Design of the Day-Ahead Auctionof Contracted but Un-Nominated Capacity
Final Recommendations
December 2017
Contents
Abbreviations
1.Introduction and Summary
1.1AEMC’s recommendations on the day-ahead auction
1.2Consultation on the design of the day-ahead auction
1.3Final recommendations on design of the day-ahead auction
1.4Consistency of the final recommendations with the NGO
1.5Next steps
1.6Structure of report
2.Assessment Framework
3.Products to be Auctioned
3.1Transportation products to be subject to the auction
3.2Priority of forward haul and compression auction products
3.3Other features of the auction product
3.4Zonal versus point-to-point auction products
3.5Summary of final recommendations on product design
4.Auction Design
4.1Auction format
4.2Reserve price
4.3Pricing rule
4.4Determination of winning bidders
4.5Treatment of curtailment on the gas day
4.6Allocation of auction residue
4.7Auction quantity
4.8Information available to auction participants
4.9Auction timing
4.10Summary of final recommendations on auction design
5.Coverage of the Auction
5.1Coverage and exemption options identified by project teams
5.2NERA Analysis
5.3GMRG’s preliminary view
5.4Feedback provided through the consultation process
5.5GMRG’s final recommendations
6.Design and Use of the Auction Platform
6.1Auction platform and systems
6.2Auction platform settlement and credit risk management
6.3Recovery of AEMO’s and service providers’ costs
6.4Interaction with other facilitated markets
7.Legal and Governance Framework for the Auction
7.1Auction Agreement
7.2Legal and governance framework
The views and opinions expressed in this publication are those of the GMRG.
While reasonable efforts have been made to ensure that the contents of this publication are factually correct, the GMRG and its advisors, NERA Economic Consulting and Johnson Winter & Slattery, do not accept responsibility for the accuracy or completeness of the contents, and shall not be liable for any loss or damage that may be occasioned directly or indirectly through the use of, or reliance on, the contents of this publication.
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Abbreviations
Term / DefinitionAA / Access Arrangement
ACCC / Australian Competition and Consumer Commission
ADP / Amadeus to Darwin Pipeline
AEMC / Australian Energy Market Commission
AEMO / Australian Energy Market Operator
AER / Australian Energy Regulator
AEST / Australian Eastern Standard Time
BB / Natural Gas Services Bulletin Board
Biennial Review / AEMC Biennial review into the growth in liquidity of wholesale gas and pipeline capacity trading markets
CGP / Carpentaria Gas Pipeline
COAG / Council of Australian Governments
CTA / Capacity Trading Agreement
DTS / Declared Transmission System
DWGM / Declared Wholesale Gas Market
East Coast Review / AEMC’s Eastern Australian Wholesale Gas Market and Pipelines Framework Review (May 2016)
EGP / Eastern Gas Pipeline
Energy Council / COAG Energy Council
ERA / Economic Regulation Authority (WA)
FTP / File Transfer Protocol
GMRG / Gas Market Reform Group
GSH / Gas Supply Hub
GTA / Gas Transportation Agreement
HPTP / High Pressure Trade Point
JWS / Johnson, Winter & Slattery
LPTP / Low Pressure Trade Point
MAPS / Moomba to Adelaide Pipeline System
MCF / Moomba Compression Facility
MDQ / Maximum Daily Quantity
MHQ / Maximum Hourly Quantity
MOS / Market Operator Service
MSP / Moomba to Sydney Pipeline
MSV / Market Schedule Variation
NER / National Electricity Rules
NGL / National Gas Law
NGO / National Gas Objective
NGP / Northern Gas Pipeline
NGR / National Gas Rules
RBP / Roma to Brisbane Pipeline
SCO / Senior Committee of Officials
SIP / STTM Interface Protocol
SRA / Settlement Residue Auction
STTM / Short Term Trading Market
SWQP / South West Queensland Pipeline
TGP / Tasmanian Gas Pipeline
Transportation services / This term is used to jointly refer to pipeline and compression services
Vision / COAG Energy Council’s Australian Gas Market Vision(December 2014)
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1.Introduction and Summary
The Gas Market Reform Group (GMRG) was established by the COAG Energy Council (Energy Council) in August 2016 to lead the design, development and implementation of a range of reforms set out in the Gas Market Reform Package, including a package of capacity trading reforms.[1]
The capacity trading reform package was recommended by the Australian Energy Market Commission (AEMC) as part of its Eastern Australian Wholesale Gas Market and Pipelines Framework Review (East Coast Review) and endorsed by the Energy Council at its August 2016 meeting. The reforms, which relate to transmission pipeline and compression services (jointly referred to as ‘transportation services’) include the development of:
a day-ahead auction of contracted but un-nominated capacity, which would be conducted shortly after nomination cut-off and subject to a reserve price of zero (with compressor fuel provided in-kind by shippers);
a capacity trading platform(s) that shippers can use to trade secondarycapacityahead of the nomination cut-off time and provides for exchange-based trading of commonly traded products and a listing service for other more bespoke products;
standards for key contract terms in primary, secondary and operational transportation agreements to make capacity products more fungible and, in so doing, facilitate a greater level of secondary capacity trading; and
a reporting framework for secondary capacity trades that provides for the publication of the price and other related information on secondary trades.
Work on the design of these reforms was initially expected to be completed during 2018, allowing the recommendations to be considered by the Energy Council at the end of 2018 so the reforms could be implemented by 2021. However, in response to a request from the Hon. Josh Frydenberg MP, Minister for the Environment and Energy, the GMRG examined opportunities to accelerate this work and committed to providing its final recommendations on the capacity trading reforms by the end of 2017. Specifically, the GMRG agreed to provide its final recommendations to the Energy Council on:
Who should operate and administer the capacity trading platform and the day-ahead auction in July2017.
The capacity trading platform, the standardisation related reforms and the secondary trading reporting framework in November 2017.
The day-ahead auction of contracted but un-nominated capacityin December 2017.
The GMRG’s recommendations on items (1) and (2) were endorsed by the Energy Council at the 14July 2017 and 24 November 2017 meetings, respectively.[2]At the 24 November 2017 meeting the Energy Council also agreed that the full package of reforms should be implemented by 1 March 2019 and that a review of the application of the reforms to the Northern Territory should be conducted ahead of this.
The remainder of this paper focuses on the design of the day-ahead auction (item (3)).
1.1AEMC’s recommendations on the day-ahead auction
The day-ahead auction of contracted but un-nominated capacity is a key element of the capacity trading reform package and is expected toimprove the efficiency with which short-term transportation capacity is allocated and used, by making contracted but un-nominated capacity available on a daily basis to shippers that value it most. The auction is expected to achieve this objective by:[3]
improving the incentives that firm capacity holders have to release any spare capacity they may have prior to the auction; and
limiting the ability of service providers to price short-term capacity products above the levels that would be expected in a workably competitive market.
It is also expected to overcome the co-ordination failures that can otherwise be associated with procuring day-ahead capacity.
Elaborating further on this element of the reform package in the East Coast Review, the AEMC noted that:[4]
shippers may not have a strong incentive to sell spare capacity because the cost and effort of doing so,and the risk of being short capacity if the sale occurs a long time before the nomination cut-off time,may exceed the revenue generated;
the service provider, as the only seller of day-ahead capacity after nomination cut-off time, has the ability and incentive to price contracted but un-nominated capacity above the levels that would be expected in a workably competitive market;[5] and
the market for contracted but un-nominated capacity is complex and subject to co-ordination failure, because multiple buyers need to transact with multiple sellersto reach the welfare-maximising allocation and the only way this can currently occur is through bilateral negotiations, which can be lengthy, complex and expensive.
The AEMC went on to add that high prices for contracted but un-nominated capacity, in conjunction with the limited incentive shippers have to trade capacity and the co-ordination failure described above, may result in inefficient outcomes and price prospective shippers out of the market.[6]
The way in which the AEMC expected the day-ahead auction to address these shortcomings is reflected in the following extract:[7]
“Firstly, in instances where shippers simply forego the opportunity to sell capacity because it is not core-business, a prospective shipper's alternative is to purchase contracted but un-nominated capacity from the pipeline owner. However, high prices for this capacity may be pricing prospective shippers out of the market. The auction would provide prospective shippers the opportunity to purchase competitively priced capacity. In the limited cases identified by the ACCC where an incumbent shipper is deliberately withholding capacity, the auction would also improve the shipper's incentive to sell the capacity prior to the nomination cut off, given that the auction will limit the incumbent shippers' ability to block access to a competitor.
The auction provides a pricing and allocation mechanism that is less costly for participants, and, depending on its design, the auction may provide a platform to simultaneously coordinate trades - allocating capacity in an efficient manner to the combination of shippers that value it highest as indicated through their bids.”
The AEMC considered the effect that the day-ahead auction could have on investment in pipelines and while it recognised the potential for the auction to give rise to a free-rider effect and some de-contracting, it did not consider this to be a material issue given the nature of the product being auctioned:[8]
“The Commission acknowledges that on some occasions, shippers would be able to access very-short term capacity at a potentially low price (i.e. at or just above the reserve price) on the occasions that they require it, without the long term commitment of a take-or-pay contract used to underwrite investment. This could, theoretically, create a free-rider effect, whereby shippers do not underwrite capacity because they are able to buy cheaper capacity underwritten by another shipper.
However, the Commission does not consider that this is likely to be a material issue in practice for day ahead auctions of contracted but un-nominated capacity. Very few, if any, shippers would be able to rely solely on day-ahead capacity to manage their gas needs, or the gas needs of their customers, over any medium to long term period. The majority of gas users are either relatively inflexible in their usage (for example, residential gas customers) or require a relatively consistent supply of gas to justify sunk investment in immovable assets (for example, a factory).
Relying on capacity purchased through the auction would entail both price and volume risk. While prices could be low at some times (at or just above the reserve price), at other times, when the demand for capacity is high, the auction would be expected to clear at a high price. When demand is high enough, all contracted capacity will be nominated – leaving no capacity available for sale at the auction.
Most shippers will therefore require long term contracts (used to underwrite capacity), with the ability to fine-tune capacity requirements on an ongoing basis. The recommended auction serves to improve the ability of all shippers to fine-tune their capacity requirements without affecting the requirement for long term contracts that underwrite new investment.”
The AEMC’s view on this issue is consistent with the view that the GMRG’s independent economic consultant, NERA Economic Consulting (NERA), reached. In short, NERA found that de-contracting and free rider possibilities are limited by:[9]
the imperfect substitutability of the auction product for firm primary and secondary capacity (e.g. because the auction product will be a standardised product that is subordinate to firm capacity holders’ renomination rights and will only be available on a day-ahead basis);and
the inability of shippers to fully de-contract en masse (i.e. because there would then be no contracted capacity to acquire through the auction).
NERA also noted that it would be wrong to automatically equate any de-contracting with dynamic inefficiency because in the absence of a liquid short-term market, shippers may have been unable to meet their short term needs for capacity without signing long-term contracts. NERA went on to add that rather than compromising dynamic efficiency, the auction could improve dynamic efficiency by discouraging inefficient over-contracting and systematic overbuilding of capacity.[10]
Table 1.1provides further detail on the AEMC’s recommendations, which were categorised as:
required outcomes – these recommendations were described as outcomes that must be progressed and are necessary to the implementation of the reforms;
preferred outcomes – these recommendations were described as outcomes that should be pursued unless it is clear there are greater benefits in other approaches; or
suggested outcomes – these recommendations were described as outcomes that have in-principle benefits but require further consideration.
Table 1.1: AEMC’s Recommendations: Day-ahead auction
Required Outcomes- Auction design:
–Auction happens shortly after nomination cut-off time.
–Reserve price of zero dollars, with compressor fuel provided by shippers in-kind.
–At least all contracted but un-nominated capacity placed for sale through auction.
- Product design: Accommodate nominations or renominations by incumbent shippers after the auction is conducted.
Preferred outcomes
- Geographic scope: Single auction across the east coast market, in order to optimise allocation across as many products as possible.
- Auction design:
–Single round auction to reduce complexity and opportunities for anti-competitive behaviour between participants.
–Bidders pay the value of their winning bids ("first-price" rule) to reduce complexity.
–Winning combination of bids to be determined using a profit maximisation algorithm (constrained by requirement that at least all contracted but un-nominated capacity is put on sale in auction).
- Product design: Capacity purchased in auction curtailed before firm capacity.
- Exemptions:Exemption from the auction for pipelines serving a single user.
Suggested outcomes
- Exemptions: Exempting on a case-by-case basis pipelines that are not fully contracted from needing to conduct the auction.
- Operator of the auction:The auction to be run by the same institution(s) which run the capacity trading platform.
- Other: As available rights in current gas transportation agreements (GTAs) to be phased out to avoid them competing with rights allocated in the auction.
Source: AEMC, Stage 2 Final Report: East Coast Review, 23 May 2016, p. 16.
1.2Consultation on the design of the day-ahead auction
The GMRG commenced work on the day-ahead auction in March 2017, with the assistance of the Day-Ahead Auction project team[11]and the GMRG’s independent economic consultant, NERA, and legal advisor, Johnson Winter & Slattery (JWS).
One of the first matters the GMRG considered was who should operate and administer the day-ahead auction. In the East Coast Review, the AEMC identified a number of organisations that could carry out this role but did not reach a concluded position. It instead recommended the GMRG consider the options in further detail. The GMRG’s recommendation on this issue was presented to the Energy Council in July 2017. In short, the GMRG recommended that AEMO be accorded responsibility for the operation of both the day-ahead auction and the capacity trading platform.[12] This recommendation was endorsed by the Energy Council at its 14 July 2017 meeting[13] and the design of the auction has proceeded on this basis.
Following this decision, the GMRG has worked closely with the Day-Ahead Auction project team, NERA and JWS on the end-to-end design of the day-ahead auction. This has required consideration to be given to the following design elements:
the product(s) to be sold through the auction;
the auction design;
the coverage of the auction (i.e. the pipelines and compression facilities that should be subject to the auction and the exemptions that should be available);
the design of the auction platform and the arrangements shippers will need to have in place to use the platform; and
the legal and governance framework that will underpin the auction.
To facilitate consultation with other stakeholders on these design elements, the GMRG published a consultation paper on 10 October 2017. The GMRG also published an independent report by NERA on the coverage of the day-ahead auction on 27 October.
The consultation paper set out a number of options for the form these design elements could take and the GMRG’s preliminary view on each option. Stakeholders were given four weeks to provide written feedback on the options presented in this consultation paper and were also invited to attend a public forum in Melbourne on 31October 2017. The consultation period for this paper ended on 6November 2017.
The stakeholders that participated in this consultation process included the Australian Competition and Consumer Commission (ACCC), AEMO, the AEMC and a number of organisations with interests across the gas supply chain, including, amongst others:
gas producers, such as APLNG, Esso, Shell, Santos, Central Petroleum (Central) and Senex, and the Australian Petroleum Production and Exploration Association (APPEA);