Carbon taxes, emissions trading and electricity prices: making sense of the scare campaigns

Dylan McConnell, University of Melbourne

Yet again, electricity prices are set to be a key point of contention in an Australian federal election.

The Coalition responded quickly to Labor’s election commitment to an emissions trading scheme (ETS), with Prime Minister Malcolm Turnbull warning of “much higher electricity prices” and a “very big burden” on Australians.

Other ministers joined in. Treasurer Scott Morrison labelled the plan a “a big thumping electricity tax” and Environment Minister Greg Hunt branded it “Julia Gillard’s carbon tax on steroids”, warning of “even higher electricity prices for Australian families”.

The centrepiece of the Coalition’s climate policy, meanwhile, is the A$2.5 billion Emissions Reduction Fund. An important element of this scheme is the “safeguard mechanism”, which is due to kick in on July 1 this year. This has implications for the electricity sector and may also affect electricity prices.

National summary of retail electricity cost components
2015 Residential Electricity Price Trends

These policies will affect the wholesale electricity market, in which electricity is bought from power generators and sold on to retailers and consumers.

As you can see from the figure to the right, the competitive component of the retail prices makes up about 50% of the typical household electricity bill, and the wholesale component typically makes up half of that. The other major cost is poles and wires.

So how exactly will the different climate policies affect electricity prices?

The safeguard mechanism (Coalition)

The safeguard mechanism will require Australia’s largest emitters to keep emissions below a baseline. This will prevent emissions reductions under the ERF being offset by increases elsewhere. Businesses that go over the baseline will have to pay.

The safeguard is based on the high point in annual emissions from the whole electricity sector between 2009-10 and 2013-14. Generators’ individual baselines and associated penalties only come into play if the whole sector goes over the baseline.

As you can see in the figure below, emissions have fallen by almost 20 million tonnes per year since the first baseline year (2009-10), partially in response to years of declining demand.

Electricity Sector Emissions
Quarterly Update of Australia’s National Greenhouse Gas Inventory: December 2015

Current projections for electricity growth suggest that the baseline won’t be breached for some years. As such, individual generators are unlikely to be penalised, and wholesale prices would not be expected to change dramatically.

Electricity sector emissions trading (Labor)

Labor’s electricity sector ETS is a “baseline and credit” scheme, based on a model proposed by the Australian Energy Market Commission (AEMC), which actually submitted the proposal to consultation on the safeguard mechanism.

This also places a baseline on the electricity sector, but it is calculated on the basis of emissions intensity (tonnes of emissions per unit of electricity generated) rather than overall emissions. Generators with emissions intensity below the baseline (for example, gas generators) would earn credit, so “cleaner” power plants would generate more credits.

Power plants that go over the baseline (for example, brown coal) would have to buy credits for the amount they go over. “Dirtier” plants would thus have to buy more credits.

This is substantially different to a carbon tax or the previous emissions trading scheme. Under these policies, all generators are penalised, some more than others, as you can see in the figure below.

Impact of carbon price and baseline and credit scheme on different generation technology in the electricity sector. A carbon prices increases all prices, relative to emissions intensity. A baseline and credit scheme increases the price of high-emissions-intensity generation, but lowers the price of low-emissions-intensity generation.

This difference is important for electricity prices. Dirtier plants would be expected to increase their selling price to cover the financial penalty on their emissions. But cleaner plants, earning revenue from selling credits, could afford to sell their electricity more cheaply.

This is important, because cleaner plants (typically black coal or gas) set the price. Gas in particular would probably be significantly cheaper under this proposal. As such, the impact on wholesale prices would be small, or negative.

In fact, as the AEMC itself noted, the impact on the wholesale market could be an increase or decrease in prices (depending on where the baseline is set).

The brown coal exit (Labor)

Another component of Labor’s climate platform is a plan to finance the closure of brown coal power stations, an idea first proposed by ANU climate economists Frank Jotzo and Salim Mazouz.

In this proposal, brown coal plants would bid for the payment they would require to finance their own shutdown, with the cheapest bid being selected. The remaining plants would pay this cost, in line with their emissions.

Similar to the ETS, it would be expected that this cost would be reflected in increased offer prices to the market from the remaining generators. The direct costs would be temporary (a one-off payment) and small, relative to the overall wholesale price.

Indeed, Jotzo and Mazouz estimated it could cause a one-off rise of 1-2% in retail power bills. Analysis company Reputex found the impact could be between 0.2% and 1.3%.

However, Danny Price of Frontier Economics has suggested that the scheme could push up retail power prices by between 8% and 25%, as the result of a short-term price shock. But given the significant excess capacity in the market, and assuming that the market is indeed competitive, it is hard to see how such a increase would happen.

This point aside, the price argument misses the point of the scheme, which aims to deliver an “orderly transition” away from brown coal. The longer-term effects on supply and price of a brown coal exit will be similar, regardless of how the industry closes.

In fact, if it were left entirely to the market, the sudden retirement of an entire power plant might create even more of shock. This proposal is chiefly about ensuring an orderly, predictable transition.

50% renewable energy target (Labor)

The final element of Labor’s climate platform is a 50% renewable energy target by 2030. At this stage, not much detail has been unveiled other than shadow environment minister Mark Butler’s pledge that it will be “designed in a way that does not disturb investor sentiment around the delivery of the existing Renewable Energy Target” – something that a sector beset by uncertainty would welcome. As such, it is quite difficult to speculate on how electricity prices might react.

The current Renewable Energy Target is a certificate scheme that requires retailers to buy a certain amount of renewable energy. The cost of these certificates is passed on through electricity bills. However, as shown by the government’s own modelling, the interaction with the wholesale market results in a net saving to consumers.

Interestingly, and as the AEMC points out, the electricity ETS is designed to be flexible and integrate with a renewable energy target. Indeed, such an ETS could drive investment in renewable energy, replacing current subsidies through the Renewable Energy Target. The 50% target could theoretically be achieved through the ETS alone, if the baseline was set at the right level.

A bipartisan approach?

As it stands, the government’s climate platform is unlikely to have any impact on electricity prices. However, it will also not have a major impact on the electricity sector’s emissions.

Labor’s policies will have an impact, but as the AEMC notes it may occur “without a significant effect on absolute price levels faced by consumers”.

The government’s current polices will require strengthening to further reduce emissions. To achieve this, the Grattan Institute and others including the Business Council of Australia have supported ideas that would turn the Liberal platform into something very similar to Labor’s.

Indeed, modelling commissioned by the government itself assumes that Direct Action will eventually morph into a similar baseline-and-credit ETS, in order to meet long-term climate commitments.

Political slogans aside, perhaps a bipartisan approach is possible, without a significant effect on power bills.

The Conversation

Dylan McConnell, Research Fellow, Melbourne Energy Institute, University of Melbourne

This article was originally published on The Conversation. Read the original article.

South Australia is now coal-free, and batteries could fill the energy gap

Roger Dargaville, University of Melbourne

South Australia’s last coal-fired power station closed on Monday this week, leaving the state with only gas and wind power generators.

The Northern Power Station, in Port Augusta on the northern end of the Spencer Gulf, has joined Playford B – the state’s other coal-fired power station which has already been retired.

The coal mine at Leigh Creek that supplied brown coal to the power stations also closed earlier this year, so there is no easy option for re-opening the power stations.

The immediate impact of the closure was a brief wobble in wholesale electricity prices, with more energy brought in from Victoria’s brown coal power stations (adding to carbon emissions).

But how could it affect the state in the long term?

Could South Australia run out of power?

Average electricity demand in South Australia is 1.4 gigawatts, and the state record for peak demand of 3.4 gigawatts was set in January 2011. In the past two years the highest demand was 2.9 gigawatts.

Rollout of rooftop solar panels is one of the reasons demand from the grid has been going down. The impact on the peak demand – the time of day when most people are using appliances – is less clear, because if the peak occurs after sunset, solar panels will not reduce it.

With the closure of the 520 megawatt Northern Power Station, South Australia is left with 2,800 MW of capacity in its gas-fired generators, which can be fired up when needed, and 1,500 MW of wind farms, which of course produce energy only when the wind blows. Most gas generation capacity comes from the Torrens Island A (480 MW) and B (800 MW) installations, built in the 1960s and 1970s, respectively.

There have been discussions about retiring Torrens Island A (it was mothballed for a period in 2014), but the departure of Northern appears to have delayed those plans.

The state also has a total of about 600 MW of rooftop solar, but, as noted above, this technically counts as reducing demand rather than adding to supply.

South Australia is also connected to Victoria via two transmission lines, one at Heywood (recently upgraded to 650 MW) and one at Murray Link (220 MW). This gives the state access to a potential 870 MW of Victorian power.

If South Australia gets close to record demand, the state clearly outstrips the capacity of the local gas generators. If the wind isn’t blowing, then the state will depend on the interconnectors.

But there is an unfortunate factor that transmission lines tend to fail under very high temperatures, which correspond to the times of highest demand.

It may sound unlikely, but South Australia is at risk of failing to meet demand. This would depend on a very specific set of circumstances:

  • record demand (despite the increase in rooftop solar reducing demand)

  • no wind

  • failed interconnectors (or failure of local generators).

A role for storage

This situation means the state is the most likely location for investment in storage. The Australian Renewable Energy Agency (ARENA) recently published a report on storage that identified several locations in South Australia that would be logical places to install commercial-scale batteries.

We at the Melbourne Energy Institute have previously written about pumped hydro storage options, in particular the novel approach of using salt water. This may be of particular use in a very dry state such as South Australia.

But batteries are only going to be attractive investments if there is sufficient volatility in the market to provide arbitrage opportunities. Arbitrage, put simply, is the process of buying low and selling high.

Storage systems need be able to be charged with low-cost energy (for instance, overnight when demand is low, or when the wind is blowing hard) and dispatch the power back onto the grid at a sufficient profit to cover the investment costs.

We are currently in a low-demand period of the year (the shoulder seasons have both low heating and cooling requirements). This means there has not been much shift in electricity prices coming out of South Australia with the removal of Northern. It might not be until next summer, with hot temperatures and increased demand from air conditioners, that we are able to see the true magnitude of the impact of this exit on electricity prices and market volatility.

To date (only a couple of days since the closure), the wind has been blowing hard and there has been no need to increase substantially the generation from other fossil generators. Likewise, there have been no discernible shifts in the spot market prices.

Finally, the impact on carbon emissions will also be interesting. This will depend on how the remaining generators respond. The gap left by Northern may be filled with South Australian gas, in which case total emissions will fall, but more likely the gap will be filled with Victorian coal power via the interconnectors, resulting in no reduction in net emissions.

We will know the net result in due course – watch this space.

The Conversation

Roger Dargaville, Deputy Director, Energy Research Institute, University of Melbourne

This article was originally published on The Conversation. Read the original article.