Solar tariffs and the merit order effect: A response to AGL

A recently released paper by AGL’s chief economist, its head of economic policy and sustainability, and an AGL energy market analyst continues to distort the truth about Australian solar power by masquerading lobbying activity as a formal academic paper.

Many of this website’s readers will recognise such actions to be consistent with those of the vested interests of a utility whose business model is threatened by a popular disruptive technology.

Tim Nelson and Paul Simshauser’s lobbying activities have succeeded before, to the point where the authors infer their work is linked with the scuttling of solar industry tariffs in other states. It’s not that their latest paper, “Queensland solar feed-in tariffs and the merit-order effect: economic benefit, or regressive taxation and wealth transfers?” doesn’t make any good arguments,  it’s just that its supposed academic qualities are repeatedly undermined by opinionated language, a lack of impartiality, and generally poor rigour of calculations.

This is not the first time Nelson and Simshauser have created a faux-academic paper to influence the less well informed. Their earlier paper (with Simon Kelley), “Australian residential solar feed-in tariffs: industry stimulus or regressive form of taxation?”, was criticised by many solar academics for being unscientific, opinionated, and counterfactual.

In personal correspondence, the authors noted the many shortcomings I pointed out, but published their paper without satisfactorily addressing its failings. (Thankfully it didn’t make it into in any highly prestigious journals, and even its eventual publisher labelled it controversial, but this didn’t diminish its impact on less well-informed readers).

In making the argument that PV policy support represented a regressive form of indirect taxation, the authors claimed (on the basis of unsubstantiated, internally-created private evidence) that mostly wealthy families were installing PV, despite evidence to the contrary – evidence both direct and indirect. For example, the graph below shows the correlation between PV uptake and affluence, based upon ORER and ABS data, and is supported by direct evidence: income surveys of solar households that formed part of government rebate applications.

Source ORER, ABS as presented in Solar Progress

Nelson and Simshauser’s evaluation of feed-in tariffs are crafted on their own terms (and I quote): “Based upon an assessment against our public policy criteria, it seems clear to us…” The authors unilaterally decide to measure justification for feed-in tariffs by the extent that solar power reduces network expenditure.

This ignores the multiplicity of government-communicated reasons for feed-in tariffs (most of which relate to building a solar industry and providing householders with a simple way of reducing their electricity bills). Instead, the authors decide that people working during the day and returning home to use electricity at night is sufficient reason to abandon feed-in tariffs as a policy measure. It’s easy to win an argument when you invent the rules as you go along.

Nelson and Simshauser declare all premium feed-in tariffs to be bad because they lead to industry growth (the objective of such policies) followed by industry contraction – i.e. boom and bust. However, industry contraction occurs not because of the inherent nature of feed-in tariffs, but due to political response to poorly designed policies that cause cost blowouts.

In lobbying for removal of feed-in tariffs, they wish to simply throw out the baby with the bathwater, rather than consider how to raise a child. To make matters worse, their latest paper has to resort to incorrect assumptions, inaccurate calculations, dubious methodology, and misleading tables in order to make a case that the poor are $10/year worse-off due to feed-in tariffs.

In fact, it can be shown that because it is predominantly lower-income households that have bought PV systems, the welfare of this demographic group has been improved by $40-$80/year per household on average, and those who remain are shielded from the $10 average cost of the policy by Queensland’s $230/year pensioner electricity discount. In summary, supporting PV installations helps lower income families to reduce bills, funded by the better off families that don’t mind paying a few dollars a year more.

AGL’s chief economist lends his weight to the existence of the merit order effect. However, it is argued that the reduction in electricity prices is temporary, as long-term prices reflect average costs of production rather than instantaneous costs (which are zero for solar power). The authors state as incontrovertible fact (cheekily referencing themselves as the source of this ‘fact’) that renewable resources are “unambiguously more expensive than thermal plant,” which they reason should thus increase average prices in the long term, using wind farms as an example.

The fallacy of this argument (even before health and environmental externalities are considered) is that grid parity has been reached: at the point of consumption, distributed PV is now cheaper than thermal plant. This means a PV-specific merit order effect will occur in tandem with sustained substitution of centralised generation by point of consumption PV. Even if it was only a hypothetical example in their minds, at least Nelson and Simshauser concur “If a merit order effect occurred due to natural market disruption events, such as the entry of a new renewable or low emission technology with lower marginal running costs and lower total costs than incumbent generators, it would produce an unambiguous improvement in welfare.” Until you can set up a 10kW coal-fired generator in your backyard, PV has lower total cost at the point of consumption.

This is not to say that Nelson and Simshauser don’t make some good, if somewhat moot points. The Queensland feed-in tariff should avoid a boom-bust scenario that has hurt NSW. PV doesn’t cost-effectively reduce distribution network peak demand (though PV combined with energy storage can easily be a more valuable solution than network upgrades). It’s just a shame that their arguments are tarnished by misleading language, assumptions, calculations, and appearance.

Though posing as an academic paper, their calculations lack scientific rigour. And their language is clearly not that of an impartial academic: “excessively generous”, “too successful”, “surely make for sobering reading”, “It has been surprisingly well documented in academic literature”, “unambiguously more expensive”, “an oversupply of higher cost renewable capacity was purposefully engineered”, “would represent courageous assumptions at best”.

One could conclude from reading this paper that employees of a utility whose business model is threatened by a popular disruptive technology are seeking only to minimise the damage through a poorly disguised lobbying exercise. The paper notes that the real wealth transfer resulting from the merit order effect occurs from producers (generators) to consumers. The threat to, and of, a major utility is barely hidden, claiming premium feed-in tariffs “raise tangential doubts about the entire sustainability of the [electricity] industry.”

Perhaps the work of Nelson and Simshauser can best be summed up in their own misleading language: “has a certain superficial appeal, despite the obviously erroneous nature”.

(Please note that the author has nothing personally against the authors of the papers mentioned, but instead is acting to defend the solar industry from misleading lobbying efforts).

Comments

17 responses to “Solar tariffs and the merit order effect: A response to AGL”

  1. Tim Buckley Avatar
    Tim Buckley

    Warwick
    Well put. For AGL publish such an article dressed up as an academic paper is ridiculous, it is nothing but a shameless piece of lobbying from a blatantly self-serving vested interest group.
    Maybe AGL should consider asking themselves the question – would AGL working with their customers to help them save money in the end produce a better business for AGL? It might for starters lower their customer churn rate.
    Cheers
    Tim

  2. Herb Powell Avatar
    Herb Powell

    Timothy Nelson is a brilliant man with lots of well thought-out, practical, ideas. He is insuring the financial security of this national for years to come.

  3. Ken McAlpine Avatar
    Ken McAlpine

    A couple of things come to mind.

    Firstly, what is a “solar academic”?

    Also, why should a feed-in tariff be provided only for small generating units like PV panels? What’s the policy objective here? If the goal is to increase the take-up of renewables and change Australia’s energy mix, surely a feed-in tariff should apply to all renewables or none at all.

    If the policy objective is some kind of social welfare there are far better ways of delivering this without using solar panels to do so.

    The authors of the AGL papers are right to focus on the question of public policy benefits rather than private benefits. Others like Warwick are free to point out other public policy issues that go the other way. But surely we can have a debate on these things without the ad hominem attacks.

    1. warwick Avatar

      Thanks Ken,

      I respect your comments. IMO, a ‘solar academic’ is someone with some university education in solar energy – at least with the ability to make an ‘average’ performance estimate.

      As mentioned at the end, I do not wish to personally criticise the paper’s authors, but the way to reference a paper is typically by its authors names (Please note that the author has nothing personally against the authors of the papers mentioned, but instead is acting to defend the solar industry from misleading lobbying efforts).

      The stated policy objectives for most FiTs has never been to improve welfare.

  4. Chris Fraser Avatar
    Chris Fraser

    They could just invest more in RE and save themselves the effort of needing to justify silly stuff in the first place.

  5. Warwick Avatar
    Warwick

    I’ve read the AGL paper. I think it makes two main points 1) FiT’s are regressive benefitting some at a cost to all 2) The MOE Is transitory and does not make electricity bills cheaper because the underlying energy costs increase.

    I note that some of the ad hominem attacks criticize the AGL authors as vested interests or criticise AGL as lobbying as part of some self interest group. Anyone could rightly make the argument that the author of this “AGL response” is a vested interest lobbying for very generous solar tariffs or anyone else that proposes that FiTs are a good idea and work in the solar industry. Neither of these arguments are constructive.

    With regard to AGL’s argument that FiTs are regressive is backed up by referenced links in their paper that are comprehensive. To dismiss their studies is not particularly clever as they use data taken from network businesses, regulators and others that have useful relevant data. It’s not clear what the author is showing by their chart and raises more questions than it answers as it seems to be cherry picking statistics. The most obvious questions are where are the references and dates to the underlying data? Why are only “couple families” chosen? Why not singles or share houses? What is a negative PV penetration? Does that mean people are ripping them off their roof in the high income bracket?

    What is often ignored that income is not necessarily a sign of wealth. This is particularly evident with retirees who are asset rich but income poor. Home ownership and in particular a house with a roof is a pre-requisite to join the PV club, something most struggling single mothers, the unemployed and students can rarely afford. It is not unlike the inequity of novated car leases that previously encouraged excessive driving that were only available to those privileged enough to have a “white collar” job that allowed salary packaging and a reduction in their tax liability despite the fact that the vehicle was 100% private use. It is therefore difficult to see that a subsidy that is only paid to those who own a house (an asset often worth more than 500K) should be paid for by the whole community unless there is some positive benefit.

    So recently there have been a number of determinations in Victoria, NSW and elsewhere about the value of rooftop PV. Most of these have recognised solar PV has a significant premium over flat 24-7 energy i.e. despite some variability the fact that it generates more on sunny days correlates with some of the higher priced periods and is usually worth around 8c/kWh as against wholesale prices around 4c/kWh (This even included submissions on behalf of the PV industry to IPART). Many in the PV industry also argued that there were network benefits i.e. If solar exports reliably correlated with distribution then the community could benefit but studies by network operators such as Ausgrid have basically said that the absolute best case scenario in one feeder was less than 1c/kWh and that was highly variable. I suggest readers read the submissions to IPART by the network businesses and form their own opinion.

    With regard to the latest trend is the so called “Merit Order Effect” which basically argues that lower spot prices for electricity will result if a lot of low (or zero) short run marginal cost generation enters the electricity market. This is generally true, in that much of the time spot prices will be lower as was the case when earlier this century in Queensland when plenty of supercritical coal plant was introduced at Milmerran and Callide C and it is a phenomenon that is not unique to renewables but also fossil fueled power stations and demand side abatement. However, many then take the leap of faith that possible lower spot prices equate immediately to lower electricity bills. This logic is flawed as electricity markets are more complex than that. There are some key issues that are not considered:
    1) Many of the power stations bid at zero currently because they let other power stations set the price and do not want to be potentially told to switch off. This means analysing historic bids against a hypothetical increase in solar PV will dramatically overstate the reduction in pool prices.
    2) Most existing gas power stations are under “take or pay” contracts where they contract a given amount of gas for price certainty but this also means that gas then becomes a “sunk cost” i.e. As you have already paid for the gas, the decision to run your power station depends only upon the start up cost and the hourly running cost. This means gas plant can bid close to zero. If the scenario of 5GW of PV suddenly eventuated the power station would be somewhat reluctant to contract all that gas each year and would more likely buy spot gas. This will alter their bids as they would need to ensure that the decision to run covers both operating costs and the gas purchases.
    3) SRAC (short-run average costs) will change. When a peaking generator starts it incurs a significant “start cost” which is a maintenance cost that is incurred as each peaking unit will need maintenance after a given number of starts or hours. This start cost will often run into thousands of dollars and needs to be considered when running a power station. If the expected run-time is reduced under the MOE scenario as is often suggested then those peaking power stations will only run at a higher price than they would have previously as they have less time to recover their start up costs.

    So those 3 issues listed will suppress the MOE somewhat as the pricing will be more volatile even if the average spot price is lower.

    Finally, to assume that low spot prices equals low customer prices is flawed as it does not consider contracts and the costs of hedging customers. If it were so, then why didn’t Tasmanian consumers have the cheapest electricity bills in 2006/07 when they had the lowest spot prices around about the same time that the gas fired CCGT at Bell Bay was being commissioned (I.e bidding inflexible which is effectively the same as bidding at the market floor price, just like non-dispatched generation).

    So rather than simply criticising an individual or company based upon their natural position or “vested interests” isn’t it best to ask their experience in the topic they talk about? Maybe it’s just me but I go to a dentist for advice on my teeth, and I think I’ll put greatest weight on network issues by information from the network operators, advice on solar technology by solar businesses but when it comes to wholesale energy markets and retailing I’ll closely examine the arguments put forward by the market operator, the regulators and energy market participants first.

    All up, It seems solar is a good renewable energy technology which is scalable and is starting to benefit from falling costs. That said despite it’s intermittentcy, it benefits from generating at many of the peak demand times therefore commanding a 100% premium to base energy.
    What is uncertain is as it already receives subsidies for being renewable what exactly the purpose of a FiT would seek to achieve as the author states that grid parity has been reached. If PV is already cheaper, why do you need an extra subsidy?

    1. Warwick Johnston Avatar

      Thanks for your lengthy comments, Warwick. You’ve obviously thought long and hard about your response, though your examples could equally be considered ‘cherry picking’, though I don’t have time to perform further research into your claims. But I do thank you for your contribution to the discussion.

      For the record, the graph shows the correlation of solar uptake (measured as a percentage of dwellings with PV systems on a postcode basis) with proportion of the postcodes’ occupants that fall into each income bracket, broken down by family type. It demonstrates that high solar uptake is correlated with lower incomes, rather than AGL’s assertion to the contrary (no data for which has ever been provided).

  6. GF Avatar
    GF

    i am stunned that such a nasty personal piece made it past the editor of this site. The author and this site should be ashamed of themselves. Regardless of whether you agree with the authors, the facts are that the paper is a peer reviewed journal article. Furthermore at least two of the authors hold academic positions. It is a sad day for this industry that people are now attacking academic work.

    I know one of the authors very well and it is well known that he played a leading role in the industry’s advocacy for the significantly expanded renewable policy in 2006. Furthermore these same authors published a piece in Economic Papers which has been quoted by half of Canberra in the context of needing to reduce uncertainty and introduce emissions trading.

    I for one will be no longer looking at this site.

    1. warwick Avatar

      Hi GF,

      as mentioned below, I have respect for the broader works of the authors, and (as pointed out at the bottom of the article) I do not wish to personally attack them (but rather just refer to their paper by its authors names, as is common practice).

      To my current understanding, the latest article has not yet been accepted into a peer-reviewed journal.

  7. Mindy Avatar
    Mindy

    Why do people automatically think that individuals who work within an organisation who publish content are conspiring to do evil? Assuming OP is an employee within any organisation, think about you, your position and if you had the opportunity to publish academic papers… Should we all assume you have sinister motives? From what I have read of AGL’s published papers, they’re factual and unbiased and present a very interesting economic view. All in all, they do nothing but promote positive change for the industry.

    1. Warwick Johnston Avatar

      Mindy,

      that was what I first thought too… the papers are impressive, until you look deeper and question their assertions. You can see that they’re certainly not factual, nor unbiased by reading the evidence at http://sunwiz.com.au/index.php/articles-in-the-press/200-agl-queensland-solar-feed-in-tariff-merit-order-effect-paper-littered-with-errors.html

  8. Ken McAlpine Avatar
    Ken McAlpine

    I would also add that Tim and Paul were a big help and were both in Canberra regularly during 2010 as the renewable energy industry pushed hard for the essential reforms to the RET legislation, and played a key role in getting this done with multi-party support (Liberal, National, Labor, Greens). Most of us wouldn’t have a job in the sector today without those reforms.

    1. Warwick Johnston Avatar

      Ken,

      I agree that the phantom RECs created by the solar multipler were a terrible mess and that something needed to be done in order to support all renewables. However, while the eRET may have led to (eventual) better conditions for wind farms, the SRES has been a further example of a poor policy.

  9. Giles Parkinson Avatar
    Giles Parkinson

    Thanks for these comments. There is no doubt that Tim and Paul have made important contributions to the renewable energy debate and industry in this country. That does not mean that their latest paper should somehow be beyond criticism, as some (here and in private emails) would like to suggest. Their paper provoked a strong reaction from many in the solar industry, not so much for its content as their views are well known, but the forum and its manner of its presentation. This article reflects that.

    1. warwick Avatar

      Thanks and agreed, Giles.

      I have respect for the broader works of the authors, and (as pointed out at the bottom of the article) I do not wish to personally attack them (but rather just refer to their paper by its authors names, as is common practice). I have previously tried to privately and directly engage in a conversation on their earlier findings, which only received a promise to respond without actual response prior to publishing. In such light, a public comment in defence of the solar industry (which is under new attack) is warranted.

      My intention was to point out the shortcomings of the paper, to ensure that the solar industry doesn’t receive short-thrift from an unconsidered acceptance of all the paper claims as fact. But I welcome debate and response, and also think the Queensland government should rationally investigate making an appropriate and considered adjustment to its feed-in tariff settings, just not on the basis of the paper’s rationale.

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