Careful compromise or huge headache? - Grattan Institute

The Albanese government has just delivered a masterclass on political compromise or created a self-inflicted major headache.

It walked into an economic, political and social problem in Australia’s energy sector where no potential solution would satisfy everyone.

When the Treasurer, Jim Chalmers, delivered his first budget speech on October 25, he announced that Treasury advice showed that Australians could expect increases in electricity and gas prices of more than 50 and 40 per cent over two years. This became, and has remained, a headline challenge.

Global demand had dramatically increased the price of gas and coal, delivering windfall gains to Australian producers and governments in the form of profits and royalties respectively. While most Australian gas and coal is sold under long-term contracts with stable prices, the spot markets in both commodities respond rapidly to changes in demand and supply. And for electricity, the price of the last and most expensive supply to meet demand determines the price for all supply.

In normal times, the market worked to deliver low-cost supply. But these are far from normal times. With the endorsement of Treasury, the government announced it would act, and now they have. Action was never going to be easy.

As the government set about finding the best approach, the gas and coal suppliers reacted with outrage about the prospect of any move to cap their prices or impose a tax on their windfall profits.

In Charles Dickens’ Hard Times, published in the 1850s, when the government threatened to make the owner of the Coketown mills more accountable for his actions, the owner would “come out with the awful menace, that he would sooner pitch his property into the Atlantic”. Of course, he never did.

In this tradition, the gas and coal industries of today have argued that the best answer to current high prices is more supply. And they warned that any price controls would bring investment in the sector to a halt just when it’s most needed. They also raised concerns about Australia’s international reputation as a reliable supplier. They refused to see that the alternative was untenable.

And, just to “help” further, the Queensland and NSW premiers expressed outrage that their governments’ own windfall gains might be at risk. The other east coast states are not affected since they export neither commodity, nor is Western Australia affected because it has its own gas reservation policy.

Friday’s announcement by the prime minister looked like the best we could have reasonably hoped for. The federal and state governments agreed to impose temporary price caps on gas and coal. The gas price cap of $12 per gigajoule would apply only to gas supplied by LNG producers to the domestic market beyond contracts. And the coal price cap of $125 per tonne would apply only to domestic supply of coal for power generation.

These price caps will reduce windfall profits. However, the domestic market for NSW coal miners is only about 10 per cent of production, and much of that is contracted at prices below the proposed cap. As for LNG suppliers, the cap will apply to less than 5 per cent of their production. Their overseas contracts are not affected, and they can continue to make windfall profits on spot cargoes.

Finally, the Queensland and NSW governments recognised the fundamentally bad aspects of their position and dropped their ambit claims for compensation.

Government intervention in markets is never ideal, and unintended consequences are always a concern. A $12 cap appears to be a fair gas price, based on market prices prior to the war-driven escalation and to be removed when those prices return. Yet late on Friday the government announced that the fair price concept will be based on a definition of reasonable profits based on costs and investments. This an alarming approach to price controls.

Federal parliament will be recalled to legislate the gas price cap. Queensland and NSW will use individual policy levers to impose the coal price cap. And the federal Treasury will work with its state counterparts to deliver short-term power bill relief.

This is a complex process. While some industrial consumers and wholesale power prices may benefit quickly, it will be well into 2023 before the full benefit of avoided price hikes emerges. Coal producers will not be happy – and don’t expect reduced power bills any time soon. Unsurprising alarm has been raised by gas industry analysts and participants.

It may be that the alarm is based on an unintended consequence and can be addressed. It would be profoundly disappointing if the government has delivered a hollow victory when a winning compromise was there for the taking.

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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