1. Australia’s energy markets: change and challenge JOHN TAMBLYN CHAIRMAN AUSTRALIAN ENERGY MARKET COMMISSION ASSOCIATION OF POWER EXCHANGES 12-15 OCTOBER 2008

2. CHANGE AND CHALLENGE Significant changes in energy market reform and development –Successful stationary energy reform since 1990s –Market structure, incentive regulation, competition –Delivering real benefits to Australian economy –Estimated contribution of $A 2.0 b per annum to growth Policy and market frameworks must continue to be responsive to –Changing market circumstances –Community expectations for efficient, reliable and affordable energy services Emerging energy market challenges –Climate change policy responses

3. Efficient investment, production and use of energy resources Maintain long-term energy security and reliability Promote energy efficiency and environmental sustainability Improve productivity and competitiveness of the economy Promote economic growth and community welfare ENERGY REFORM OBJECTIVES

4. 1990s Competition Policy Reform –Agreed national energy reform strategy, objectives & processes –Market restructuring, corporatisation & privatisation (some states) –Establish competitive energy markets –National access codes / independent regulation (federal / state) Energy Reform since 2003 –National energy market governance, laws and institutions –Promote network interconnection, competition, capital investment –Create integrated national energy market TWO PHASES OF ENERGY REFORM

5. COMMON NATIONAL MARKET OBJECTIVE, RULES & INSTITUTIONS REGULATORY FAILURE MARKET FAILURE ECONOMIC EFFICIENCY GAINS REFORMS ADD $2 BILLION PA TO AUSTRALIAN ECONOMY (IEA) KEY DRIVERS OF REFORM INDEPENDENT TRANSPARENT GOVERNANCE + BALANCE OF REGULATORY OBJECTIVES AND COMMERCIAL OUTCOMES FACILITATION OF COMPETITIVE MARKET + =

6. PARTICIPANTS WHOLESALE ENERGY SUPPLIERS MARKET CUSTOMERS (RETAILERS) PARTICIPANT END USE CUSTOMERS NETWORK OPERATORS TRADERS NATIONAL ELECTRICITY/GAS RULES ASIC AUSTRALIAN ENERGY MARKET OPERATOR NEMMCO (AEMO) AUSTRALIAN ENERGY REGULATOR (AER) ECONOMIC REGULATION & RULE COMPLIANCE GAS AND ELECTRICITY SYSTEM AND MARKET OPERATOR AUSTRALIAN ENERGY MARKET COMMISSION (AEMC) MINISTERIAL COUNCIL ON ENERGY POLICY DIRECTION NATIONAL COMPETITION LAW (ACCC) NEM GOVERNANCE SINCE 2005 NATIONAL ELECTRICITY/GAS LAW

7. CUSTOMERS ELECTRICITY MARKET EVOLUTION RETAIL GENERATION NETWORK GENERATION NETWORK RETAIL CUSTOMERS PRE- 1990s TODAY INDEPENDENT SYSTEM OPERATOR NEMMCO

8. ELECTRICITY MARKET DESIGN Premise: effective generator/ retailer competition; efficient monopoly network regulation; decentralised decision-making Power system security / reliability: standards, obligations, and incentives specified in market Rules Wholesale market: regionally-priced, energy-only, gross pool (no capacity payments/ nodal pricing) Network regulation: networks subject to CPI-X open access regulation (generator shallow connection/ no network access rights) Retail market: fully competitive but with price regulation for small customers

9. Abundant fuel sources Generation remote from load Long connections network required Transition to interconnected national market ELECTRICITY MARKET FEATURES GAS FIELDS ELECTRICITY NETWORKS COAL DEPOSITS

10. COAL SUPPLIES > 40% OF AUSTRALIA’S TOTAL PRIMARY ENERGY SUPPLY INCREASING EMISSIONS INTENSITY OF OUR PRIMARY ENERGY SUPPLY IS DUE TO INCREASING RELIANCE ON COAL FOR GENERATION ELECTRICITY SUPPLY BY FUEL TYPE 2008 SOURCE: NEMMCO 2008 Black Coal 59% Hydro 7.2% Oil and Other 0.3% Brown Coal 25% Natural Gas 8.5%

11. Reforms designed for Australian context Australia among lowest priced/most reliable energy markets Reforms add A$2 billion pa to Australian economy –Improved productivity/availability of generation and networks –Interconnection of previously separate state markets –Required capital investment (mainly private) is occurring –Strong wholesale competition/improving retail competition –Security/reliability being maintained or improved Outcomes contributing to Australia’s competitiveness & economy REFORMS HAVE MET AUSTRALIA’S NEEDS

12. Tightening domestic energy supply/demand balance –Forecasts of potential supply shortfalls –Rising energy input costs Uncertain world energy market –Rising world oil and gas prices –Growing energy demand and emissions Energy market impacts of climate change policies –A common issue for most countries EMERGING ENERGY MARKET CHALLENGES

13. Australia is now a signatory to Kyoto Protocol Developing policy responses to climate change –An Emissions Trading Scheme (ETS) by 2010 –Renewable Energy Targets (RET) to be met by 2020 –An emission reduction target to be met by 2050 Impacts on energy market structure, economics & performance? –Will the current energy market design deliver efficient outcomes? CLIMATE CHANGE POLICY

14. GENERATION ADEQUACY AND INVESTMENT DISPATCH IMPACTS AND SYSTEM OPERATION NETWORK INVESTMENT & CO- ORDINATION RETAIL MARKET RISK AND COMPETITION 1 2 3 4 CLIMATE CHANGE AND THE ENERGY MARKET CLIMATE CHANGE POLICIES WILL ‘STRESS TEST’ ENERGY MARKET DESIGN’S ABILITY TO DELIVER EFFICIENT OUTCOMES FOR CONSUMERS

15. SYSTEM AND MARKET OPERATION Likely changes in variable costs (inputs, emissions)? What merit order changes likely and technically feasible? Impact on system security and reliability? Level and volatility of spot prices? Network congestion from changed flows? Required level of reserves – how procured? 1 ISSUES $ BLACK COAL NOW FUTURE COST DRIVES MERIT ORDER

16. EMERGING TIGHT SUPPLY/DEMAND POSITION FROM 2011 ARE MARKET SIGNALS FOR INVESTMENT SHARP ENOUGH? RESERVE TRADER INTERVENTION FOR SHORT TERM GAPS ONLY GENERATION INVESTMENT WILL INVESTORS BE DETERRED BY CLIMATE POLICY RISKS UNTIL ETS AND RET DESIGN RESOLVED? 2 IS A CAPACITY MARKET NEEDED?

17. NETWORK INVESTMENT 3 ISSUES } LARGE IMPACTS ON THE TRANSMISSION NETWORK? } Investment planning in this ‘noisy’ environment? Not ‘crowding out’ market responses How to incentivise / remunerate transmission companies? How are network users charged? Definition and allocation of transmission rights? Who bears the risk of ‘asset stranding’? UNCERTAIN IN TIME + LOCATION NETWORK SPENDING DETERMINED BY CHOICE BETWEEN GAS, WIND, OR COAL GENERATION

18. RETAIL COMPETITION AND EFFICIENCY 4 PRICE PRICE CAPS ENERGY ENVIRONMENT COMPLIANCE NETWORK CHARGES PRUDENTIALS 1.Price regulation? 2.Financial distress and market exit? 3.Investment / entry incentives? 4.Vertical integration? 5.Competitive opportunities? ISSUES RETAILER COSTS

19. AEMC requested to review and report on: –Likely energy market impacts –Capacity for energy market to accommodate –Options for design change where necessary Presumption in favour of competitive markets, efficient regulation and decentralised decision-making Interaction of review with climate change policy process REVIEW OF ENERGY MARKET IMPACTS