Federal energy minister Chris Bowen and state energy ministers at Lake Cethana pumped hydro facility. Supplied.
Time’s nearly up and fortune favours the bold. In writing this note about the state of Australia’s emissions and electricity policies, both at federal and state level, I made seven big learnings.
First: Work on the social cost of carbon has greatly increased its usefulness and the best estimate is around $US180/t CO2 and that is likely still an underestimate.
Second: The cost of producing fossil fuels exceeds their value when using a carbon cost of $US180/t
Third: Excluding land use, Australia’s emissions are flat over the past 20 years.
Fourth: The RET scheme is now a charity because certificates have value only thanks to people giving them away (so called voluntary surrender). More broadly, federal policy is like a backing band, competent but missing the main act and therefore unsuccessful.
Fifth: State schemes tend to pick winners (they pick them fairly and competitively but still they pick them), are slow, can crowd out the private sector (the ALP possibly likes that) and are prone to failure. For instance, Victoria’s VRET2 has run into issues.
Sixth: The best impact of the IRA, essentially a system of transferable/directly paid tax credits, in the US is that it has an implied carbon price of $US83, less than the European price, and will act to sharply reduce electricity prices. In my opinion this makes it well worth considering as an Australian federal policy centrepiece, despite Australia having a franking credit system.
Seventh: The job growth in Australia is in skilled work, education and healthcare, and to a lesser extent in mining and construction. In terms of decarbonising, the most important vacancies should be for behavioural psychologists and people skilled at negotiationg social licence. Those people are to be found in the regions and state and federal governments could expand regional education in this area and likely get a better job multiplier than focusing on city based manufacturing.
As a result of the federal policy vacuum for a decade, for which all major parties share responsibility, states stepped in with their own targets and policies.
But these policies, very well intentioned in every case, nevertheless require a heavy state hand. They are, slow, bureaucratic, end up with the state picking winners. They can crowd out the private sector and, so far, other than in the ACT, arguably haven’t achieved all that much.
In reviewing policy design and outcome, my summary is that over the past decade various Australian federal and state governments have tried a number of different policy approaches.
My main learning is that there is no good substitute for a federally funded target, one that lets the private sector work out how the target should be achieved.
In comparison to a carbon price, as in Europe, a tax scheme lowers electricity prices and everyone is a winner and so it’s achievable. The cost is to the budget. The resulting implied price of carbon is lower than the European price.
Looking forward, if I were Chris Bowen, and I’m glad I’m not, I’d be looking into two policies: (i) A transferable tax credit system to replace the LRET and which is extended to storage and possibly to some categories of local value adding; (ii) an employment subsidy for regional psychologists, social license negotiators, etc.
There are many subsidies already for farmers. This would essentially be developing regional skilled cohort operating out of towns in a growing service industry and helping to evolve regional Australia from its low and narrow employment base into the more skilled and prosperous place we need.
Still interested? Well read on.
I have compared the US IRA and the European carbon price as policies the ALP could take to the next federal election. For that matter, so could the coalition.
It won’t take more than a couple of heart beats for the ALP to reject a cap-and-trade scheme, despite the clear evidence it’s working in Europe and it’s pride of place in the economist theory tool kit.
By contrast, a transferable tax credit has a lot going for it. However, if applied in Australia, the impact on and the impact of franking credits would need to be considered.
On the positive side, firstly it’s all carrot an no stick and thus tends to get support from all sides of politics.
Secondly, it provides a certain easily valued benefit to investors. Once a project meets the deduction guidelines the benefit is locked in for the project life.
Thirdly, the transferability of the tax deduction means it ends up in the hand of those to whom its most valuable or alternatively the tax deduction is just paid as a grant to the recipient.
Fourthly, a defined window, like the next five-seven years, for a tax deduction provides an incentive to get projects up and running.
Fifthly, it can easily be extended to storage. Sixth, local content adders can be included as can local employment, or regional preference. Projects located in REZs, for instance, could get bigger deductions than other projects.
Seventh, it can be extended to the behind-the-meter segment.
This section is based around the Brookings Institute paper on IRA economic implications. A section of the abstract quoted below explains why I think the policy should be considered for Australia as a new centrepiece.
“Substantially higher investments in clean energy and electric vehicles imply that fiscal costs may be larger than projected. However, even at the high end, IRA provisions remain cost- effective. IRA has large impacts on power sector investments and electricity prices, lowering retail electricity rates and resulting in negative prices in some wholesale markets. We find small quantitative macroeconomic effects including a small decline in headline inflation, but macroeconomic conditions – particularly higher interest rates and materials costs – may have substantial negative effects on clean energy investment.”
The IRA is expected to reduce USA greenhouse gas emissions 32% to 42% below 2005 levels by 2030; 6-11 points more than they otherwise would have been. It does that and lowers electricity prices.
There are many points to consider about the IRA but one of them is that the scope of the program is so vast as to give it something of the impact of a carbon price.
At the worst the implied carbon price is about $US83/t still below the European carbon price, but the cost may also be a lot lower. It’s just to early to tell.
As Figure 1 below shows the credits are larger than what was available in 2016, even though costs for – say – solar are half what they were then and wind costs are also lower.
A break up of where the IRA climate provisions money is estimated to go, but noting it’s uncapped and will turn out different to estimate is:
Note that roughly 20% of the tax credits go to household and EVs, combined, although the EV category also includes all low carbon transport.
Also note that for all the talk about carbon capture, hydrogen and clean energy manufacturing, their share of the tax credits is expected to be fairly low. Again, these are just initial estimates. Bound to be wrong.
The value of the wind and solar credits is shown below:
“The IRA does two things to make the tax credits easier to use: It makes some of them direct pay and some of them transferable.
Direct pay essentially transforms the tax credit into a grant and means that entities such as nonprofits and state and local governments are eligible to receive them.
The production and investment tax credits begin to phase down either in 2032 or when power sector emissions reach 25% of their 2022 emissions, whichever is later
Now let’s look at recent work on the social cost of carbon.
Historically I have been sceptical about using the social cost of carbon. However, reading this prestigious and deeply researched journal publication leads me to think that the modelling has improved out of sight in the past decade.
One of the things I have always had difficulty with is the measuring how serious the impact of climate change will be. The article linked above is by far the best thing I have ever read on this topic, showing just how far things have come since the original Nordhaus/Stern invention of the social cost of carbon for which Nordhaus won a nobel prize. The main components of the updated cost are Agriculture and Mortality.
However the biggest driver of the change from the prior estimate of $US55/t is using a 2% discount rate. A fundamental problem with any discount rate in a climate change model is it is considered from the point of view of today, when the estimate is made. The value, or in this case cost, will become larger as the present value factor falls. 2% is low but not as low as 1%. Anyhow.
Now lets put the SCC to work.
Equating everything in dollars will cause scientists and environmentalists to turn off. But hey, I’m a financial analyst with a background in accounting and finance and that’s what I do.
As far as I know the figure that follows hasn’t ever been published before. It’s an accountant’s view of the global carbon balance sheet, comparing the value of production with the implied carbon cost. There is none of this scope 1,2,3 stuff; the carbon cost is the social cost using the global best estimate.
One can see that oil value exceeds the social cost, the gas value is about equal but coal is a value destroyer. Coincidentally or not, that’s to an extent how we think about these fuels.
It’s with this background that I think about Australian policy and our carbon emissions.
Based on European and USA indicators Australia’s annual carbon cost is about $65-$145 bn
Even the submarine bill isn’t this big but, like the submarines are supposed to do, this hidden cost sinks without trace.
The red line shows that excluding land use emissions have fallen just 1% since 2005.
Land use change is regarded by many as, at best, hard to measure, and more likely the reduction is overstated. In any event, land use is not really what policy has ever been about other than politically.
If I look at self interest as an explanation then it suits the federal government to have a successful ACCU program and to ignore or minimise problems.
Firstly, it improves the overall achievement optics and, secondly, it provides a relatively low cost way for those emitters with a liability under the Safeguards Scheme to offset their liability.
If ACCU registration was tightened and some ACCUS removed, prices would shoot up and there would be political blowback.
But that is not the point, the real point is that evidence shows that, so far, policy has done no more or less than to hold non land use emissions constant.
Now lets turn to review the policy tools at federal and state level. This section should be expanded but I already try my reader’s patience.
Since 2014, when the carbon tax was repealed, until 2023 when the Emissions Safeguard Scheme was given some baby teeth, the only federal policies with any real meaning were the LRET and SREC certificate schemes.
Since easily enough renewable energy is produced to satisfy the LRET obligation the scheme only has value because (1) the market believes they have some option value and (2) voluntary surrender of upto 20-25% of certificates produced.
So the LRET is not a policy anymore – it is now a community goodwill scheme. The federal government now effectively relies on the the community taxing and policing itself because it lacks either the willpower or the ability to implement a serious policy.
However, I tip my hat to the value of the community. It bolsters my faith in Australians being willing to do the right thing.
Federal policy now consists of:
(1) The Safeguards Scheme. It’s a fine scheme, I suppose, but by definition it only impacts large emitters.
(2) The about-to-be introduced capacity investment scheme. I will return to this scheme when discussing the emerging problems with reverse auctions. But essentially it will be slow, pick winners and will tend to crowd out other capacity.
(3) The government announced in April 2023 that it is introducing a fuel efficiency standard. The formal consultation around the standard ended some months ago and I suppose we now await the draft standard and the circus that will no doubt open around its adoption.
The Emissions safeguard scheme and fuel efficiency standards have the advantage that they apply in a blanket way across the sectors they impact. That is, once they are introduced the government’s role is limited to enforcing compliance.
Finally the government is helping to finance decarbonisation by allocating money to the CEFC, specifically money to assist transmission development.
There are also a range of smaller schemes to assist – for instance, business electrification.
Each of these schemes is worthy and useful, but they are like the backing band waiting for the star to appear. What is missing is a centrepiece policy.
It’s really only Victoria and NSW that have state “schemes,” per se. Queensland has an ambitious decarbonisation plan but its all being done by the Ggovernment.
Even so, the Queensland scheme has already aroused skepticism and, unlike the New South Wales scheme, was mandated by one party taking no account of the other side.
It was getting the ALP and, for that matter, the NSW nationals on side that demonstrated the true skills of Matt Kean. Implementation in NSW is, let’s be honest, off to a poor start. But the political foundations should stand the test of a change in government. That said….
Matt Kean announced the NSW Roadmap in November 2020. It will take until 2028 for the first transmission line to a REZ to be up and running.
The plan will drive 12GW or more of wind and solar investment, but in the almost three years since it was announced it has not resulted in 1 watt of new renewable energy.
So far, the consensus is that the social licence side of building REZs has been done badly and the REZ planning and construction process is well behind schedule, to the point where prospective developers in Orana still don’t know what their transmission and connection costs will be.
Finally the LTESA arrangement at best provides some insurance protection to debt providers but in no way will LTESA payments of themselves make a project bankable. Customers still have to be found for the output. The first LTESA contract was awarded
Victoria’s VRET 2 is a minor mess at the moment with maybe two of the projects awarded contracts for difference unlikely to proceed as things stand.
That’s because the process was relatively slow and the market moved quickly. So projects got locked into a price that wasn’t and isn’t high enough to justify the higher capital costs and higher cost of capital.
This illustrates that, from one point of view, reverse auctions can be seen as option by the bidder. Bid low, win a PPA and then if you can’t make it work, just walk away.
More fundamentally, the process has taken lots of time and effort by all parties but hasn’t resulted in much new generation.
It illustrates the general problems of a government picking winners; it’s slow, bureaucratic and can also crowd out other investment.
Beyond that, though, and speaking as someone that has supported Victoria’s efforts and I do still support the intent, but the outcomes are becoming a joke just now.
As things stand in Victoria, and I suspect South Australia, new solar projects face curtailment and unacceptably low MLFs. NSW prices are attractive but transmission constraints make them unachievable.
Fixing that is itself subject, within Victoria, of knife fighting with a noisy “no new interstates” group lead by Bruce Mountain against every one else in the industry.
Worse than that is the subsidies to LYA and by implication LYB as they share a common coal mine and Yallourn to keep operating.
Whether the subsidies, probably called capacity payments, are justified or not is a matter of debate. What there surely should not be a debate about is the fact that the amount and terms should be public knowledge. In the end, secret arrangements mostly end up causing trouble.
But on top of that, the biggest consumer in the state, Portland smelter, is also subsidised.
Putting yet another burden on consumers on current estimates Victoria’s offshore wind program will, in my opinion, likely easily result in the highest cost renewable electricity in Australia, even taking into account correlation with demand and better capacity factors. And because it will be the highest cost it will have to be significantly subsidised or energy intensive industry will move elsewhere.
Granted, my opinion about offshore wind is debatable. It’s a complicated question that needs to take account of onshore transmission and firming costs, the former of which seem to go ever upwards.
The 2024 ISP will be out in draft form in late November. It will likely provide an update, although it will also take Victorian government policy as an input assumption.
It seems to me the great attraction of offshore wind is that it doesn’t need any social license. You don’t have to deal with a bunch of land owners. The Victorian and federal governments can simply divvy it up and the environmental approval process seems to become relatively simple.
Broadly, a successful policy would result in less carbon emissions, provide employment in Australia one way or another, help Australia successfully replace fossil fuel exports and lower – or at least not raise – costs to consumers.
Other desirable characteristics are that the government’s role is limited to putting the policy mechanism in place, and not involving government in the policy execution.
Most important of all, a successful policy would be politically achievable. The clear way to achieve success is to provide carrots and not sticks. Any that can be used as a stick will be used as a stick.
A carbon price implemented via cap and trade is clearly the economist’s preferred way of achieving a carbon reduction goal.
Experience has shown that there are a couple of big downsides: (1) Generally speaking the cap is set too high or too low and, consequently, the wrong price evolves; (2) the policy, at least as implanted in Australia. collects tax revenue which then has to be redistributed or otherwise it’s a macro restriction on the economy, and; (3) it raises costs to consumers.
The LRET scheme which sets a renewable energy annual target has clearly been successful up to a point. In my opinion the problems with the LRET are that it does raise electricity prices.
The cost of the certificates is passed by retailers on to their customer base and presently adds about 4% to customer bills for low consumption customers. Taking the DMO allowance out, which is what gentailers compete against, raises every other cost as a proportion of the remaining total.
Of course, as the certificate scheme comes to an end those environmental costs fall but then there is no policy at all. If the scheme was expanded to say 60% of 2030 consumption must come from post scheme start new renewable production costs to consumers of the scheme would likely rise dramatically. Offsetting that wholesale costs would fall.
In some ways though, the bigger disadvantage of the RET seems to be that it depends partly on the retailers, and since the retailers are gentailers they have really only been mailing it in.
From the renewable investor point of view the scheme’s issues are that the price is uncertain and is just about as hard to forecast.
Australia’s broad employment by job category showing the share of total and the growth over the past 23 years is shown below:
You can see why many want to revive manufacturing, but you might as well try to bring back fishing in my opinion. Instead I would rather focus on the things we do have in our workforce. Lots of skills, lots of languages, lots of technical ability and to keep growing GDP in areas that take advantage of where the growth already is.
The real message in the above table is that there is plenty of jobs growth. The jobs are largely skilled jobs, last time I looked “Profeessional, scientific and technical services” was a relatively highly paid sector requiring skilled workers, same with “education and training”, same with “public admin and safety”.
Although mining’s share of the total is small and will likely remain so, supporting the mining industry has lead to heaps of regional employment.
Right now, where do we need jobs? Where is the opportunity? At least in energy the vacancies are essentially psychology. What’s needed, as John Pickering pointed out, is a large increase in the employment of people skilled at negotiating change.
Arguably, Transgrid, Powerlink and who ever is responsible for transmission in Victoria need to employee a large number of people, hopefully locals from within the regional community who can negotiate easements and the regional social license.
You might argue that RE_Alliance is the most essential and easily overlooked (including historically by me) organisation in the entire renewable energy supply chain.
Arguably there should be several similar organisations, well funded, but most importantly filled with well trained and experienced people. Perhaps these organisations already exist and I just don’t know about them.
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