The Nelson Review in action: ESEM draft legislation released

Overview

On 11 September 2026, the Energy and Climate Change Ministerial Council (ECMC), excluding Queensland, agreed to release for public consultation a draft regulatory package implementing the core recommendations of the independent review of the NEM wholesale market settings (the Nelson Review). The package comprises amendments to the National Electricity Law, detailed in a Bill (Bill) and amendments to the National Electricity Rules, along with an accompanying consultation paper.

If ECMC agrees to the final package in December 2026, the Bill will be introduced into the South Australian Parliament in the first half of 2027.

The ESEM

The centrepiece of the package is the ESEM, a scheme to facilitate long-term investment in generation and storage by competitively procuring electricity services — firming, bulk energy and shaping — through derivative contracts.

The ESEM is intended to replace the patchwork of existing state-based investment support mechanisms with a nationally consistent framework. Participation will be voluntary at the jurisdictional level, with each NEM jurisdiction electing whether to opt in.

An ESEM Administrator (ESEMA) will set a 15-year anticipated entry trajectory (which will determine the quantity of services to be procured through the ESEM) for each NEM region based on jurisdictional nominations, conduct bi-annual procurement rounds, and recommend contracts to a Financial Management Entity (FME).

Determining the extent of the ESEM

Jurisdictions will nominate the following, which will inform the ESEM trajectory:

• electricity sector targets to reduce or contribute to reducing Australia’s greenhouse gas emissions;
• reliability targets (which may be in addition to the NEM reliability standard, which will be the back-stop if no reliability targets are nominated); and
• scheduled generator exit assumptions.

These inputs, together with modelling from AEMO, will then guide the ESEMA in determining an “entry trajectory” (being the quantity of services to be provided through the ESEM mechanism).

Determining the contracts to be used as part of the ESEM

The ESEM contracts will be determined by the contract co-design committee and are intended to effectively underwrite new generation in the NEM.

A separate consultation has commenced with respect to the initial contracts that will form part of the ESEM. At this stage they are contemplated to be:

• (Bulk energy) a swap determined by reference to the scaled dispatched volume of a regional fleet of technologically similar assets (to remove inter-regional weather risk) that will provide renewable sellers with long-term price certainty, which may increase the bankability of a project as a whole.
  
  It is proposed that the PPA will be capped at/not settled above $600/MWh and floored (either through a knock-out mechanism where volume is zeroed or a price floor mechanism) at $0/MWh.

• (Shaping) a dynamic time of day block spread swap that is intended to provide buyers with a hedge against intra-day volatility.
  
  The swap will be between an agreed arbitrage spread (being the difference between daily low-price charge period and high-price discharge periods) and a realised spread in exchange for a premium (paid to the Seller), with charge/discharge periods being nominated (at this stage) a day ahead (by 16:00) by the ESEMA; and

• (Firming) a $600/MWh flat cap, being an insurance product that provides a buyer with coverage where spot prices are greater than $600/MWh in exchange for a premium that will provide the Seller with long-term stable cash-flows and an ability to retain some merchant revenue under the cap.
  
  The bulk energy contracts will be available to new renewable projects (eg wind, solar etc), the shaping products will be available to dispatchable assets (eg batteries) and the firming products will only be available to assets that can provide continuous dispatchable power for 8 hours or more (eg hydro or gas).

Other services facilitated by the ESEM

The draft legislation also facilitates:

• optional procurement of “long-term out of market capacity or demand response arrangements to cover high-impact, low-likelihood events or temporary arrangements in advance of generator exits”;
• special purpose procurements to support technologies that face barriers beyond the tenor-gap; and
• the procurement of essential system services (either on a standalone basis or together with ESEM services).

These services may alter the ESEM trajectory and therefore the extent of any ESEM contracting and are envisaged to utilise the same:

• eligibility criteria as normal ESEM contracts (see below at paragraph 3.5); and
• suite of contracts determined by the contract co-design committee, with limited tweaks to specific matters such as contract tenor and in-market periods (the latter of which may be reduced in its entirety).

The FME

The FME, an investment-grade entity, will be the enduring counterparty to all ESEM contracts and will recycle ESEM positions back to market to promote forward contract liquidity and manage financial risk.

FME costs will be recovered from customers on a non-profit basis through the NEM settlement system, with costs allocated to the jurisdiction where they arise.

Costs will be estimated and set for the year ahead, with any under- or over-recovery adjusted in subsequent years, enabling retailers to reflect allocations onto consumer bills and regulated default offers.

A cost relief mechanism will award input credits to Market Customers who independently contract for ESEM-equivalent services, preserving incentives for voluntary long-term PPAs.

ESEM Auction eligibility requirements

The draft legislation recommends that there be standard criteria that apply to all ESEM auctions and jurisdictional criteria, that will apply to specific jurisdictions to achieve broader social and economic policy goals of a jurisdiction.

The standard criteria requires:

• (project) that a proponent have an interest in the proposed project that is being bid into the ESEM process;
• (criteria) that the project satisfy ESEM project criteria being, broadly, that the project is new, owned by the proponent and not subject to other underwriting arrangements (with the limited exception of refurbished assets that may have received underwriting prior to the assets’ end of life).
• (competition) the proponent must not breach relevant competition thresholds set by the AER in accordance with the NEL.
• (guideline criteria) that the proponent satisfy any other criteria set out in the ESEM guidelines (to be published).

ESEM Bonding

Allowances have been made in the legislation for the FME to require bonding from successful proponents to disincentivise failure to meet certain thresholds.

The Consultation Paper and draft legislation suggest that this mechanism will be used by the FME to cover the period between contract award and the date that:

• unconditional notice-to-proceed is issued by the proponent; and
• other enforceable project milestones and performance of qualification criteria obligations are met.

ESEM in-market period

The ESEM is designed to bridge the gap between new generators' need for long-term revenue certainty and electricity buyers' preference for short-term contracts. It does this by ensuring that the operational components of the ESEM contract term only commence after a designated “in-market” period.

The legislation contemplates an in-market period of at least 3 years (which may be amended by the NER), being the period that the project must be in-market for before ESEM coverage is provided.

Details on how this will be determined from time to time will be set out in the ESEM (General) Guidelines from time to time.

ESEM Contract recycling

As part of the ESEM design, the FME may “recycle” the ESEM contracts it enters into once market demand manifests (i.e. closer to the commencement date of the ESEM contract).

The legislation facilitates contract recycling through both exchange traded markets and through over-the-counter transactions, although it is contemplated that the FME will likely utilise over-the-counter transactions to support the recycling mechanism.

The MMO

The MMO framework is designed to improve price transparency and liquidity in the trading of electricity derivatives.

It will require certain large generators supplying ESEM services to post minimum volumes of bids and offers for standardised derivative contracts within specified bid-offer spreads on transparent, AER-approved trading platforms (i.e. similar to platforms like the ASX futures markets). When triggered, the MMO will apply in the next full quarter, and continue to apply for a forward period of 11 quarters.

The MMO will:

• initially apply to cap contracts for firming services in South Australia by a specified date, replacing the existing FERM Market Liquidity Obligation;
• not initially apply to Tasmania or Queensland (although an ability to opt-in to the scheme has been included); and
• apply to other jurisdictions when the AER determines that liquidity levels when measured against pre-determined criteria are breached, noting that consultation with the relevant Minister of a region to which an MMO will occur prior to the MMO being applied.

Notwithstanding this, Ministers retain a right to opt out for a particular service in their region.

Key Gaps and Issues for Consultation

Several elements of the package are explicitly flagged as unresolved or require further development:

• Governance arrangements remain open. The appointment model for the ESEMA and FME, and whether they will be the same or separate entities, is subject to governance considerations sitting outside the NEL and NER.
• Cost relief is at an early stage. The cost relief provisions in the draft NER are described as an "early draft" intended to illustrate the mechanism and invite feedback, with the detailed ESEM (Cost Relief) Guidelines yet to be developed.
• Price responsive resources rules are still pending. The Bill establishes rule-making powers for a mandatory visibility and dispatch framework, but substantive NER provisions will depend on AEMO's Market Visibility Framework recommendations, expected in December 2026.
• Data centre framework interactions are unresolved. The Commonwealth announced on 15 July 2026 that it will introduce a nationally consistent regulatory framework setting minimum requirements for large data centres' energy, water and land-use. The consultation paper notes that the Commonwealth "will consider interactions with the ESEM" but provides no detail on how this will be achieved. Given the significant and growing electricity demand from data centres, particularly hyperscale facilities, the absence of a clear framework for how data centre energy requirements will intersect with ESEM procurement, cost recovery and eligibility raises material questions. For example, it remains unclear whether data centre operators could qualify for cost relief as Market Customers contracting for ESEM-equivalent services, how data centre load growth will be reflected in the anticipated entry trajectory, and whether mandatory energy efficiency or renewable sourcing obligations under the data centre framework could overlap or conflict with ESEM service categories. Stakeholders in the data centre and energy sectors should monitor this space closely and consider raising these issues in their consultation submissions.

What This Means for Market Participants

The regulatory package represents a pathway to increased liquidity in contract markets, and an alternative underwriting mechanism for new generation in the NEM.

Market participants should pay close attention to the consultation, particularly:

• (project proponent takeaway) the ESEM eligibility and competition threshold criteria;
• (retailer/large customer takeaway) the cost allocation principles that will determine how ESEM costs are shared across jurisdictions and to customers;
• (generator takeaway) the proposed MMO thresholds and liquidity obligations; and
• (data centre developers’ takeaway) the interaction between the proposed data centre regulatory framework and the ESEM.

The first ESEM procurement round is indicatively scheduled for late 2027, with the first contract recycling anticipated around July 2030.

Submissions are due by 13 October 2026 via the DCCEEW Have Your Say webpage in respect of the legislative package, and are due by 2 October 2026 in respect of the ESEM contracts contemplated by the contract co-design committee via the ASL consultation webpage.