Argument for subsidies has no power in economic merit based world - Grattan Institute

Published by The Australian, Thursday 12 July

Australians need energy policy that is driven by neither green evangelism for renewables nor a deep-seated fear to protect the role of coal for baseload power.

The Turnbull government’s national energy guarantee may be that policy. Reflecting the ideological nature of Australian energy policy, many are criticising the NEG as the destroyer of investment, jobs and lower prices that come from renewable energy.

Meanwhile, many others say the NEG, if supported at all, must be complemented by direct government funding for new coal-fired generation to deliver lower prices and acceptable reliability.

Give your favourite economic modeller the right assumptions and they almost certainly can validate your preferred view. But a dispassionate review of the key economic factors can be revealing.

Since 2009, grid-based electricity demand across the National Electricity Market has been flat or falling, except for the 2014-15 period when the liquefied natural gas export facilities in Queensland were starting up. The trend looks likely to continue. As a result, there will be new investment only if existing plants close because of age or poor profitability, or subsidies force in new supply.

Barring a significant technology breakthrough or disaster, this investment will be coal, gas, solar or wind. All four are proven technologies. But all face challenges.

Three years ago, wholesale electricity prices were less than $50 per megawatt hour. Today, they are closer to $80/MWh. New-build coal and gas-fired plants can be expected to deliver electricity at an average cost of $75 to $85/MWh — assuming the plant runs more than 20 hours a day on average. If the plant runs less often, then the cost quickly escalates beyond $100/MWh. Announced off-take agreements for solar and wind are supplying energy at prices of $60 to $80/MWh. The average costs rise by $25 to $30/MWh when adding in the cost of running an intermittent plant or storage when the sun doesn’t shine and the wind doesn’t blow.

A return to the wholesale prices of less than three years ago is unlikely anytime soon. There are additional challenges for new investment in baseload generation from coal or gas. During the next decades, the long-run costs of solar and wind are likely to continue to fall, and so more will be built.

As a result, there will be more hours each day with very low ­prices in the spot market, and fewer hours each day when coal and gas-fired generators will run and contribute to paying back their construction costs. And with the plausible possibility that emissions targets will be tightened during the next few decades, which would further erode the future profitability of coal-fired generation, the risks for prospective financiers become insurmountable.

The challenge is reflected in the position taken by the industry in rejecting new coal as a viable investment. A new coal-fired plant almost certainly would require a subsidy from government and a shield against any future emissions reduction obligation. The threat of such support for a new coal-fired plant or to extend the life of an existing one beyond normal commercial viability creates additional market uncertainty.

Energy Australia recently emphasised this point in announcing its plan for a new $400 million gas-fired power plant in NSW.

New investment beyond 2020 needs the direction that comes from credible, stable policy to deliver the lowest cost technologies within the constraints of our emissions reduction targets and power system reliability standards.

Embedding the obligation for emissions reductions within the market ensures present and future targets will be met. The past two years show how the system becomes less reliable as coal-fired plants close, gas-fired plants are mothballed and there are more localised areas with a high share of intermittent renewables.

In our increasingly electric economy, the costs of disruption are higher for all consumers, particularly large, energy-intensive industrial companies.

Embedding an obligation for reliability within the market meets these concerns.

The NEG is designed to impose both obligations, building on the existing combination of spot and contract market arrangements.

Within the dual constraints, the policy is indifferent to the tech­nology mix, whether new-build or the extension of the operating life of an existing, newer coal-fired plant. The NEG, if its present design is broadly implemented, will provide a credible and sustainable platform for investment. The case for renewables or new coal, whatever the costs look like today, then will rest on the economic merits. In that world, there is no case for subsidies for new coal or for subsidy extensions for renewables.

As yesterday’s report from the Australian Competition & Consumer Commission clearly demonstrates, markets need to be well-regulated or consumers will suffer. Resetting the electricity market for today’s circumstances is a job for governments and regulators. Unpredictable intervention is not.