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Power price confusion as carbon policy is fiddled

By Geoff Carmody - posted Monday, 3 September 2012


The Prime Minister has accused the states of increasing electricity prices to milk household budgets to fatten their own budget bottom lines. A Federal-state shouting match has ensued. Meanwhile, two months after it began, the Government has also changed its carbon pricing policy. Confusion reigns.

Let's have a genuinely independent review, with broad terms of reference, of the current rules determining investment in the electricity network's 'poles and wires'. A similar review of the bidding rules under which power generators supply the wholesale market would be useful too.

The Productivity Commission should be involved, including though its current Electricity Network Regulation Review.

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Efficient power supply, avoiding 'gold plating' or price gouging, should be the review objective. ('Gold plating' investments exceed those necessary for cost-effective power supply over the demand cycle, including peak demand periods, for given reliability standards.)

The Prime Minister's concern about conflicts of interest between efficient power supply and boosting state budgets can be eliminated without a review. All power generation, transmission, distribution and retail assets still in government hands should be privatized. Where privatization has already occurred, power supply is more cost-effective.

Remaining retail price caps, and any restrictions on time-of-day power pricing, should also be removed ASAP. These restrict market competition and transmission of price signals to power users.

Then governments can concentrate on their proper role: facilitating cost-effective power markets, not using power as a milch cow for their budgets.

This new confrontation, initiated by the Prime Minister, and the Government's latest carbon pricing policy backflip, raise more questions about how Australian greenhouse gas emissions will be reduced.

First, some Economics 101. Increased prices reduce power demand (and thus emissions). Price reductions increase them.

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Why prices increase: increased investment in 'poles and wires', increased generation input costs (eg, higher gas prices or regulated renewable energy targets), or the Government/Greens carbon tax, etc., don't affect this conclusion.

Higher-priced power, however caused, is a signal to use less. This is the carbon tax rationale.

The Prime Minister has objected to state price increases 'justified' by the need for increased investment in 'poles and wires', claiming such increases hurt households because they are uncompensated.

Whatever their magnitude, higher prices 'justified' by the need for network investment cannot finance that investment and household compensation as well. Revenue can only be spent once.

The Prime Minister supports price increases attributed to the carbon tax because most households are compensated. Even if they don't reduce their electricity demand, most households won't be worse off. Overcompensation for lower income households means they will be better off, for a while.

The Prime Minister wants lower electricity prices, or smaller future increases, where these are attributable to investment in 'poles and wires', and net increases in post-carbon tax income for many households, allowing them to increase their power (and emissions) consumption. Won't emissions increase?

For power supply, the reasons for price increases can influence emissions reduction outcomes.

Price increases due to Australia's carbon tax can shift power generation input mixes towards lower-emission sources, by making current higher-emission inputs (eg., coal) less price competitive. But the carbon price must be high enough to make such a switch commercially attractive.

Australia's current and projected carbon price is unlikely to induce any significant shift towards lower emission power generation for the foreseeable future – especially after the Government's policy backflip.

Price increases financing investment in upgrading and expanding network 'poles and wires' do not reduce emissions. They can facilitate increased emissions, because of larger power transmission losses (and associated emissions), and to the extent there is increased effective customer demand for power (and emissions) supported by such investments.

Measures eliminating any network 'gold plating' that exists have no obvious emissions reduction effects.

Regulating reductions in power prices might reduce emissions, albeit inefficiently. If lower prices deterred genuinely needed network investments, current power reliability standards could be breached, leading to more power 'brownouts' and 'blackouts'. This conclusion is closely related to policy decisions on reliability standards as well.

Political benefits obtained by forcing reduced power prices might quickly be outweighed by the backlash from less reliable power supply and the economic costs associated with that.

Reduced demand for power and associated emissions at present is the only realistic hope for affecting Australian emissions (ignoring the fact such effects are globally insignificant). But the Prime Minister seems determined to remove price signals inducing such reductions pre-2015, and now, quite possibly, after that as well.

On the supply side, discouraging genuinely needed network investments could reduce emissions by degrading network reliability and forcing reduced power supply through 'brownouts' and 'blackouts'. This could be inefficient and politically unsustainable.

Now the Government has added to the confusion by dropping the post-1 July 2015 carbon price floor of A$15, and seeking to 'link' emissions trading in Australia to the European emissions trading scheme. This 'link' still comes with access restrictions, both for Australian buyers of overseas permits, and overseas buyers of Australian permits, so it is partial, at best, for the foreseeable future. New limits also apply to purchases of cheap (and dodgy?) UN Clean Development Mechanism (CDM) permits.

This policy backflip highlights two crucial elements of so-called emissions trading schemes (ETS), and adds emphasis to the reality that they are, indeed, schemes, with all the implied rorting and abuse that label implies (and EU experience illustrates).

Taking these elements in reverse order, this policy backflip underscores the practical reality that the 'trading' part of ETS must lead to carbon price convergence within the trading market – unless governments try to prevent this by regulation. Such regulatory attempts only increase the incentives to rort the (government-created) system anyway.

Even partial attempts to 'link' an Australian ETS with the EU ETS creates the wrong trading market for Australia. Australia's main trade competitors don't have ETS systems, and siding with the EU ensures adverse effects on Australia's international competitiveness. Sure, aligning with a carbon price that may well be lower than under the previous version of Australia's carbon policy might be an improvement, but it still makes no sense in Australia's national interest – or indeed, from the perspective of trying to secure a genuinely global deal.

The second element is the most important – that is, if you believe that the purpose of ETS is to reduce greenhouse gas emissions. This is the process whereby governments impose 'caps' on the number of emissions permits issued. This is the mechanism that will drive permit prices up by making them scarce, thereby providing a signal to reduce emissions. (In contrast, the 'trading' part of such schemes just shuffles the given number of permits around. In total this number – and the emissions it allows – is unaffected by trading.)

Forecasts of increasing permit prices require governments in the relevant ETS markets to authorize increasingly scarce numbers of permits relative to those demanded under a 'business as usual' scenario.

The EU experience has been that, to date, this requirement has not been met. It seems highly unlikely that such discipline in issuing new permits will be met in the foreseeable future, given the diabolical economic mess in which the Eurozone (and Europe more generally) now finds itself. For Europe, any emissions reductions are likely to occur despite low permit prices, and because of recession. Ditto the global economy.

If, as is claimed, the 'linking' of Australia's ETS with the European ETS means that European decisions on permit issue will 'call the shots' for prices paid by Australian permit buyers, this suggests a lower Australian price trajectory than that underpinning Government forecasts. If so, less permit revenue is a Budget concern, and less incentive to reduce emissions is a climate policy concern.

I wouldn't bet my house, or even one dollar, that EU (or Australian) governments will restrict emissions permits sufficiently to produce a permit price of A$29, let alone one that would significantly change the economics of energy supply inputs, this side of 2020 (or beyond).

In this even more confused power pricing environment, Australia's carbon price is even more inefficient and ineffective. We should start again.

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About the Author

Geoff Carmody is Director, Geoff Carmody & Associates, a former co-founder of Access Economics, and before that was a senior officer in the Commonwealth Treasury. He favours a national consumption-based climate policy, preferably using a carbon tax to put a price on carbon. He has prepared papers entitled Effective climate change policy: the seven Cs. Paper #1: Some design principles for evaluating greenhouse gas abatement policies. Paper #2: Implementing design principles for effective climate change policy. Paper #3: ETS or carbon tax?

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