The Nelson Review: Addressing the uncomfortable truths facing Australia's energy and net zero transition

Failure of spot prices to incentivise investment. Interaction between CER and wholesale generation. Risk allocation across businesses and governments. Achieving net zero targets in desired timeframes. The growing state government role in energy policy. There is clearly no shortage of issues emphasising the need for the National Electricity Market wholesale market settings review (the Nelson Review).

With submissions recently closed, Nous Group’s Energy and Decarbonisation team, supported by our Energy Advisory Council and some of Australia’s leading energy thinkers, stood back and reflected on the context of the Nelson review and what it may deliver. Five themes loomed large.

The Nelson Review is a timely and welcome review of the energy system, designed to help future-proof the National Energy Market (NEM) and to recognise the exponential pace of technological change that is impacting on the future shape and dynamic of the energy system.

The Nelson Review will build on the hard gains to date. Its ideas need to be bold and aspirational if they are to contribute building an energy system that is adaptable, agile in adopting new and emerging technologies, and able to deliver an economic dividend to energy consumers, all while delivering on net-zero emissions targets. 

The complexity of the energy system also means we need solutions that are: simple, practical, and easy to implement; reflective of the breadth of challenges we face; and appreciative that this breadth requires an equally broad range of (consistent) responses. (For economists, this is Tinbergen’s principle: each policy target needs its own policy instrument.)

We also need – and this bears emphasis – a determination to implement the Nelson Review’s recommendations.

The challenges facing the NEM are well understood, yet the best path forward remains highly contested. The shift to renewables is inevitable, but how will their high capital costs and low marginal costs reshape electricity economics? How can consumer-generated electricity be integrated without destabilising the grid? Spot pricing works in real time, but how can the energy system also incorporate long-term price signals to ensure the required investment in generation?

With the pace of change only set to accelerate, we do ourselves a disservice if we take, and then attempt to implement, strident views on what change is required. The Nelson Review, in its recommendations for future policy settings, must prioritise flexibility, adaptability, and reversibility. We cannot afford to lock in rigid policies that fail to account for the degree of change to come. The energy transition is an ongoing experiment, one that demands dynamic policy settings rather than static solutions.

At the intersection of so many policy areas, there are no shortage of purist positions attempting to dominate influence future policy settings. Simply stated, these include: 

• The economic view that market-based solutions will provide sufficient incentive to deliver the investment required.
• The engineering focus on optimal design and construction solutions with insufficient focus on cost and time.
• The environmental view that the transition to net zero can be achieved in an unrealistically short timeframe or that biodiversity and conservation objectives can remain sacrosanct without impeding progress.

Such purity is the enemy of progress in achieving energy transition objectives. The level of complexity, and the scale and pace of change required, means pragmatism must rule. It also means recognising that prioritisation across competing objectives is essential, grounded in an appreciation that the net zero challenge is the overriding challenge of our time.

Discussion of energy consumers often defaults to consideration of households. Residential consumers are important, though they account for only around 12 per cent of total final energy consumption. Further, the demands of the residential consumers on the overall energy system continues to decrease, largely due to installation of rooftop solar PV systems.

Industry is the dominant energy consumer, with the transport sector alone accounting for 41 per cent of total final energy consumption, followed by manufacturing at 20 per cent. While total industrial demand is expected to increase, this is even more pertinent given demands for electrification driven by the need to decarbonise and declining electivity costs, spurred in large part by increased renewable energy generation.

Ensuring households retain confidence in the energy transition is critical to the success of the transition. The future energy system needs to meet their needs, and ensure the transition is fair and equitable across the diversity of households. It must do so in a way that also allows the system to support the massive energy transformation in the industrial sectors of the economy.

Australia energy transition – indeed, the world’s – is driven by an overriding societal objective: the decarbonisation of energy generation as a fundamental element of decarbonising the overall economy and society. Achieving this social objective is all the harder as private capital, subject to the hard constraint of shareholder returns, will not take on the risks commensurate with the requirements of the transition. Such risks, and the requirement for their resolution, include:

• Investment risk – ensuring there is a sufficient return so critical infrastructure is built even if initial utilisation is low
• Cost risk – sharing financial burdens for cost overruns outside of companies' control
• Timing risk – addressing delays in project delivery and grid connections
• Environmental and planning approvals risk – facilitating robust regulatory assessment consistent with the timing imperative of the transition

The global dimension of the energy transition makes this challenge even starker, as capital has endless choices as to where it can invest globally.

Governments, like business, face risks in navigating the energy transition. There is, however, a crucial difference: for governments, risk is a function of prioritisation, i.e. which public policy goals are given primacy. The Nelson Review needs to be explicit on the role of government in addressing the above risks. It also needs to be transparent that there will be additional costs that government will need to incur. There also needs to be a clear appreciation that the replacement of ageing, coal-fired generation assets will create additional costs, regardless of the net zero imperative.

Australia's energy transition is at a critical juncture. The Nelson Review has the potential to reshape market settings and investment signals to accelerate progress toward a clean, secure, and affordable energy future. To achieve this, it will have to be able to answer a number of questions in the affirmative. Can the Review deliver practical, implementable solutions? Prioritise flexibility and adaptability? Ensure that risk is distributed appropriately between the public and private sectors?.

Just as importantly, the Nelson Review is likely to ask a critical question of energy system stakeholders as well: are we prepared to embrace a path forward grounded in the compromise and prioritisation necessary to achieve progress in an increasingly complex energy system?

If the answers to all these questions is yes, the Nelson Review might prove to be a signature moment in Australia’s energy transition.

Get in touch to discuss how energy and transition issues impact your organisation.

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Prepared with input from Simon Pickering.