The NEM - Part 1: Overview

A series explaining Australia's National Electricity Market

Like most industries, electricity folks tend to get lost in a myriad of acronyms and jargon. This creates some inaccessibility for people new to the industry or who are just interested in understanding it a little better.

For a while, I’ve wanted to write a series trying to explain the National Electricity Market (NEM) in relatively simple terms and minimal acronyms. This is the first part of that attempt, I hope you enjoy!

Before we start

There’s a few things to note as we kick off this series:

1. These posts will focus on how the energy market is designed and how it is intended to work. Of course, in reality, things are more complicated as the rules and politics and market change. These posts won’t go into detail on any topical issues and instead will focus on broad accessibility.

2. If you’re the kind of person who lives in LinkedIn comments “umm actually”-ing everyone, the oversimplification in posts might get you pretty excited. In many places I’ll aim for brevity and simplicity over letter-of-the-law accuracy. I also am likely to get some things wrong. Please give me feedback if there’s something I’ve not explained clearly or if you think I’m made a mistake. I intend to wrap up this series with a Q and A style post!

3. I hate long blocks of text so I tend to break it up with loosely related gifs I find funny. If this bothers you, I apologise.¹

What is the National Electricity Market?

The complex task of understanding the National Electricity Market (NEM) starts with its name. The National Electricity Market is an umbrella term that encapsulates the electricity market (flows of electricity and payments for that electricity), the rules for how that market operates, and the physical infrastructure that allows the energy market to exist (poles and wires, generation). It covers the east coast of Australia. There are separate markets in the NT and WA.

Source.

When people mention the National Electricity Market (or “NEM”), they can really be referring to any range of sub-components. To break it into (hopefully palatable) chunks, there will be a series of posts following this overview that will cover:²

1. This overview + some brief history

2. The operation of wholesale market for electricity

3. Some key design choices for the wholesale market

4. Generation of electricity

5. Retailing electricity

6. Poles and wires

7. The contract market

8. Metering

9. Distributed energy resources

10. A response to any³ questions sent through as these posts are coming out.

If this is you right now, don’t worry, we’ve all been there.

At a high level, the National Electricity Market covers the generation and supply of electricity across the populous east coast of Australia. It coordinates the generation of electricity across a large range of generators (who are owned by governments and private industry) and transports the electricity through a large, interconnected system of poles and wires to where it’s needed e.g. your house.

Electricity market?

The fact that there is an underlying electricity market where a wholesale price for electricity is set every five minutes of every day is likely not common knowledge.

My partner when I’m running around the house turning stuff on simultaneously trying to explain the spot price is negative…

Electricity has not always been traded through a market. In the history of electricity, markets make up a small and recent chapter.

The electricity industry was started by a mix of entrepreneurs, councils and eventually state governments. It was only in the 1980s that countries around the world starting trying to introduce markets and competitive forces into the electricity industry.

Electricity has a number of quirks that make electricity markets different from the more common markets for goods or commodities.

• Firstly, you can’t directly trade electricity without a physical connection for the electrons to flow. The general consensus is that it would be wildly impractical for us all to have individual power lines connecting us to the power stations we’d like to trade with, so all electricity travels through the centralised network.⁴ All electricity in the NEM essentially goes into and comes back out of a big pool.

• Secondly, unlike most commodities, electricity is difficult and expensive to store. To store electricity, we need to convert the energy to other forms. Historically, the energy in electricity might be stored as potential energy in pumped hydro systems (where electricity is used to pump water uphill so it can flow back downhill later on to produce electricity). More recently, lots of energy is being stored as chemical energy in batteries.

• Third, and related to the above points, the supply and demand for electricity need to match in real time. Other goods can sit in storage for extended periods of time to meet future demand, whereas this process is prohibitively expensive for electricity. The amount of electrical energy being generated in the National Electricity Market as you read this is being matched by the electrical energy coming out of the system (accounting for electrical losses).

Cool, but why have a market for electricity?

Prior to the introduction of electricity markets in Australia, the entire industry was owned by state governments.⁵ In the global wave of microeconomic reform during the 1970s and 80s, these large state owned juggernauts were viewed as inefficient.

The Australian government commissioned an inquiry into Australia’s competitiveness and how it could be improved. The inquiry was chaired by Professor Hilmer, and it recommended a raft of measures including reforming the electricity sector to introduce markets.

In practice, an electricity market is designed to be more efficient than a government owned and operated industry. Instead of taxpayers, private players would need to make decisions about how they invest and how they operate. They would bear the risks of making poor decisions (i.e. lose their money) and profit from smart decisions.

When did the NEM start?

The gradual process of introducing competition started with the states.⁶ Evolving from a series of state government commissions to a competitive market followed these steps:

• Separating out the industry into three segments: generation, transmission and distribution/retail. Each of the segments was treated as arms length from the government.

• Trials of power markets started in NSW and Victoria in the early 1990s.

• Establishment of independent regulatory agencies responsible for economic regulation of the sector.

Following trials of markets, there were actual live electricity markets started in Victoria in 1993 and in NSW in 1996. These two markets were joined in 1997, creating the early bones of today’s NEM. South Australia joined for the commencement of the National Electricity Market on 13 December 1998. Queensland also joined the NEM, but operated separately until it was interconnected with NSW in 2001. With the completion of the undersea cable Basslink, Tasmania joined the NEM in 2005.

What does the market do?

We’ll break this down further in subsequent posts, but the NEM facilitates flows of information, electricity and money.

In broad strokes, generators of electricity (wind farms, solar farms, hydro, coal, gas) produce power. This flows through the transmission system (large towers, higher voltage), the distribution system (smaller towers like the ones on your street, lower voltage) and into your house.

At the same time, generators are being paid for selling their electricity in the wholesale electricity market. Retailers purchase electricity from the wholesale market on behalf of their customers.

Separately to the wholesale market, there is a contract market for electricity. In this market, generators and retailers (as well as financial speculators) can trade electricity derivatives for future periods. This helps them manage some of the risks associated with buying and selling from the wholesale market.

Source: Me.

Who runs the NEM?

There are a collection of regulatory bodies that govern the National Electricity Market. At a high level:

• The Australian Energy Market Operator (AEMO) is responsible for running the electricity market, including the flows of electricity, money and information. AEMO is also responsible for keeping the exceptionally complex system operating securely. It also supports the planning on the system. The pronunciation of the acronym AEMO is was the subject of debate.

• The Australian Energy Market Commission (AEMC) is responsible for reviewing the National Electricity Rules (i.e., the regulation that sets out a lot of the detail for how the National Electricity Market is meant to operate).

• The Australian Energy Regulator (AER) enforces regulation and economically regulates the monopoly businesses running the poles and wires.

• Energy Ministers from the State and Federal governments meet semi-regularly to set high-level policy directions.

A quick note on units

The two main concepts for units in electricity are electrical energy and power. Using a car as an example, electrical energy is equivalent to how far the car drove, and power is equivalent to how fast the car drives.

The main units people use to quantify electrical energy and power are:

• Electrical energy is measured in Watt-hours (Wh). One Wh is a very small amount of energy so we normally reference things units like:

  • Kilowatt-hour (kWh) = a thousand Wh. Equivalent to running a kettle for about 30 minutes.

  • Megawatt-hour (MWh) = a million Wh. Equivalent to powering two fridges for a year.

  • Gigawatt-hour (GWh) = a billion Wh. Equivalent to powering 200 houses for a year.

  • Terawatt-hour (TWh) = a trillion Wh = Equivalent to 0.5% of the annual electricity used in Australia.

• Power is measured in Watts (W). As with Watt-hours, we use bigger units.

  • Kilowatt (kW) = a thousand W. An average rooftop solar system is ~7kW.

  • Megawatt (MW) = a million W. A very large solar farm would be 300MW.

  • Gigawatt (GW) = a billion W. Eraring, the largest coal-fired power station in NSW is 2.88GW at full capacity.

  • Terawatt (TW) = a trillion W. The peak electricity consumption in China is about 1.15TW.

The end of part 1

Next post, we’ll look at wholesale market for electricity. I’ll explain the how the central feature of the NEM - the wholesale electricity market - works.

1. Given it’s going to be a long series, I’ve lent on the show I Think You Should Leave. It is ripe for gifs. If you haven’t seen it, it’s on Netflix and I’ll guarantee you’ll either love it or hate it.

2. I’ll probably add to this list in the future.

3. Unless I don’t really wanna answer them.

4. There are exceptions of course – you could always try stealing your neighbour’s power.

5. We would like to look at the commencement of the NEM in more detail this year. If you have stories to share about that time, please let us know, we’d love to hear them!

6. This section was summarised from a paper by Tim Nelson and Alan Rai. Thanks fellas!