, becoming Grid Management primarily made up of Treasury/Energy Council (NGMC) and policy officials from the jurisdictions electricity industry excluding Western Australia and Northern Territory. The NGMC’s working groups, created to resolve more detailed technical The reform program established by COAG issues, drew heavily on industry resources had a division of labour with the NGMC from the electricity authorities and established to manage open access member jurisdictions. to the grid, competitive sourcing of generation, and the supporting legal and › “John had the good skill to talk to regulatory framework. As noted above, senior politicians with their own jurisdictions were responsible for industry agendas. When he started there restructuring, local trials of competitive was hostility around the room markets, setting up an independent with participants from states economic regulator and supporting the (energy ministers) with their legal and regulatory changes. Initially it own agendas. Industry had seen was important that utilities were involved governments come and go and as they had knowledgeable staff that thought this reform agenda were able to participate in developing might pass too. They were the market design options. prepared to try to wait it out.”

Several reform participants commented on the importance of having the right 2.6.1 Importance independent chair for the program:

of an independent • You needed someone who had chairperson status and a name to give the process cudos. The person also needed The NGMC was led by an independent the conceptual skills to drive the Chair, John Landels, and initially consisted process and time to do it. Status and of senior executives from the vertically credibility were two key elements. integrated utilities (e.g. Pacific Power, • The NGMC Chairman, John Landels, ETSA, State Electricity Commission had excellent political access of Victoria, ACTEW) and government to the Prime Minster, Premiers, officials from Queensland and Tasmania. Energy Ministers and the business As the NGMC matured and the nature community (e.g. Business Council of Australia). • He had a strong background in 2.6.2 Value of private sector industrial relations with unions. research and the • It was important to have a Paper Trial Simulation Chairperson who had the good skill to talk to senior politicians with their Between 1991 and 1993, the NGMC own agendas, interact with senior prepared several research and discussion Ministers with a focus on reform papers on the design of a competitive outcomes and minimal technical electricity market incorporating access knowledge; thereby allowing and pricing arrangements in electricity technical details to be left to officials. networks for public discussion including:

› “Great patience is also another key • options for network service pricing attribute. In the case of the NGMC and asset valuation methodologies; Chair, John Landels, it took a long • options for common trading time to build trust between John arrangements for electricity based on and Ministers who changed during a review of market models overseas; the six years so he regularly had to start over. He was able to • options for the structure of an facilitate a general understanding interstate transmission network for by the Energy Ministers which eastern and southern Australia; helped to achieve progress.” • options for regulatory arrangements for a national electricity market; • key issues for government in establishing a market; • options for demand management in the NEM; and • options for reducing the initial 10 MW customer threshold for choice of electricity supplier. 24

› “One of the key lessons was the › “The focus of the reform process importance of recognising what at the national level at that stage was happening in the rest of the was on generation expansion world. There is sometimes the competition, i.e. the best process tendency to not be interested in across multiple states instead of what is happening elsewhere each state looking after themselves. in the world but to invent it here There was little interest in retail in Australia. The approach competition or major restructuring was to look worldwide for the in those days (early NGMC best expertise to help design days). Industry wanted to minimise and implement.” the change. Basically the Grid Protocol set out a national process In 1992, the NGMC produced a national for generation expansion.” grid protocol (NGP) which established a set of rules, responsibilities and technical In early 1993, the NGMC’s research requirements for connecting to the showed that a number of market national grid and participating in trade models were either in operation or of bulk electricity. While initially limited being discussed both in Australia and to generators and large customers, the overseas. The NGMC, with the agreement NGP established an initial framework for of COAG, determined that a Paper Trial the development of a single national of a national electricity market should be market. Although the Protocol spoke of conducted involving as many participants a national market, there was no detail and stakeholders as possible to assess around how the concept would be the operation of an electricity market designed and established. in the Australian context. It was also viewed as a suitable vehicle through which all stakeholders could raise their awareness of the operational and financial implications of a competitive electricity market with no financial risks to the participants. The National Electricity Market (NEM) 2.6.3 Clear Paper Trial simulation was conducted from November 1993 to end of June objectives were set 1994. Approximately 170 organisations for a competitive took part including major customers, electricity market distributors and generation utilities.

› “Every participant learnt from Following the Paper Trial, the main the process, but especially those objectives of a fully competitive national jurisdictions like Queensland, electricity market proposed by the NGMC ACT, South Australia, and were agreed by COAG at the meeting of Tasmania which had not been 19 August 1994: running a regional market.” • the ability for customers to In assessing the important lessons of choose which supplier, including the Trial, the NGMC was mindful that the generators, retailers and traders, market model used was a compromise they will trade with; between the views of the parties • non-discriminatory access to the involved in its establishment. All parties interconnected transmission and acknowledged that the model had a distribution network; number of features that would not be • non-discriminatory legislative or accepted in a real market (e.g. ancillary regulatory barriers to entry for new services were not taken into account in participants in generation or retail the scheduling of generation plant). It supply; and was also recognised that commercial and reliable information systems would need • non-discriminatory legislative or to be developed and be in place before regulatory barriers to interstate the market commenced. and/or intrastate trade.

› “First half of ‘90s there was a lot › “Challenge was to bring a mixture of resistance but after the Paper of states along in the reform Trial it tipped the other way. process – each had its own unique People got on board.” set of issues – and try to achieve a uniform market design for the competitive market objectives.” 26

2.6.4 Appropriate In 1994, the NGMC established the Market Steering Committee, the Market resourcing of the Implementation Steering Committee NGMC’s reform and various NGMC working groups program (e.g. Market Trading WG, Transmission Pricing WG, and National Electricity Code WG). The Market Steering Committee In July 1994, the NGMC recognised and Code Working Groups had broad that the reform program was going too representation of market participants, slowly using part-time resources from including generators, retailers, Network industry. The NGMC was provided with Service Providers, major customers (e.g. joint funding from the Commonwealth from the BCA and the Australian Chamber and jurisdictions to engage appropriate of Commerce and Industry), power expertise to support the development systems operators and the financial sector. of the NEM. A full-time General Manager Projects, Neville Henderson, was › “Central agencies will only intervene appointed with consultancy support if they think you’re not doing the job. including a project manager and a In late 1993 the NGMC nearly ran legal advisor. out of gas because the electricity industry providing support started › “Importance of full time Program to back off and withdraw resources. Management Office to drive the That was a weakness until Neville national process: First two years was appointed.” with part-time industry resources was not working – it was taking The various working groups were tasked too long.” with developing a National Electricity Code (Code) that would specify market governance arrangements, market trading rules, power system security rules, third party access arrangements for transmission and distribution networks, and metering rules.

› “Access to appropriate expertise and budgets – they hired good people to research other countries and studied the dynamics of the industry.” 2.6.5 Value of › “An important lesson is that you need to choose people with the industry resources right intellect, not driven by ego, who want to get the job done Engagement of industry was vital to build and who can work constructively trust and encourage involvement. The with others.” process was made up of people who had a long history within the industry The NGMC’s cross-jurisdictional working and a good understanding of issues that groups were beneficial to the program. enabled the industry to work out how the market would operate. There was a geographic distribution of working groups (working group › “There were a lot of people in the heads were spread across the states industry who supported change, and membership of the working groups but the process was set up in was always cross-jurisdictional). such a way that key resistance from other senior people was Each member could go back and marginalised as the NGMC communicate to their teams. This process reported through the Senior worked well in communicating working Officials Group straight through group developments and providing to COAG and not through utility a feedback loop into the process. boards or Chief Executives.” The members were all technocrats, but The electricity industry also played an went back to states and had others important role in educating governments provide commercial input where required. and other stakeholders about how If issues could not be resolved within competition could be introduced in working groups / state discussions there generation and retail. This role was was an escalation process to ensure important because, unlike other sectors, rapid resolution within the objectives no one in the Commonwealth, State of the reform. Government or the business community knew much about electricity (except for large electricity consumers). 28

“The sign off by 2.6.6 Setting a Market simulation program to test each Premier of considered pace the wholesale market design the conceptual In late 1994, the NGMC commissioned for reform – time to Intelligent Energy Systems to develop wholesale electricity “demystify the process” a market simulation model to test design provided the key features of the market design in a high level drafting Political approval for the conceptual laboratory environment. Many functional instructions for the wholesale market design areas of the proposed market design are still at the leading edge of global detailed market In late 1994 and early 1995 the NGMC developments in electricity market design design and the considered and endorsed several policy and although some aspects have been papers developed by its working groups Code and avoided used in other markets, they were untried on a set of market trading arrangements in the electricity sector. on-going debates on and an access regime. These policy papers the type of wholesale provided the initial “drafting instructions” › “It was very important confidence market (i.e. energy for the National Electricity Code. building, learning experience and understanding of market A key milestone was achieved in 1995 only versus a technical details – Lesson when each State Premier signed off on capacity market).” learnt from that, getting the wholesale electricity conceptual confidence, demystifying design (i.e. proposed market National concepts, communication is Design). Achieving this milestone all key to getting support for required significant time investment something. Adept management by the chair of the NGMC, as well as and knowing you are unlikely to influence from within the industry get things right first time around. and certain Government officials to Simulation effectively does that. get it approved. The proposed design Once you have operated with provided structure to the NEM, leaving it you get more comfortable.” the technical detail to be developed around these design guidelines in the conceptual design paper. In addition, it was clear to the NGMC › “We were lucky to engage that there were certain features of the Vernon before he won the Australian electricity industry that Nobel Prize. After 2002, we would require special attention to may not have been able to ensure that the market model was afford him. His contribution workable and the resultant outcomes to market simulation were consistent with achieving market program was invaluable.” objectives endorsed by COAG. The simulation testing program was › “If you look at some jurisdictions, conducted with market participants. which did not have regional It demonstrated the feasibility of markets, the simulation model the proposed market design and was very important to get the importance of providing market them comfortable. Talking to participants the ability to make their people there, the simulation was own, independent commercial important in getting grips on decisions regarding when to commit the interaction between the spot their generation plant. market and vesting contracts etc. Simulation allowed them to see Independent review of the this, and then inform ministers wholesale market design in the of this.” draft National Electricity Code

The US economist, Vernon L. Smith was › “Mega-brief program – Was commissioned as a consultant advisor to helpful at the time. Provided the market simulation program. Vernon expert overview of key elements Smith was engaged because he had of whatever they were looking at.” popularised experimental economics which highlighted the value in trials and In late 1995, after the NGMC had released experimentation as part of the process its first version of the National Electricity of designing a market. Later in 2002, Code for public comment, the NGMC Vernon Smith was awarded the Nobel undertook a major consultancy program Prize in economics “for having established (“mega-brief program”) to subject the laboratory experiments as a tool in proposed Market Rules and System empirical analysis, especially in the study Security Code provisions to a final review of alternative market mechanisms.” by independent consultants. Most of the world’s leading firms in electricity industry reform and market design participated in the program. The objective was to obtain 30

an independent review of the market › “Several government officials were design as set out in the draft Code and not familiar with Corporations to receive proposed refinements to the Law and the concept of a market design (e.g. Inter-Regional Trader, Members Agreement and Articles short term forward market and Reserve of Association for NEMMCO Trader) and to develop recommendations and NECA. There was a strong on operational details of some of the initial reluctance to relinquish market mechanisms. The Market control to the Boards of these new Rules in the Code were subsequently companies. It took over a year to revised, to incorporate many of the get all jurisdictions on board to consultants’ recommendations. establish NEMMCO and NECA.”

› “Rigorous checks and balances. NECA’s major roles were to manage Get others to look from different the Code change process and monitor perspectives, legal, consultants Code compliance and seek enforcement etc to ensure it is developed as of Code breaches through a National robustly as possible.” Electricity Tribunal.

NEMMCO’s major roles were to Getting jurisdictional agreement operate the physical dispatch to the market governance process across the NEM, register arrangements took a long time Code participants, and perform pool In 1995/1996, the NGMC developed settlements and co-ordinate and the institutional and governance plan for power system security. arrangements for the market; including the establishment of NEMMCO (National Establishing these companies in Electricity Market Management Company) effect took some of the control of the as the market and system operator electricity businesses away from the and NECA as the National Electricity State Governments. However, establishing Code Administrator as companies independence for the national market under the Corporations Act with an institutions was important to create independent chair and participating an environment to attract private jurisdictions as members. sector investment. Getting agreement to the National › “A lot of trouble from a Electricity Law (NEL) was even harder governance point of view to get this locked in. States In order to operate the NEM, it was weren’t allowed to unilaterally necessary to harmonise laws and change the rules. It was unique regulations governing electricity supply and bespoke. It was ideas / in participating jurisdictions. Because the compromises that were worked Commonwealth had no constitutional through to create the NEL.” authority over electricity, it was necessary to get an agreement from the jurisdictions The NEL requires all Network Service to these harmonised instruments. Providers, anyone operating a wholesale electricity market, all purchasers of › “The NEM required a credible electricity from NEMMCO and all regulatory regime that would generators, to register with NEMMCO in provide legitimacy for private accordance with the National Electricity sector investment, by giving Code (now the National Electricity Rules). consumers and Governments confidence that their interests › “Getting agreement to the would be protected. That NEL was a major achievement, legitimacy would also give as it was only the second time confidence to investors about cooperative legislation had the security of their investment been agreed to and passed and returns.” by the jurisdictions.” COAG endorsed a cooperative legislative scheme that allowed one jurisdiction, South Australia, to be the lead legislator for a National Electricity Law (NEL).

Each participating jurisdiction signed on to a Legislation Agreement, where each participating jurisdiction agreed to adopt legislation identical to that of the lead legislature (i.e. South Australia) and not to change or repeal the cooperative legislation without unanimous consent. 32

A staged transition to the been operating the smaller markets and NEM in 1998 avoided a big therefore they were already aware of the bang approach technical and commercial implications of competing in the market. This reduced the There was a staged transition to the risks for the market as a whole but also, NEM from the initial trial markets in importantly, for each of the businesses. Victoria and NSW in 1991/92 through to a live market in Victoria in 1993 (VicPool › “One of the reasons this worked. III), the NSW State Market in 1996 and The jurisdictional trials and regional the joining of the Victorian and NSW markets enabled experience in Markets under NEM1 in 1997. South how to operate in the market with Australia participated as a separate a safety net. You could try different trader. Queensland joined the NEM ways of running a market as we and implemented a wholesale market did initially with different market in 1999, which operated as a separate designs in VicPool III and ELEX (NSW regional pool until interconnection internal market 1991/92), NSW with NSW in 2001. Tasmania joined State Electricity Market in 1996, the NEM in 2005. NEM1. When it came time to do it for real, not just half a dozen who › “A triumph of this process was put it together understood it, but that detailed development of there were 100’s in the businesses markets could be done at the who knew how it was supposed to state level and successfully work, what their role was and how transferred to the national level. to pick up things that fell through A national process needs to the cracks. It’s the people in the have practiced trialling on the business who made it work.” ground, at the state level.”

Taking the lessons learnt from each stage, particularly when combining the separate markets that were operating in Victoria and NSW, to get the final market ensured there was clarity around what worked. It also meant there was a significant pool of people who had 2.6.7 Open and The NGMC Chairman and the GM Projects, Neville Henderson, made presentations on adequate consultation the reform process at numerous industry across all stakeholder conferences and had frequent meetings groups with electricity industry, business, federal, state and local government representatives, environment and other groups to discuss The NGMC consulted widely in issues related to the competitive reform. determining the model for the NEM and as they developed the Code. One of the key aspects to all of this consultation was the two-way › “The thing that characterised communication that resulted. Feedback all of this was the degree of and ideas were genuinely taken on by consultation and opportunity the NGMC and incorporated into the final to have an impact on the outcome. It was accepted that the market outcome. The effort that went was complex and no one person could into a genuine conversation was design it in isolation. important. There was serious consultation. We didn’t always get › “On everything you must engage what we wanted but neither did people. Impossible to know it all. anyone else. So overall, it probably You need to test against reality. Not delivered a good outcome.” just electricity but everything. Very complex thing, no one had done The NGMC utilised a seminar/submission anything like this before. Needed process as a consultative tool to develop to get experts to bear on issues. a number of key issues in its early years Wouldn’t have been successful (1991 to 1994). In addition, a general without taking the time and mailing list was used to circulate material having adequate consultation.” or notify of its availability. This list grew to include some 3000 individuals and The consultation also resulted in a organisations who had expressed significant improvement in the general an interest in the reform process. As knowledge of how the industry the NGMC structure moved to the functioned and the impact of the “Development” phase (post 1994), the reforms across a wide stakeholder group. use of this general mailing list was largely This was important as it increased the overtaken by the establishment of the number of advocates and it reduced Reference Group and the interactive the perception of risk amongst those process that it entailed. Public seminars in decision making roles. continued to be used from time to time to develop the Code. 34

2.6.8 On-going and To assist in these roles, the ACCC was an “active” observer on most of the NGMC’s staged engagement working groups. with regulatory bodies In addition, the ACCC issued interim like the ACCC authorisations for the Victorian and NSW wholesale electricity markets as well as Before the NEM could commence, the the initial combined market. This included network access regime in the Code would approval for the third party access require ACCC approval under Part III of regimes in each state. the Trade Practices Act, 1974 while the market rules would require authorisation This involvement provided both the under Part IV. jurisdictions and the ACCC with important experience prior to the submission of the › “It was good the ACCC was actively Code. ACCC approval was required for the involved on the Code working establishment of the market so engaging groups. This allowed a clear them early meant they understood the understanding of what was meant significance of the issues surrounding the with every word, and how the market design and the expected impact Market was meant to operate. This on the businesses that were to join it. was a very complex process at the time. ACCC involvement allowed The Code went through applications and competition law requirements reviews by the ACCC from the approval to be factored in at the design in mid 1997 for the access regime and and drafting stages of the Code. authorisation for the market rules to This proved extremely beneficial December 1999 where some additional in the long run in ensuring the market mechanisms were authorised. authorisations of the Victorian, NSW and combined markets and the final National Electricity Code.” 2.7 Limitations “The reform process relied on resources from state electricity bodies, this had its of the electricity limitations. Feds understood, and John reform process [Landels] understood, that the NEM wouldn’t happen without buy in from all Participants were asked to comment those organisations (state bodies). Political on any limitations or negative aspects intervention wasn’t enough. Needed their of the electricity reform process during market and technical input / understanding the period 1991 to 1998. The range of to make sure it was designed right. It could feedback is given below: have scuttled at any point unless there was a process to ensure everyone understood all the issues. Process took 3-4 times as long Role of electricity industry – as anyone thought as we just kept peeling “Initially, senior utility people shouldn’t have back the layers finding more and more been on the NGMC. They had agendas issues to resolve.” they were pushing and probably delayed process a few years. The Victorian reform Difficulties in managing process killed that. On the other hand senior reform across the states – public servants have a high turnover which can be seen in NGMC membership records. “Where they could, the states persisted in The problem was a high turnover of these being parochial. They all reserved the right guys. These aren’t a solution either. When to have their own structure, market opening trying to design a process to work: clear timetables, regulatory regime and network policy direction and constraints should be standards. There were very few things other documented with clear timeframes. Form than dispatch that they conceded at the a group of people who know what they’re national level.” doing to get on with the work.” “Timetables, political agendas, cabinet decision made it hard to manage across the states. Had to agree with the states what were their priorities and get them to focus on this as a priority to be done in an orderly, timely way.” 36

A disjointed reform process – Delays in NEMMCO’s Market IT systems with unrealistic deadlines – “Got a result but would have been better with a clear objective from Federal Government “Following the decision to establish NEMMCO, and clear engagement to achieve the the interaction with industry became even objectives from the beginning. The process more important. Reasonable interaction was being developed as it went along which between NEMMCO and the generators resulted in it being disjointed.” on establishing the NEM could have been improved. NEMMCO over-promised and “Would have been better to have formed under-delivered, particularly with respect a National Grid Corporation and let them to timelines. There was a lot of pressure on lead the reform process instead of NGMC NEMMCO to deliver the IT systems in certain – no support from States for Keating timeframes. NEMMCO lost credibility in the proposal made in 1992.” early stages as whatever date they put up failed. When you have a lot of interaction Uncompetitive industry structures – with business, combined with the political pressure, NEMMCO were forced to promise “Other than Victoria, privatisation in other things that were impossible to achieve states led to uncompetitive industry in terms of deadlines.” structures. Ownership matters, but the reason for privatising should be for competition and efficiency, not for Wind up of the NGMC in maximum sale proceeds. It follows that February 1997 – governments need to be very careful when “Winding up the NGMC was a huge mistake privatising to avoid sacrificing competition which subsequent events proved to be the benefits for sales proceeds. Anyone can sell case. It created a policy vacuum for 2-3 a monopoly at a high price as monopolies years where nothing moved except the are a licence to print money.” development of the Frequency Control Ancillary Services Market in 2001 which NEMMCO led.” Was it a success? – “Might not be happy with precise outcome but can’t complain about the process. In assessing the limitations, some Design of market has stood test of time. participants commented that the overall Basic structures are still there.” process was still appropriate given the challenges of convincing the jurisdictions “The initial focus was to put into place to establish and join the NEM. Four key structural separation of generation comments were: and transmission with a competitive wholesale market across the states that “Overall it was a process fit for the time. would provide the foundation for retail It wouldn’t have happened without some competition and other reforms. There may of the key forums that were put in place at be some unfinished reforms like retail price the time, they weren’t always perfect but deregulation but the wholesale market they served the purpose overall. It was a underpins all other reforms.” success as a model to move forward with.”

“The NGMC worked really well. Bringing the working groups together with the jurisdictions, this brought everyone along on the process. This provided participants’ full ownership of the process and end result. It was very complex to do this. There were a lot of issues and problems that had to be resolved in those working groups. Eventually, the team process took over, the groups would see a problem then massive effort would go into fixing it. In some instances the working groups were working so perfectly some members were called back to their jurisdictions to bring them in to line with a view to pushing their jurisdiction issues rather than taking a pure market approach.” 38

3 Evolution of the NEM post 1998 period ‘91

There have been three major developments in the evolution of the COAG established NEM in the post 1998 period. The first Australian Competition and was the gradual introduction of full Consumer Commission (ACCC) retail competition in electricity in the participating NEM jurisdictions; the Jurisdictional laws and regulations second was the major change in the for electricity supply administered by Governments NEM governance arrangements in 2004/05 and the third has been the National Grid Management Council major changes in the structure of established by COAG the electricity industry. Full government The diagram provides a summary ownership – vertically of these major changes with snap integrated industry (generation and shots of 1991, 1998 and 2013. transmission) with distribution/retail with local government in some states

Interstate trade between NSW, Victoria and South Australia was governed by the Interconnection Operating Agreement (IOA)

No network connections to Queensland or Tasmania ‘98 ‘13

COAG and ACCC Standing Council on Energy and Resources (SCER)

Independent jurisdictional Australian Energy Regulator – electricity networks economic regulators – electricity and non-price retail regulation (in most states) networks and retail regulation National Electricity Law and National Industry structure – Electricity Retail Rules in place of Code separate corporation for generation, transmission, National Energy Retail Rules distribution/retail (removed (in most states) from local government) Australian Energy Market Operator (AEMO) – electricity and gas market operator National Electricity Law and National Electricity Code for Australian Energy Market Commission (AEMC) wholesale electricity market – to determine electricity and gas rules and provide market development advice to SCER National Electricity Market Management Company (NEMMCO) Vertical integration and market National Electricity Code concentration of generation Administrator (NECA) and retail as “gentailers”

Privatised industry in Victoria Privatised generation except in QLD and Tasmania (NSW underway) with privatised NEM commences across NSW, VIC, networks in SA and VIC, and privatised retail SA, and ACT and replaces IOA except in Tasmania

Planned network connection NEM operates across NSW, VIC, SA, ACT, QLD, and to Queensland Tasmania – across transmission interconnectors

Retail competition only for Full retail competition in all jurisdictions large customers except Tasmania 40

3.1 Introduction of The unfinished agenda for FRC is the full de-regulation of retail prices full retail competition and the introduction of the National in electricity Energy Customer Framework across all NEM jurisdictions. Full retail competition was an important In 2013 only Victoria and South step as it created competitive pressure Australia have implemented full in the wholesale electricity market and de-regulation of retail prices. Recently provided customers with the power of Queensland indicated they may choice in electricity supplier. remove electricity price regulation in Full retail competition (FRC) was south-east Queensland by July 2015 gradually introduced across the NEM, along with the introduction of price with Victoria and NSW the first to go monitoring. NSW is still considering to full competition in 2002. The other a recommendation by the Australian states followed and Tasmania intends Energy Market Commission to remove to introduce FRC in January 2014. retail price regulation.

The introduction of FRC was a complex In 2010, the National Energy Retail Law exercise led by NEMMCO who worked (NERL) was passed by South Australian with market participants to develop the Parliament. The NERL established a market procedures and IT systems to single national set of laws, regulations support retail competition. and rules which regulate the sale and supply of electricity and gas by retailers and distributors to end-use customers. The National Energy Retail Rules (NERR) have been adopted in Tasmania, ACT, South Australia, and NSW. Decisions by Queensland and Victoria are pending. 3.2 Change in The MCE agreed to a series of far reaching reforms of the energy market. NEM governance At its December 2003 meeting, the MCE arrangements recommended to COAG that NECA be abolished and two new statutory Following the establishment of NECA commissions be established: and NEMMCO, governments withdrew • an Australian Energy Market from the policy space with respect to Commission (AEMC) replaced NECA the NEM. However by 2001 there was as the Rule maker and provides general dissatisfaction with the original market development advice to governance arrangements for the SCER; and NEM, particularly in relation to NECA progressing policy matters. At that time • an Australian Energy Regulator COAG commissioned an independent (AER) to be responsible for economic review of the strategic direction for regulation and Rule compliance stationary energy market reform in at national level. Australia. The final report of the review (Parer Report) published in early 2003, In 2004 COAG approved the Australian recommended significant changes Energy Market Agreement which set out to the NEM institutions. the new national governance, regulatory and legislative framework of the Prior to that in 2001, COAG established Australian Energy Market (and the NEM). a new Ministerial Council on Energy (MCE) to provide a forum for national leadership In 2005 a new National Electricity Law on energy issues. The MCE included (NEL) commenced to replace the old NEL federal, State and Territory energy and the new National Electricity Rules ministers. The MCE was responsible replaced the old Code to reflect the status for providing policy leadership for the of the Rules as a set of statutory rules, stationary energy sector. though the new Rules were in much the same form as the old Code. 42

Some important changes were: directed by the Ministerial Council on Energy (now SCER: see below). • The original list of Market objectives This strict policy control on market in the Code were replaced by a single development was introduced national electricity objective in the because of the importance of NEL. The new NEL objective is an attracting finance to the Australian economic concept and is intended to energy sector at competitive rates. be interpreted as “acting in the long In the view of COAG, this required term interests of consumers”. If the a policy environment that investors National Electricity Market is efficient understand and that is relatively in an economic sense the long term stable, with transparent and well economic interests of consumers in understood processes for any respect of price, quality, reliability, policy changes. safety and security of electricity services will be maximised. In 2009, the Australian Energy Market • The new NEL enables any person Operator (AEMO) was established by to initiate a Rule change proposal, COAG to manage the NEM and gas including industry participants, markets from 1 July 2009. AEMO carries end users, the Ministerial Council out the electricity functions previously on Energy. undertaken by the National Electricity Market Management Company • The AEMC is not empowered to (NEMMCO) with respect to the NEM initiate any change to the Rules other and the planning responsibilities of the than where the proposed change Electricity Supply Industry Planning seeks to correct a minor error or is Council (ESIPC, South Australia). non-material. Instead, its role is to Additionally, AEMO assumed the retail manage the Rule change process and wholesale gas market responsibilities and to consult and decide on Rule of the Victorian Energy Networks changes that are proposed by others, Corporation (VENCorp), Retail Energy including the Ministerial Council on Market Company (REMCO), Gas Market Energy, the Reliability Panel, industry Company (GMC) and Gas Retail Market participants and electricity users. Operator (GRMO). • In so far as its market development function is concerned, the Australian In 2011, COAG went one step further Energy Market Commission must and merged the MCE with the Ministerial conduct such reviews into any Council on Minerals and Petroleum matter related to the national Resources (MCMPR) into one body called electricity market or the Rules as the Standing Committee on Energy and Resources (SCER). 3.3 Change in The generator Snowy Hydro owns Red Energy, which operates in the industry structure New South Wales, Victorian and and ownership South Australian retail markets. The Tasmanian Government owned While governments structurally separated Hydro Tasmania has a retail arm the energy supply industry in the 1990s, (Momentum Energy) that trades 2 generation and retail were in separate in the NEM outside of Tasmania. corporations. Since then retailers and Separate transmission companies generators have tended to vertically still operate in each state. There has integrate to form ‘gentailer’ structures, been major restructuring of electricity as a way of managing the risk of price distribution in New South Wales and volatility in wholesale energy markets. Queensland. In NSW six electricity Some key examples are: distributors are now three operating • Three retailers – AGL Energy, Origin subsidiaries under the holding company Energy and EnergyAustralia – jointly Network NSW. In regional Queensland, supply 76 per cent of retail electricity six electricity distributors were merged to customers and 85 per cent of gas establish Ergon Energy in 1999. Tasmania customers in eastern Australia. The has plans to merge their electricity entities increased their market share transmission company, Transend, and in generation from zero percent electricity distributor, Aurora Energy in 1998 to 35 per cent in 2012. into one company by July 2014.

• Many new entrant retailers since Generation has been privatised in 1998 are vertically integrated all states excluding Queensland and with entities that were previously Tasmania (NSW is a work in progress). standalone generators – for example, Electricity retail is also privatised except International Power (trading as in Tasmania. Electricity transmission and Simply Energy in retail markets), distribution have been privatised only Infratil (Lumo Energy) and Alinta. in Victoria and South Australia. Government owned generators are also vertically integrating.

2  Australian Energy Market Regulator, State of the Energy Market 2012, page 19. 44

4 Key lessons for the future

This case study presents a summary of the • The Industry Commission (now key lessons from the NEM reform process. the Productivity Commission) Based on interviews with some of the key was used to establish an participants, these lessons can be listed independent assessment of the as following. real and material problems and potential policies to address 1. The material problems were defined them, thereby providing clear and clear reform objectives were set reform objectives. • Government policy was driven • The electricity reform benefits by policy debates, about what were large enough to withstand was best for Australia’s future. changing state priorities or • In embarking on the reform resistance from existing rent of the electricity sector, clear holders (and seekers). objectives for change were • The economic and policy set and the change approach implications, commercial and was transparent. financial impacts, and technical and operational impacts were brought into alignment. This alignment was maintained throughout the process and has underpinned the NEM’s durability. 2. Reform took high-level political 3. Strategies were developed to drive; provision of time, energy, enhance confidence in the reforms and according to many reform • Confidence in the proposed participants, financial incentives reforms was developed by • Ministers involved in the specifying market designs and reform were required to make rules in detail and then taking a significant commitment the time to run trial simulations of personal time in order to and model the reforms with make things happen and keep the involvement of the key the process on a consistent industry and government path. They were able to sell it representatives to iron out design effectively because they took the flaws. This also drove further time to understand upfront the engagement by stakeholders. pros and cons, the risks and the • Electricity market reforms were consequences of what they implemented at the state level were doing. before moving to a full national • In the energy sector, the National electricity market. The learning Competition Payments had from these state experiences three benefits: first, the State was invaluable and boosted Governments had an incentive confidence in the national to change as they wanted the electricity market. payments; second, there was a political cost if some payments 4. Strong and appropriate support were seen to be withheld; structures were established with and third, they could use the key stakeholder participation payments as an argument to • Reform across the Commonwealth undertake reform in the face of and the States required opposition. Looking to future significant collaboration and reform, there are risks that the cooperation. Establishment incentive becomes payment of appropriate governance maximisation, rather than structures across federal, policy optimisation; and the jurisdictional and industry levels relationship between the was essential to ensure the Commonwealth and the states reform process had appropriate changes from a partnership co-ordination of policy, technical to a quasi contract. Incentive design and implementation. payments are not a substitute for mutual commitment to policy outcomes. 46

• Reform programs are often • Linked to the governance complex involving a wide structures were the people range of stakeholders. Full-time chosen for each working group. resources were allocated to They were the right people, with manage the program, and access the appropriate skills, knowledge to the appropriate subject matter and influence. Keeping the specialists was included working groups to a critical in resource budgets. mass, with all the relevant parties represented, minimised the • The Commonwealth Government need for multiple briefings and recognised that jurisdictions and bartering outside the formal industry had skills/knowledge reform process. The people that the Federal Government did chosen were able to consider not have. Electricity reform was everything from the bigger a collaborative process. picture rather than bringing their • While each state was not at the own agendas to the table. same point along the journey, they each agreed to drive the 5. The pace of the reform allowed reform within their jurisdiction, for effective consultation across to be signed up financially and all stakeholders politically, and to learn from • It was important to ensure the each other throughout the time allowed for reform was process. It was also important manageable and realistic for to ensure each jurisdiction all involved. had a key role to play, either owning sub-committees or “The moral is clear. It was not in the national governance enough to set strong goals and framework. The more connected to have a clear vision. The reform to the process each jurisdiction road was long and required was, the more they understood constant attention.” the complexities and became • The reform was managed so advocates for the overall agenda. that the key things were done • It was important to give early, such as setting agreed credibility to the process. principles and conceptual design This was enhanced by having for the market mechanism. This an independent, highly regarded resulted in an agreed roadmap chair. The people who were for all to follow throughout the involved understood the process, which in turn enabled commercial realities of the the relevant government businesses and the impacts and industry bodies to justify of the reform on them. allocating budget and time to the reforms. Ensuring there were competition. For example, incremental implementation in the State of Victoria the steps and delivery of incremental old electricity generation benefits helped keep stakeholders monopoly was broken up into engaged on the longer journey. many separate operating units despite considerable opposition • Identifying the key stakeholders at the time. The subsequent and having open and ongoing reform experience has seen the dialogue helped to build development of a diverse and trust and engagement. The competitive electricity generation stakeholders were identified at and retail sector. all levels. It was also recognised that no one person knew all the • It also demonstrated there is an aspects of the major reform so explicit trade-off between the it was important to work with benefits of a competitive industry all the participants to identify structure and maximising sales issues early and adjust the reform proceeds from privatisation. as required. The gains for the economy of a competitive industry structure 6. Getting the industry structures right need to take precedence over was key for effective competition the fiscal impacts of privatisation. • The process highlighted that To do otherwise poses a risk competitive markets only to the benefits of the reform work well with a competitive being sustained. industry structure. • When restructuring the incumbent electricity monopolies there were two key elements, one vertical, and the other horizontal. At the vertical level, there was a separation of potentially competitive segments (e.g. generation and retail) from the natural monopolies segments (electricity transmission and distribution and system operations). At the horizontal level, it was important to break up the competitive segments to create sufficient 48

Acronym Glossary ACCC Australian Competition and NCP National Competition Policy Consumer Commission NECA National Electricity ACT Australian Capital Territory Code Administrator

AEMC Australian Energy NEL National Electricity Law Market Commission NEM National Electricity Market AEMO Australian Energy NEMMCO National Electricity Market Market Operator Management Company AER Australian Energy Regulator NERL National Energy Retail Law BCA Business Council of Australia NERR National Energy Retail Rules COAG Council of Australian NGMC National Grid Governments Management Council Code National Electricity Code NGP National Grid Protocol NSW – ESPIC Electricity Supply New South Wales Planning Council OTTER Office of the Tasmanian ETSA Electricity Trust of Economic Regulator South Australia QCA Queensland FRC full retail contestability Competition Authority

GBE Government QLD Queensland business enterprise REMCO Retail Energy Market Company GDP Gross Domestic Product SA South Australia GMC Gas Market Company SCER Standing Council on GRMO Gas Retail Market Operator Energy and Resources

ICRC Independent Competition SECV State Electricity and Regulatory Commission Commission of Victoria

IPART Independent Pricing VENCorp Victorian Energy and Regulatory Tribunal Networks Corporation

MW megawatt of electricity VIC Victoria

NCC National Competition Council NATIONAL ELECTRICITY MARKET A case study in successful microeconomic reform

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