Garnaut fails to understand the real issues when it comes to electricity

Professor Ross Garnaut’s latest report is deeply concerning to the energy sector on two counts in particular. Firstly, his continuing refusal to recognise the need for assistance for generators to transition to a low emission future and secondly, his curious forays into network regulation in the National Electricity Market.

The Energy Supply Association of Australia rejects Professor Garnaut’s position of refusing assistance to electricity generators to transition to a low emission future as it risks achieving a smooth transition to a low emission electricity sector.

Australia’s economy and society depends on energy and the community rightfully demands a first‑class supply of energy from the industry. To meet these high expectations, businesses in Australia’s energy industry invest in, operate and maintain a world‑class energy supply chain. Australia’s energy users today enjoy a supply of energy that is exceptionally safe, secure, reliable and efficient, with prices that are low by world standards. The energy industry is proud to underpin Australia’s economy and way of life.

Australia has benefited immensely from its energy industry over the last century, but because of its historical development and Australia’s low‑cost, readily accessible coal reserves, Australia’s energy supply today is relatively emissions intensive. As the energy sector is Australia’s largest source of emissions, energy supply must transform to a lower carbon intensity if Australia is to achieve domestically deep emissions reductions in the long term.

The task of transforming Australia’s energy supply should not be underestimated. Even abatement targets belittled by some commentators as insufficient will be difficult to achieve. The commercial, financial and technological challenges for the sector to reorient five decades of investments based on fossil fuel to low emissions alternatives are significant.

To assist the businesses that will power Australia into the future to respond to the new expectations of the community, it is essential that the right policy settings are in place to make a smooth transition. The energy supply industry strongly supports an efficient, equitable and enduring emissions trading scheme enabling a smooth transition to a low emission economy and delivering reliable electricity. In contrast, failure to achieve the right settings will increase the risk of a disorderly transition and undermine energy security.

Against the significant challenges for the energy sector to adjust to climate change policy, Garnaut’s final report is simply a continuation of wanting to treat the symptoms instead of the causes.

The policy of providing loan guarantees for assets in distress caused by the clumsy application of a carbon price is just not sensible.

This does not assure energy security because companies in this situation will have no ability to trade their way out of financial disaster despite the guarantee, leaving the Australian tax payers exposed to a massive loss. It must be recognised that the proposal of loan guarantees to highly emissive generators is very different to the situation of guarantees to banks during the Global Financial Crisis. While banks were expected to recover once market conditions stabilised, the intention to keep increasing the carbon price will intensify financial pressure on generators.

A recent Investment Reference Group Report commissioned by the Government indicated that the allocation of capital to Australia’s generation sector on the best possible terms depends fundamentally on the government treating existing capital with care while resolving carbon policy uncertainty.

The transition to a low emission energy sector comes at great cost and it is in the national interest to minimise this by encouraging – not dissuading – capital from our shores.

In this sense, allowing equity in businesses to be destroyed without compensation as proposed by Garnaut is self‑defeating. The electricity industry is one of the most capital intensive in the world and the massive re-build and re-investment required in Australia to modernise infrastructure and reduce carbon emissions presents the sector with an unprecedented capital raising challenge. According to a recent speech by the Minister for Resources and Energy, between $72 billion and $82 billion could be required for investment in new electricity generation and transmission by 2030. If further investment in distribution networks, gas pipelines and associated infrastructure is added to this, the overall investment task for the energy sector could exceed $220 billion.

Investment of this magnitude will not happen by itself; it will require the energy industry to have the confidence to commit to very large investments that can generate returns over the lifetime of the assets (which may run to several decades).

Australia will need to attract overseas debt and equity as well as domestic investment if it is to find the capital to meet this investment task; the sector is internationally exposed in this regard. Given the ubiquitous regulatory risk of investing under carbon policy, Australia consequently must take steps to ensure it presents as an attractive destination if it is to raise this capital in the volumes required and at the lowest possible cost. In direct contrast to this imperative, destroying equity investments through a disorderly transition will send a profound and damaging signal to the international investor community about Australia’s sovereign risk and raise the risks of doing business in its energy sector. This will have consequences in higher equity risk premiums, which will add to the cost of energy supplied to the community.

The transition to carbon pricing will be most successfully made by ensuring any carbon pricing scheme recognises up-front the disproportionate losses – for debt and equity – and recompenses them.

However, it is important to recognise that the industry’s calls for appropriate transitional arrangements are not tantamount to allowing a business as usual approach, rent seeking, or ‘payments to polluters’. The affected generators will still face the carbon cost and will have to make sound business judgements about whether to continue operating (and face the ever-increasing carbon cost) or close down. But given the multi‑billion dollar extent of impairment to assets from carbon pricing, sound transitional arrangements will ensure that the companies are able to close plants in a controlled fashion and importantly be able to reinvest in the new low emission technologies that will be required.

For this reason, the Association rejects any implication that the industry is trying to short change the community or that consumers and industry are adversaries in the changeover to carbon pricing. The generation assets under threat were built at a time when there was no cost on greenhouse gas emissions and no clear prospect of when or how such a cost might be introduced. The direct beneficiaries of these investments were households, businesses and large industrial producers who paid considerably less for their energy use than if either a carbon price had been in place or less‑emissive technologies had been chosen instead.

Additionally, Australia has never introduced such massive structural change without supporting the affected industries to adjust to their new environments. The Australian automotive industry is a prime example. By 2021, it will have received more than $12 billion to transform its operations as tariff protection rates are reduced.

But by using Garnaut’s approach, the electricity industry which drives Australia’s economy would be provided with no assistance whatsoever to fundamentally alter its emission performance, dramatically increase its chances of stranding billions of dollars of assets in the process and as a result, threaten the reliable supply of electricity.

This approach is not sensible. It is poor policy and is more likely to hinder rather than help Australia achieve a low emission outcome.

The Energy Supply Association of Australia is also disappointed and dismayed with the way the network and related regulatory policy issues in the National Electricity Market have been treated in the most recent Garnaut Report.

It is unfortunate electricity prices had been rising strongly over the past few years, but the causes of these cost increases and the options for keeping any future increases to a minimum is a much more complex area than the report appreciates.

Among other things, the report contends government-owned network companies have an incentive to over-spend compared to privately owned companies; that peak load growth is avoidable; and that inter-state electricity connections should be bolstered.

It is unfortunate that the report has again strayed in to a technically complex area that is well beyond its remit and expertise.

Professor Garnaut has repeated overly simplistic claims made by a group of industrial electricity consumers that used selective analysis and came to dubious conclusions.

Closer examination of these claims reveals:

• Network companies, regardless of ownership, must obtain the approval of the independent umpire – the Australian Energy Regulator (part of the ACCC) – to capital works programs and their operating expenditure budgets according to a set of uniform rules made by the independent Australian Energy Markets Commission;

• Individual States determine on behalf of their communities the level of reliability that networks must achieve. This affects what has to be built and how the networks are to be operated and is not a matter that the companies can ignore;

• Peak load is growing as more Australians install air conditioners and energy hungry appliances. The electricity supply system is required to meet these peaks. Undoubtedly this leads to capital under-utilisation and this is a matter of concern to the whole industry. It is not, however, the fault of the network companies; and

• Reinforcing the interconnectivity of the electricity system has long been seen by many as a way to increase competition and lower energy prices. But successive economically literate policy makers and regulators, including the ACCC, have found that sound economic tests for such augmentation are rarely met. Indeed, had such investments proceeded, consumers would have paid for the upgrades which in all cases would have outweighed any reduction in energy costs.

These are all complex matters and the Governments recognise this and have established expert, independent bodies under the policy guidance of the responsible Commonwealth, State and Territory Ministers.

The established expertise, transparent consulting arrangements and independent decision making processes of the market bodies – AEMC and AER – are well calibrated to address perceived weaknesses and problems in energy markets.

The challenges facing Australia’s energy sector to transform to a lower emissions footing are immense and should not be underestimated. Despite the magnitude of the task, the energy industry can start the transformation to a lower-emissions intensity if the policy settings are sensible and the impairment of assets is appropriately addressed. Given how deeply embedded the energy industry is into modern Australia, every Australian household and business has a stake in getting it right.