Beyond the capacity market: securing Australia’s renewable future

Australia's National Electricity Market (NEM) is undergoing a significant transformation driven by the integration of renewable energy sources, the retirement of coal-fired power plants, and evolving consumer demand.

Yet, as our energy transition accelerates, ongoing discussions about market reforms have not fully addressed the fundamentals of this transition. There is an urgent need for targeted and enduring solutions which can be easily implemented, rather than a broad market redesign such as through a capacity mechanism. The reforms must deliver a pathway forward which address the basics of the energy transition and delivers secure, reliable, and affordable electricity for all Australians.

The post-2027 market design review of the NEM announced by the Energy and Climate Change Ministerial Council and the appointment of an independent review panel is a major opportunity to ensure the market settings get the basics right.

Reliability has emerged as a key issue in the transition – renewables are being blamed for energy shortfalls during periods of tight supply-demand conditions, as we shift from a system dominated by coal and gas generation towards solar, wind, and storage. We have seen state governments react to the risk of these shortfalls by supporting existing coal and gas generation - such as through the New South Wales Government’s deal with Origin Energy to extend the life of Eraring Power Station, and the South Australian Government developing the Firm Energy Reliability Mechanism. These are attempts to sure-up capacity during extended periods of tight supply-demand conditions, but risk undermining existing market signals.

Along with assessing the adequacy of existing market mechanisms, the independent review Panel must work to restore Australians' confidence in the energy transition, and investors’ confidence in market signals.

Long-term policies (resilient to changing political priorities) will be needed to provide enduring signals for investment in renewable energy and storage beyond 2030, and ensure adequate capacity and a smooth transition to low carbon energy. Government interventions and other existing mechanisms, such as the Capacity Investment Scheme, do not currently provide these.

One proposed solution is a strategic operating reserve mechanism to ensure adequate back-up capacity during extended periods of tight supply. Such a contracted reserve could be rapidly deployed and would help smooth the transition, reducing price volatility and ensuring reliability without distorting market signals for other renewable investments through more involved interventions. It would complement market-based dynamics for generation and storage projects and avoid an overarching market redesign.

Beyond these market mechanisms, it will also remain critical to ensure the timely exit of coal-fired generation. The uncertainty surrounding these retirements are a significant risk to the energy transition. Delays in the closure of stations like Liddell and Eraring have created uncertainty for developers and investors alike.

A legislated framework that provides clear timelines for coal closures could help provide certainty and improve revenue stability for renewable energy projects. Such a framework would require power station operators to define a window for closure, with penalties for non-compliance. This approach would give developers and investors more confidence to proceed with new renewable generation and storage projects, ensuring a smoother transition away from coal.

There are also several untapped opportunities which could accelerate the energy transition. Demand-side participation and Consumer Energy Resources offer additional flexibility and reliability that, with appropriate market signals, could reduce the need for new grid infrastructure, alleviate congestion and provide value for both consumers and the broader energy system.

To unlock these opportunities, governance and network arrangements must be reviewed to improve transparency and market signals. This includes enhancing transparency of network data and creating more flexible service markets, to allow consumers to play a more active role in balancing energy demand and supply.

Rather than pursuing pre-determined solutions such as a new capacity market, Australia’s energy market design review must focus on practical, targeted measures that build on existing mechanisms and address the fundamentals of the energy transition. This must deliver an orderly retirement of coal-fired power stations and support the ongoing development of renewable energy and storage.

The full text of Nexa Advisory’s white paper “A solution looking for a problem: A capacity mechanism and related post-2030 market reforms” can be accessed here.