Albanese’s risky power play - Grattan Institute

Last week, the federal government announced a Capacity Investment Scheme (CIS) to underwrite the risk of investing in new renewable energy generation and storage. The objective is to deliver “the long-term reliable, affordable and low-emissions energy system Australians deserve”.

Based on the limited information available, the scheme should indeed make a step change in renewable energy deployment in Australia. A step change was necessary, despite the significant risks and limitations of this scheme.

The government had recognised that it was not on track to achieve its emissions-reduction targets. Specifically, it was under pressure to deliver 82 per cent renewables by 2030. Now it has responded.

Under the scheme, the government will run six-monthly competitive tenders, seeking bids from the first quarter of 2024 until 2027. The objective is to deliver 9 gigawatts of “dispatchable” capacity and 23 gigawatts of “variable” capacity. Successful projects will be offered contracts in which a revenue floor and ceiling are agreed with the Commonwealth.

If the targeted investment is built, then it’s possible Australia will hit the target. The amount of new capacity being considered would certainly make a huge difference. That 23GW of new variable renewables such as wind and solar, plus 9GW of dispatchable capacity, which involves storage – mainly batteries – compares to the total generation capacity of the National Electricity Market at about 65 gigawatts.

The mechanism is important. The government and the project will have a contract-for-difference (CFD). The government is only underwriting the risk, rather than the full amount of money. If the revenue the project generates in the market is within an agreed range, the government doesn’t pay anything.

If the people who invested are getting less revenue than the agreed floor, the government will pay a proportion of the difference. But it’s not a one-sided arrangement. If the project generates more revenue than the agreed ceiling, a proportion of that money goes back to the government.

Perverse incentive

In principle, it’s a good idea for two reasons. It provides a much greater level of predictability for investors, and the government controls the volume and price.

But the CIS carries risks. Basing the CFD on a project’s revenue would seem to create a perverse incentive against the operator competing on commercial grounds in the market. The wholesale price could crash to zero and the government would pay out the full revenue to provide a rate of return acceptable to the investor. Presumably, this risk will be managed in the detail of the contract.

Creating an electricity system where most generators get their revenue outside the spot market may compromise its fundamental functions of delivering lowest-cost generation and price signalling for new investment. Whether those functions will be comprised is hard to predict, but it would seem to be a serious risk.

The CIS also has limitations.

First, as announced, it does nothing to address how transmission will be built to support the new capacity. This issue, and not the cost of renewables, has been the primary obstacle to investment in new generation. Federal and state governments still need to step up the pressure on building transmission lines to connect all this new renewable capacity to the grid.

Second, this approach puts all the responsibility for the reliability of the grid in the hands of the states. That is, dealing with the closure of the coal and making sure there’s enough capacity to replace it.

That’s probably a good idea because the states have different views about how reliability should be addressed. Some would not want to see any gas-fired generation being used to back up renewables; others may be happy to have gas-fired power or even a hydrogen power station to reinforce reliability. It will be up to them now.

Don’t expect the CIS to make much difference to system costs. While new renewables themselves are cheap, the transmission and storage needed to back them up will not be. They’ll probably largely balance each other out. The impact on consumer prices depends on what the federal government does with the balance of its contract benefits and obligations.

The bottom line: if the scheme is done well and the risks are managed, we will be getting a more reliable and lower-emissions electricity sector at a relatively low carbon cost. If not, the result could destroy the current electricity market while failing to deliver the primary renewable energy target. This is one where the devil will truly be in the detail.

Tony Wood

Energy and Climate Change Program Director
Tony has been Director of the Energy Program since 2011 after 14 years working at Origin Energy in senior executive roles. From 2009 to 2014 he was also Program Director of Clean Energy Projects at the Clinton Foundation, advising governments in the Asia-Pacific region on effective deployment of large-scale, low-emission energy technologies.

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