What is five-minute settlement, and why does it matter?

The National Electricity Market is making a major change to how it operates on October 1. Here’s what you need to know about this fundamental change, and how it’s expected to impact the grid. 

What’s happening? 

The National Electricity Market (NEM) operates as a spot market, where power supply and demand are matched instantaneously by the Australian Energy Market Operator (AEMO). 

Generators are required to make offers to supply electricity to the market. AEMO puts the generators’ offers in order from least to most expensive, where practicable, starting with the cheapest offer and working their way up to more expensive offers – until demand is satisfied. The highest price AEMO accepts becomes the dispatch price.

But even though this process happens at five-minute intervals, the spot price – the price generators are actually paid for their electricity – is settled at 30-minute intervals. So, at the moment, the spot price of a 30-minute trading interval is the average of six dispatch prices. 

From 1 October onwards, however, the Australian Energy Market Commission (AEMC) has ruled that the electricity spot price will be settled at five-minute intervals, rather than 30-minute intervals, bringing settlement in line with dispatch. 

Why is this happening? 

The difference between the five-minute dispatch period and the 30-minute settlement period has been in place since 1998, when the NEM was first established. The difference was adapted because the limited metering and data processing technologies that were available at the time were thought to make five-minute settlement too difficult. 

In other words, today’s NEM is still being operated based on the technical limitations of 1998, when Tamagotchis ruled the classroom, Seinfeld was still on the air and there were only three Star Wars movies. This is important, because there are fast-response generators in the market today – like batteries –  that were an afterthought in 1998, when the NEM was established to coordinate a less dynamic mix of generation. 

As a result, fast-start generators and large energy users that manage their consumption in real-time are being required to take their cues from price signals that might be 25 minutes out of step with the physical reality of the market. 

This came to a head in 2016 when Sun Metals – a zinc refinery in Queensland – made the case to AEMC that they had been adversely affected by the mismatch between the shorter dispatch period and the longer settlement period. (Under the National Electricity Rules, any individual, group or organisation can submit a request for a rule change to AEMC.) 

Sun Metals had been actively reducing its energy consumption in real-time in response to high dispatch prices, but found that the benefits of doing so were reduced by the 30-minute settlement period. They proposed cutting the settlement period down to five minutes, on the basis that it would eliminate unnecessary inefficiencies in the operation of the market. 

After three formal rounds of consultation, 100 stakeholder meetings, and the establishment of a working group consisting of generators, retailers, large and small consumer groups, new technology companies, financial institutions and market institutions, AEMC ruled in favour of reducing the settlement period for the spot price from 30 minutes to five minutes, but did not provide a cost benefit analysis for how it would impact the market. 

The ruling was made in November 2017. Because all existing IT systems, metering infrastructure and energy contracts had been designed with 30-minute settlement in mind, it was decided the rule wouldn’t take effect until 1 July 2021 – more than three years later – in order to minimise disruption, provide time for upgrades to IT systems and metering, and allow existing long-term contracts to be rolled off and replaced with contracts that accommodated the implementation of five-minute settlement. 

Last July, with the fallout of COVID-19 slowing down the adjustments that energy companies needed to make to comply with the changes, the rule change was delayed to 1 October 2021. 

What will it mean? 

Moving to five-minute settlement will provide price signals that incentivise generators and large energy users to respond to changes in supply and demand in the shortest practicable timeframe – if they are capable of doing so.  

For market participants – i.e. generators, retailers, meter providers and other service providers – the rule change has necessitated significant changes to their systems and processes. While the cost to the market has not been calculated, it’s estimated to be anywhere between $500 million and $2.5 billion.

For consumers, AEMC says the rule change is expected to lead to smaller power bills, although they have not provided data to demonstrate this. The assertion is that improved price signals will lead to more efficient decisions by generators, which will eventually lead to lower wholesale costs (the price that energy retailers pay for the electricity they sell to customers). Wholesale costs make up about one third of a typical electricity bill.  

According to AEMC’s latest Residential Electricity Price Trends report, households can expect to pay about $120 (or 9 per cent) less for electricity in 2023 than they did in 2020, with three key price drivers – wholesale costs, network costs and environmental costs – expected to fall. In South East Queensland, specifically, prices are estimated to fall by $190 (14 per cent). It is unclear, however, how much of this decrease – if any – is attributable to the five-minute settlement rule change.

The more accurate pricing signals that come with five-minute settlement are expected to reward customers who can react quickly. Homes with smart batteries, for instance, can earn a high spot price by feeding power back into the NEM when the system needs it, while businesses that invest in smart IT will be able to switch off machines and reduce energy consumption to avoid those same prices. 

Similarly, five-minute settlement is also expected to encourage investment in flexible, fast-response generators, such as battery storage and gas peaker plants, by maximising the value they can get from dispatching energy at times of high demand. It’s important to note, however, that many of the gas peaker plants that are currently connected to the NEM can’t start within five minutes, so this key feature of five-minute settlement will not be in place when the rule comes into effect on 1 October.

These fast-start generators are important, because by plugging the gaps that emerge when the sun isn’t shining and the wind isn’t blowing, they’ll help to support the security and reliability of the grid as more solar and wind generation comes online. 

Ultimately, then, AEMC expects the rule change to lower wholesale electricity costs, reward generators and customers who can respond swiftly to demand peaks, and facilitate a more reliable energy system. Whether or not it has these effects remains to be seen – but either way, it’s clear that the energy market is evolving.

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