This Chapter provides a broad overview of the electricity system within Australia, including the National Electricity Market (NEM), the supply chain components (generation, transmission and distribution, and retail), and the governance of the electricity market.
The Chapter discusses the current transition that the electricity system is undergoing and the impact this is having on three key energy policy objectives: affordability, reliability and security.
Finally, the Chapter considers the opportunity that this transition provides to modernise the Australian grid to ensure that we are meeting the need of households and businesses into the future.
History of the electricity system
In the late 19th century, during the early stages of electricity supply in Australia the majority of the population was concentrated in widely dispersed coastal regions. Subsequently, the electricity industry was developed around the state capitals and rural towns with electricity generation located close to the source of demand.
Initially, the electricity industry was comprised of private and public enterprises, however, in the earlier 20th century state governments began to own and operate the electricity supply industry. By the late 1940s, electricity infrastructure was primarily owned by the state governments.
During this time, the revenues generated by metropolitan consumers were utilised to support the construction and operation of rural electrical systems, with Single Wire Earth Return (SWER) lines used extensively to service remote and rural customers.
The post-World War II period was marked by a rapid expansion of the electricity industry. This led to substantial changes to the electricity grid with some states transitioning from self-contained local and regional power grids to state-wide grids that were administered centrally by public statutory authorities. Moreover, the construction of the Snowy Scheme led to the interconnection of New South Wales and Victoria in 1959.
The establishment of the National Electricity Market
By the early 1990s state governments started pursuing broad economic reform to ensure Australia’s competitiveness in the international market. In the context of the electricity supply industry the Council of Australian Governments (COAG) sought to restructure the industry and to develop a competitive electricity market. This action aimed to separate generation and retail from monopoly networks (transmission and distribution) within the industry.
The National Electricity Market (NEM) commenced operation as an energy-only market in December 1998 and coincided with an increase in the privatisation of state-owned electricity enterprises.
In 2004 the COAG entered into the Australian Energy Market Agreement. The 2004 agreement gave effect to the recommendations in the Ministerial Council on Energy Report of 2003, which set out the legislative and regulatory framework for Australia’s energy markets. This meant that electricity, which had previously been the responsibility of the States, was now a shared responsibility coordinated through the COAG Energy Council.
The National Electricity Market
The NEM is a wholesale spot market for the price of electricity, incorporating 40,000 km of transmission lines and cables and supplying 200 terawatt hours of electricity to businesses and households each year. Supplying 9 million customers with electricity, its total electricity generating capacity is 45,000 MW. Around $7.5 billion is traded in the NEM each year.
It was of particular interest to the Committee to learn that there is approximately $20 billion of financial derivatives traded each year in the NEM. These contracts assist in the management of pricing volatility.
Today, the NEM, operated by the Australian Energy Market Operator (AEMO), is one of the world’s longest geographically interconnected power systems, spanning from Port Douglas in Queensland to Port Lincoln in South Australia, and across the Bass Strait to Tasmania. It interconnects five regional market jurisdictions: Queensland, New South Wales (including the Australian Capital Territory), Victoria, South Australia, and Tasmania.
Largely due to distance, Western Australia and the Northern Territory are not connected to the NEM. However, AEMO operates a Wholesale Electricity Market for the South West Interconnected System of Western Australia. This enables retailers to purchase electricity from a generator though the Western Australian electricity market.
The Australian Energy Market Agreement, as amended by COAG in December 2013, sets out the regulatory framework for the NEM.
The COAG Energy Council is made up of federal, state, and territory energy ministers and takes the lead role in monitoring and reforming national energy policy. The Commonwealth Minister for the Environment and Energy is the chair of that Council. The Council oversees the three national market institutions responsible for the operation of the national energy markets including the NEM. These are:
The Australian Energy Market Commission (AEMC) — has two main roles in energy: as the independent rule maker for electricity rules that regulate transmission and distribution networks, and as the provider of advice and reviews at the direction of the COAG Energy Council.
The Australian Energy Market Operator (AEMO)—established in 2009, AEMO operates the NEM and is the national transmission planner. This role involves considering the National Electricity Objective, which involves the:
Efficient investment in, and efficient operation and use of, electricity services for the long term interests of consumers with respect to price, quality, safety, reliability and security of supply of electricity, and the reliability, safety and security of the national electricity system.
The Australian Energy Regulator (AER) — sets the maximum revenue that the electricity transmission and distribution businesses can recover from customers, whilst also regulating prices for the monopoly elements of the sector. The AER also oversees the operation of the wholesale generation market and retail market to ensure the players are operating according to the market rules and the legislation.
In addition to the three national market institutions there are a number of state and territory agencies that have some regulatory functions.
As Australia’s energy market increasingly shifts towards renewable energy, a number of agencies have been formed to assist the development of Australian technology that will support this shift. For example:
The Australian Renewable Energy Agency (ARENA)—was established in 2012 by the Australian federal government to manage the government’s renewable energy programs and provide support and funding to research in the field. A Commonwealth government agency, ARENA has the role of supporting the development of local renewable energy technology by funding researchers, developers and businesses that have demonstrated the feasibility and potential commercialisation of their project. ARENA has $2 billion to accelerate Australia’s shift to a more secure and reliable renewable energy system. By funding innovation from early stage research through to large-scale deployments, ARENA has the character of a planner. What it funds may shape the energy grid of the future.
The Clean Energy Finance Corporation (CEFC)— is an Australian Government statutory authority formed in August 2012 to facilitate increased flows of finance to the clean energy sector through investment activities focused on investment in the renewable, energy efficiency, and low emissions technology sectors. It has made investment commitments of over $3 billion since its inception. The CEFC considers the grid and transmission infrastructure to be critical to energy transformation.
The Energy Security Board (ESB)—was established following a recommendation of the Finkel Review to coordinate the implementation of the recommendations made in the Finkel Review and to provide whole of system oversight for energy security and reliability to drive better outcomes for consumers. It reports to the COAG Energy Council
The supply chain components
The supply of electricity to energy customers comprises multiple components. This includes generators selling electricity into the NEM on the wholesale market, the transmission of power from the generators to large industrial energy users and local distribution networks, and the retail energy market that purchases electricity from the NEM and sells it to consumers.
A range of generation technologies are used in Australia. This includes coal fired plants, gas powered generators, wind turbines, hydroelectric plants and solar photovoltaic (PV) panels.
Currently, Australia’s electricity demands are predominantly met through the use of fossil fuel generators. In 2015-2016, coal fired plants contributed 76 per cent of the electricity generation in the NEM. These facilities burn coal to create pressurised steam which is then used to drive turbine generators to produce electricity. As a by-product, this process results in emissions being released into the atmosphere. The electricity sector contributes over one third of Australia’s carbon emissions.
Due to Australia’s international commitment under the 2015 Paris Agreement to reduce its carbon emissions, there is a growing focus on renewable generation. Hydro and wind plants utilise water and wind to drive a generator. In comparison, Solar PV directly converts sunlight to electricity rather than relying on a turbine.
Each form of generation has different features that impact their operating capacity, output levels and costs.
Coal fired plants take up to three days to start up, resulting in high start-up and shut-down costs. However, once switched on they operate continuously and have low operating costs. Subsequently, coal fired generators tend to bid into the NEM at low prices to ensure dispatch, which enables their plants to keep running.
Australia’s coal-fired generation fleet is aging and parts of it are becoming increasingly unreliable, especially during heatwaves. Even some gas-fired generation has proved unreliable at hot temperatures.
Hydroelectric plants have low operating costs; however, due to limited water supplies their capacity to operate continuously is restricted. As a result they operate during periods of peak demand, allowing them to benefit from high prices.
Solar PV and wind power generators are only able to operate if weather conditions are favourable, resulting in intermittent supply. As the Finkel report discussion of new technology solutions for kinetic inertia, synthetic inertia, and fast frequency response makes clear, some renewables can be configured to provide these services and the technology is also evolving rapidly.
The transmission network is the system of high-voltage transmission lines that carry electricity from generators to large industrial users and local electricity distributors in each region. This network is made up of transmission lines, towers and wires, underground cables, transformers, switching equipment, reactive power devices, and monitoring and telecommunications equipment.
Interconnectors are the infrastructure that connects the five regional market jurisdictions of the NEM, allowing electricity to be carried between the states. This is designed to enable more competition and help to match supply and demand for electricity.
There are currently six interconnectors in the NEM:
two between Victoria and South Australia;
one between Victoria and Tasmania (the Basslink);
one between Victoria and New South Wales; and
two between New South Wales and Queensland.
Figure 2.1: Interconnectors in the NEM
Source: AEMO, An Introduction to Australia’s National Electricity Market, July 2010, p. 15.
Box 2.1: Australia as an ‘energy island’
Australia: the energy ‘island’
In addressing issues arising from the evolving energy mix, lessons can be learnt from the practices and experiences of other markets in the world. For example, several countries in Europe and North America are currently modernising their market design and regulatory framework to accommodate growing generation from variable renewable electricity while maintaining the security of their electricity supply to the grid.
While lessons can be learnt from these countries, it must be noted that their experiences differ significantly from Australia. For example, Germany, which has pursued a fairly aggressive renewable energy target, has also benefited from interconnectors with other countries such as France, and Poland, which have a significant reliance on baseload power. Germany also relies on wind and hydro power from Denmark, Sweden, and Austria. In contrast, Australia is an island without interconnectors to other electricity grids. This provides Australia with unique challenges and opportunities.
The distribution network is the system of low-voltage distribution lines that carry electricity from local electricity distribution substations in each region to homes and businesses. The network comprises poles and wires, substations, transformers, switching equipment, and monitoring and signalling equipment.
Wholesale electricity market
The NEM is a wholesale electricity market that facilitates the sale of electricity from generators to retailers who then on-sell to consumers. The system works as a spot market, in which power supply and demand is matched instantaneously.
In delivering electricity, over 300 registered generators bid into the market to dispatch electricity in five-minute intervals. The cheapest bids are chosen first, and then increasingly more expensive bids are selected until enough electricity can be dispatched to meet demand. The dispatch price is determined by the highest priced offer needed to meet demand.Financial settlement is based on the spot price averaged out over a 30 minute period and all successful bidders are paid at this price, despite how they bid. Spot prices are one of the mechanisms that influence investment in generation in the NEM. The level of spot prices (in each five-minute interval) is regulated with the aim of providing an appropriate incentive for generators to participate in the market.
Within the NEM, electricity production is matched with consumption, and excess generating capacity is reserved in case it is needed. Moreover, transmission limitations are put in place to prevent overloading the network.
The relationship between wholesale prices and reliability is discussed in Chapter 3 of this report.
Retail energy markets are the final link in the energy supply chain and are traditionally the main contact between the electricity industry and customers, such as households and small businesses.
Retailers purchase wholesale electricity through the NEM and package it with transmission and distribution network services for sale to nearly 10 million residential, commercial and industrial users.
Together the ‘Big 3’ Retailers—AGL, Origin and Energy Australia—currently supply 70 per cent of customers in the NEM. Recently second tier retailers have diversified significantly.
There has been deregulation of the retail electricity markets in Victoria (2009), South Australia (2013), New South Wales (2015), and South East Queensland (2016), meaning that the supply of electricity is via a non-state owned company. The retail electricity markets in Tasmania and the Australian Capital Territory remain regulated.
Current transition in the electricity market
As in other countries around the world, the electricity system in Australia is entering a significant period of transition. This transition is driven by the evolving mix of electricity generation, increasing adoption of new technologies in the electricity sector, and changing consumer preferences which have influenced patterns of demand.
Recent events—including price volatility and load shedding associated with extreme weather events and the announcement of the closure of a number of coal-fired power plants—have highlighted the need for this period of transition to be managed effectively.
Changing generation mix (from coal to renewable)
The current transition in Australia’s electricity market is, in part, due to the evolving mix of electricity generation, from traditional, synchronous energy generation (such as coal, gas and hydro) to non-synchronous, variable energy generation (such as wind and solar photovoltaic).
Coal-fired power plants have provided stable, low-cost energy supply for an extended period of time; however, both the high emissions rates and aging nature of these power plants present challenges. One such challenge is to Australia’s international commitment, under the Paris Agreement, to reduce its carbon emissions. Subsequently, coal-fired generators are being retired without replacement, principally due to policy uncertainty, and the installation of renewable electricity generation sources has increased.
Wind and Solar PV are the most common renewable technologies being installed; however, there are a number of other low-emission electricity generation technologies. These include concentrated solar thermal, geothermal, ocean, wave and tidal and low emission electricity generation technologies such as biomass combustion and coal or gas-fired generation with carbon capture and storage.
At the same time, the penetration of rooftop PV on residential buildings has significantly increased, with Australia ‘currently leading the world with small-scale solar PV installations’. While the rate of installation varies across the country, it is as high as one in four in some jurisdictions. It is predicted that this will increase in the future.
At 7 November 2017, the Australian PV Institute reported that there were 1,746,760 households with solar PV in Australia, with the uptake of solar PV by households per state as follows:
Table 2.1: Household uptake of solar PV by state
New South Wales
Australian Capital Territory
Source: Australian PV Institute (APVI) Solar Map, funded by the Australian Renewable Energy Agency, accessed from pv-map.apvi.org.au on 5 December 2017
Box 2.2: Solar PV and the grid
46 per cent of respondents reported that they generated electricity at their premises, with 96 per cent of those generating power from solar PV. 93 per cent of this generation was connected to the grid, and 90 per cent generated income, rebate or credit as a result.
This transition will be discussed in greater detail in Chapter 3.
The changing generation mix is also affecting the availability of services required to maintain the security of the electricity system, as these services have been traditionally provided by large synchronous generators (such as coal-fired plants).
Implications of the change in the generation mix are discussed in further detail in Chapter 3 of this report.
As outlined above, the last five years have seen a significant increase in new technologies, processes and business models across the entire energy supply chain. The latest advances include low emissions electricity generation technologies, distributed energy resources such as digital metering, rooftop solar photovoltaic (PV) , battery storage systems and electric vehicles, and software for peer-to-peer electricity trading. It is likely that technology advances will continue to impact the electricity supply industry in the future. Some of these technological changes are further discussed below.
While it is currently new technology, the consumer-driven decision to install home battery storage systems has the potential to significantly reduce the incidence and level of peak demand on the grid if the uptake is efficient and integrated. AEMO has projected that as retail electricity prices increase and the cost of batteries decline there will be a steady growth in battery storage installation after 2021.
Opportunities for battery storage to support electricity supply during emergency situations are currently being explored in Australia. The South Australian, Victorian and Queensland governments have each announced battery storage initiatives as part of their energy plans. For example, South Australia’s Energy Plan aims to deliver 100MW of battery storage during summer 2017—18 for use in extreme weather conditions that create supply shortfalls that cannot be managed in other ways.
The installation of smart meters allows network operators to capture and record electricity usage data every five minutes. This allows operators to make decisions about demand in a timely manner, for example if transformers are being overworked operators can replace them prior to them being damaged. Moreover, the data collected can be used to make more accurate predictions about demand.
Smart metering can also be used to encourage behavioural change among households to reduce overall costs of operating the energy grid.
As metering technologies become more advanced they will likely provide more detailed consumption information. This has the potential to lead to greater service possibilities for consumers and operators. There are potential privacy concerns in relation to the collection of household data in this manner.
To date, smart meters have been rolled out in Victoria. Although evidence to the inquiry did not focus on the effectiveness of these meters in driving consumer behaviour change, anecdotal evidence suggests there may be potential for stronger gains in this area too.
Changing consumer preferences and industry
Changes in the energy market, technology development, concerted efforts to lower emissions, and the lowering cost of distributed energy resources have provided residential consumers with greater incentive to choose how their electricity demand is met and to become active participants in the energy sector. This has led to significant uptake of rooftop solar PV, and it is predicted that other distributed energy resources, such as energy storage, will gain popularity as they become more cost-effective in the future.
In 2015-2016, 1.6 million households in the NEM self-generated electricity through the installation of solar PV, addressing three per cent of electricity needs in the NEM. It is likely that in the future more customers will have the ability to meet their energy needs through self-generation and battery storage.
These changes have led to different patterns of demand from households and industry. This will be discussed in further detail in Chapter 3.
Challenges and opportunities for future policy
The modernisation of the electricity grid in Australia provides an opportunity to reconsider what the system should seek to achieve, and how the different priorities of stakeholders should be balanced. Four priorities that have been identified as crucial to ensuring an effective transition, these are:
security—a measure of the ability of the electricity system to continue operating within defined technical limits, even in event of the failure or disconnection of a major system element (for example, a generator or transmission line).
reliability—a measure of the ability of the electricity system to meet customer demand—that is, having capacity available in the right place and at the right time.
emissions reduction considerations—including meeting Australia’s climate change commitments under the Paris Agreement. The Paris Agreement includes a commitment to limit global warning to two degrees Celsius above pre-industrial levels with an aspirational limit of 1.5 degrees Celsius, as well as a commitment to zero net emissions in the second half of this century.
affordability—ensuring that the system provides universal access to electricity services at the lowest practicable cost to consumers.
Both reliability and security will be discussed in further detail in Chapter 3.
The recent history of the NEM provides a summary of the opportunities and challenges the national power grid faces as it transforms 20th century infrastructure into a form that will meet the energy needs of the 21st century. As the energy mix continues to evolve, it is clear that both energy policy and energy planning will need to adapt to ensure the grid remains both an efficient and effective way of meeting the energy needs of the consumers and businesses of Australia well into the future.
These issues are addressed in subsequent chapters of this report.