What Frydenberg was told about why NEG was bad policy

Medium

By now, it’s clear that the government’s latest energy policy, the National Energy Guarantee (the “NEG”), is probably dead on arrival. That’s our assessment, and it gives us no pleasure.

There is a better alternative, taking the lead of the UK, Germany, Portugal and yes, even China, who have all set policy to move aggressively towards clean energy.

None-the-less; there are still good reasons to pick through this mess and understand why it’s so wrong-headed and why it won’t fly, not least because the stakes are so high. These high energy prices affect every home and business in Australia, and our current energy system is simply abhorrent.

It’s running up environmental debt our kids will pay, and quite literally killing people in each year we keep burning coal (keep reading for the evidence).

Earlier this month, the minister in charge, Josh Frydenberg, invited one of our friends and investors for a private briefing on the NEG. Our friend got in touch with us, so he could go into the meeting well-informed. Here’s what we told him about our view of the NEG.

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We’re coming at this as an impact investor; a funds manager that looks for attractive returns on investments that have environmental and social benefits.

We’ve arranged successful investment products for solar farms, wind farms, and green buildings.

So, we deeply understand the economics of energy. We also agree with the overwhelming weight of evidence; Australia must reduce carbon emissions to avoid the expensive, harmful and worsening effects of climate change.

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The NEG is bad policy, and it’s based on bad modelling. We don’t think it will ever be implemented, but perversely, that raises more problems. (Stick around for some happier ideas and the much better forward path. They’re coming, we promise.) But first, let us count the NEG’s wrong-headed ways.

Firstly, the NEG’s goals are woefully inadequate.

This is old news, and the world agrees. We must cut emissions to 40%-60% below our 2005 levels, by 2030. The NEG’s underlying model has us reducing by only 26% by that date and then flatlining.

That is climate malpractice. We won’t be able to hold global warming under 2°, and Australia would flunk the commitments we made to the world in Paris. You know who else doesn’t care about Paris? A clue: Rhymes with “rump”.

The NEG’s model implies that the proportion of renewable generation in Australia will rise until 2020 and then stay the same. Adopting those assumptions would send an incredibly strong signal to the renewable investors to hold their capital, or demand a high risk premium.

The result?

We hang on to our decrepit and harmful coal-fired power plants, and then — when those can’t be patched together anymore — the market will clamor for new renewable investment. Demand will force up the prices of capital, and the wholesale prices of electricity.

Even if the coal fired power plants were sparkling and new (they’re really not), we wouldn’t want to use them: Not only are they the worst, most climate-irresponsible form of electricity generation, they are hazards to human health. (Here comes the evidence we promised.)

The Lancet has published conclusions that coal-fired power plants cause around 24 deaths and 225 serious illnesses per terawatt hour of electricity, due to the small particles and toxic chemicals they pump out. In the UK, they’ve pledged to phase out coal by 2025, and they expect that will save thousands of lives each year, and save the NHS up to £3.1bn a year through prevented illnesses.

So, the NEG goals are unambitious at best, and plain wrong at worst.

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Secondly, the NEG is very badly designed (even allowing for its meagre goals), so it would have smaller intended effects, and some nasty unintended ones.

Some of the problematic effects would come from the policy’s “dispatchability targets”. The policy would require every electricity retailer to buy from sources that can be ramped up or down depending on demand.

For practical purposes that’s mostly the coal, gas and pumped hydro that are controlled by the big, vertically integrated generator-retailers like AGL and Origin (aka the “gentailers”).

We think this requirement will have dreadfully anti-competitive outcomes; the smaller retailers, the ones expected to force innovation, improve service and reduce prices, would effectively be forced to buy power from these big gentailers. Those companies are their competition. Good luck with those negotiations.

Theoretically, the Minister holds a big stick to penalise any retailer who misses their emissions reduction target. The government, the NEG suggests, could take away their license.

But we find it inconceivable that a Minister would actually do that to a big retailer; what a brave and electorally secure person that Minister would have to be, to trigger the transfer of power accounts of millions of households.

The NEG envisions sweeping changes to fundamental elements of a highly sensitive sector with numerous diverse stakeholders. The policy would impact spot pricing and established hedging products and result in less transparent, and therefore less investable market.

It will require a perfect definition of important terms like “dispatchable” in a highly imperfect world. All of that would have to happen amidst rapid technological change.

Australia’s recent track record implementing just a small change in the timing of spot prices suggests we don’t move quickly when it comes to altering these kinds of mechanisms (stay tuned to further commentary from us regarding the 5-minute rule).

There is nothing in the NEG to incentivise new generation capacity. Australia isn’t going to need less electricity, so the market will provide those incentives on its own; but it won’t be pretty.

Expect severe price increases when old generators become too expensive to repair and run, get withdrawn, rapidly dropping supply in the face of steadily rising demand.

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Here’s the upside: Policy like this, that has been so roundly criticised, doesn’t stand much chance of getting passed into law. Not least because the States need to co-operate via COAG, and that’s highly unlikely (although it could cause a Frydenberg v Weatherill rematch).

That must mean that when some truly nation-building energy policy comes along, the contrast will be stark. It will be based in evidence, and the understanding that Australia will inevitably make a transition away from last century’s toxic, irresponsible, fossil fuel-fired power.

The right policy for Australia will recognise the fortunate reality of energy and economics at this point in history. The world in 2017 has the components for a clean, healthy, and robust alternative energy system. A generator mix of solar, wind and hydro can provide clean electricity in abundance.

This will replace the generators that emit pollutants that are damaging the health of their local communities.

The remarkable innovation in demand-side management and the plummeting costs of battery storage, in combination with pumped hydro, means we can complement the clean generators to balance supply and demand, and provide a truly reliable network.

Famously, renewable generation is already the cheapest form of new generation to build, and without fuel bills, the ongoing costs are negligible. These fundamental trends will not reverse. Now is the time to double down.

The article represents the views of Impact Investment Group and is opinion only. This article does not necessarily represent the views of our investors and is not investment, financial or product advice of any kind. We provide no warranties or representations whatsoever as to the accuracy, reliability or completeness of the information and accept no liability for any loss or damage suffered as a result of any reliance upon any statements herein.

Source: Medium. Reproduced with permission.