In Australia the National Electricity Market (NEM) manages one of the most expansive interconnected power systems in the world. It stretches from Tasmania to Port Douglas in Queensland to Port Lincoln in South Australia. That’s 40,000km of transmission lines and cables transmitting 200 terawatt hours of electricity to consumers each year with a peak capacity of around 50,000MW.
As with any market the NEM has parties trying to sell and other parties seeking to buy. Within this construct it’s the Generators who are seeking to sell their electricity and Retailers who are trying to procure additional energy when they haven’t purchased enough for their customers. As demand for electricity rises so does its price, as the Generators bid into the market and offer to supply an amount of energy for a specific price. With prices ranging from -$1,000 to $13,100 per megawatt hour (yes, the price can go negative!), the NEM can be quite lucrative when demand for electricity is high.
A recent report by the Australian Energy Market Commission (AEMC), who make and amend the National Electricity Rules (‘The Power of Choice Review’), has challenged this traditional construct. For the purpose of this piece we will focus on the recommendation to reward Demand Side Participants (DSP) in the wholesale market. Under this recommendation the AEMC tasked the Australian Energy Market Operator (AEMO), who also operate the NEM, to develop a rule that enabled consumers of electricity or third parties acting on their behalf to directly participate in the wholesale market and receive the electricity spot price for a reduction in demand. The intent of this change was to give consumers more opportunities to better manage their expenditure on electricity. Should consumers embrace this opportunity the positive impact on peak demand is obvious and estimated to be somewhere between 400 to 1,300 MW by 2020.
But how will customers take advantage of this?
The scarcer a product becomes, the greater is the demand for that product. This leads to an increase in price. An example used to explain this in economics is ‘Tulip Mania’ which occurred in the Dutch golden era where tulip bulbs reached exorbitant prices. As demand grew for tulip bulbs, which were in limited supply the price per bulb rose to ten times more than a skilled tradesman’s annual salary. Similarly, in the NEM as electricity prices rise (due to a shortage of available electricity), a customer with a relationship with a registered demand side aggregator can bid to reduce their demand and capture the value of their reduction. This is realised through an agreement with their Retailer to remunerate the consumer based on their performance to these events.
Take this real world example. A Poultry Farmer in Queensland with a demand of 500kVA may react to high electricity prices when the prices in the NEM exceed $500 per megawatt hour (MWh) until they return to under $500 per MWh. The Poultry Farmer could respond through switching on any temporary generation and reducing their demand to zero for the duration of the event. As a result the customer would make $500 x 5 hours or $1,250 (after any short run marginal cost of their asset).
Why would the Retailer want its customers to use less electricity?
Retailers procure most of their forecast electricity requirements for their customer base well in advance. As predicting electricity usage is incredibly difficult and primarily driven by the weather, some exposure to the wholesale market is carried. In the event more electricity is required, the Retailer is at the mercy of the prices in the NEM. As a way of minimising their exposure, a hedge, or “cap” is purchased from another counter-party in the market.
Herein lies the win-win for the consumer and the Retailer. Should the customer be able to reliably reduce their demand within a short time frame, the Retailer can purchase fewer caps. And the customer would benefit through a saving in their electricity bill, or a special payment from their Retailer.
The next blog on this topic will centre around enabling customer response to these events.