We are now well into Act Three of the tragic comedy of errors that is Australia’s carbon and energy play. What a depressing and tedious play it has turned out to be.
In Act One, an Emissions Trading Scheme took centre stage. An Emission Intensity Scheme scheme had a walk-on part in Act One, but the leading actor in Act One, Senator Wong, called it a mongrel and it was booed off the stage by all and sundry (except Senator Xenophon and later Leader of the Opposition, Malcolm Turnbull).
Of Act Two – “scrap the carbon tax” – the less said the better. Now in Act Three, ten years later, the Emission Intensity Scheme has taken centre stage and the Emissions Trading Scheme is the naughty boy in the corner. In fact the big end of town and their representatives, some environmental organisations, influential agencies, the Federal Labor Party and even some customer groups are falling over themselves to declare their love of an EIS.
But what is this EIS? Well, in essence, it’s a rob-Peter-to-pay-Paul scheme. The Peters in the scheme are the coal-fired generators, particularly the emission-intensive brown coal generators. The Pauls in the scheme are those generators whose emission intensity is less than a “baseline” that the Government will define. The way that the money is taken from the Peters and distributed amongst the Pauls is critical.
One way to raise is to take from the Peters in proportion to their emission intensity relative to the baseline. This means brown coal generators pay the most. The money so raised can be distributed amongst the Pauls in the same way so that almost all the money goes to existing and new renewable generators that emit nothing.
In this way, a meaningful penalty on the Peters will raise a great deal of money and will provide a huge push for renewables development. This will lead to an unsustainable boom and windfall gains for existing and new renewable electricity producers.
This is poor economics and even the most ardent environmentalist would not want a scheme that delivers such large excesses as to undermine the public support for the pursuit of renewable energy.
Another way to distribute money would be to discriminate amongst the Paul’s, not on the basis of their emission intensity but based on their technology type. So for example, the rule could be that the money raised from the Peters goes to the group of Pauls that produce electricity from gas-fired generators.
A worked example illustrates this. Without an emission penalty, brown coal generators will today produce electricity if they are paid more than, say, $15/MWh. At current gas prices, combined cycle gas generators (the most efficient such generators) need prices to be above $65/MWh before they produce.
So to make coal and gas comparably competitive, split the difference ($50) by charging the brown coal generators $25/MWh and give this to the gas-generators. Now the coal and gas generators will both require electricity prices to be $40/MWh or more before they will produce (i.e. $15+$25 =$40/MWh for the coal, and $65-$25 = $40/MWh for the gas). So now the gas and coal are neck-and-neck and if you take another $5/MWh from coal and give it to gas, gas will now be ahead and in this way lower emission gas generation will substitute the coal generation.
Lets look at this arrangement in terms of emission abatement costs. Substituting the most emission-intensive brown coal plant for a modern combined-cycle gas plant will reduce emissions by around 0.8 tonnes CO2-e per MWh. At a penalty price of $30 per MWh, this means $37.5 per tonne CO2-e abated ($30 divided by 0.8).
But if we distribute the $30/MWh penalty not on the basis of a preferred technology (gas generation) but to the generators that reduce emissions the most (i.e. renewables) we get a 1.4 tonne abatement for the $30, i.e. an abatement cost of $21 per tonne. So, as a consequence of the technology discrimination (gas rather than renewables as the beneficiary of the money gathered from the coal generators) we effectively almost double the cost of abatement.
This is wasteful and means prices to consumers higher than they should be. The modelling of an EIS undertaken for the Australian Energy Markets Commission, as the modellers have configured it, shows that their EIS will substitute gas for coal, instead of renewables for coal – precisely the wasteful outcome we should be trying to avoid.
You can see where an EIS ends up: its a recipe for rent seeking by lower emission generators to get their snouts more deeply into the trough of funds raised from the coal generators. And the coal generators will no doubt demand compensation and lobby the Government to shift the burden onto someone else. Technology neutral? Not in the slightest. Market-based? Not by a country mile.
There is a sparse academic literature on Emission Intensity Schemes. It quickly withered under critical scrutiny. It is no surprise then that we can no find no example of such an approach to emission reduction in the electricity sector being adopted in any other country, ever. Telling, no?
To those that seek safety in numbers and have set their sails to the prevailing wind, dig out the tapes of Act One of this comedy of errors and spend some time on them. It would be surprising if you conclude that Senator Wong called it wrong.
If you work for one those representative organisations, authorities, political or customer groups that now think an EIS is great, I challenge you to explain why you think so now when, ten years ago, you apparently thought the opposite. Conversely it would be valuable to understand why our Prime Minister thinks an EIS is so bad now, after having previously been one of its few disciples.
One might conclude from this just how little currency proper economic analysis has in this dismal Third Act. Bring on Act Four someone, please.
Bruce Mountain is the Director of consultancy Carbon and Energy Markets and co-founder of retail market data provider, MarkIntell.