17
Jun
2017

Finkel Review is not about forecasts, it is about making informed choices

by Tony Wood


Published by the Australian Financial Review, Saturday 17 June

The Finkel Review delivered an energy system blueprint with a clear objective: secure and reliable electricity, at the lowest cost, while Australia moves to a lower emissions future. Regrettably, the current political debate seems more likely to deliver the opposite outcome: less secure and reliable electricity, at higher cost.

There is justifiable concern about electricity prices, security of supply, and the future of the coal-fired power stations that have underpinned our energy system for decades.

The economic modelling of the Finkel Review provides forecasts of what might change under various assumptions. Unfortunately, the debate over the Review’s recommendations has focused on the forecasts rather than the substance of what drives investment, prices and emissions. Such debate does little more than support the view of JK Galbraith, who famously said that “The only function of economic forecasting is to make astrology look respectable.”

We need to come back to the objective. It is neither to eliminate coal nor to save it. It informs decision makers. What’s needed is policy based on hard-headed thinking that provides a credible, stable investment environment. Such policy will deliver effective, efficient outcomes. The future for coal, gas, wind or solar, while important to their loyal fans, will rightly be determined by how well they contribute to those outcomes. The market share is simply irrelevant to delivering affordable and reliable electricity.

Hard-headed policy thinking requires working with what we know and dealing with what is uncertain.

First, we have the global commitment to tackle climate change via the Paris Agreement. Whether Australia treats its commitment as an aspiration or an obligation is important. But there are other forces at play that are more important right now. Energy and resources companies around the world are now factoring carbon prices, $40 per tonne and more, into their decision-making. These heavyweight companies are the ones putting pressure on President Trump and Prime Minister Turnbull to provide effective policy settings on climate change.

Costs rising

Second, the cost of electricity is increasing. In Australia, “old coal” delivered electricity at about $40 per megawatt hour for many years. But those plants are retiring and the cost of power from new coal plants, even the most efficient, is closer to $80 per megawatt hour. Gas-fired power, even if domestic gas prices move down closer to export parity, will cost $90-100 per megawatt hour. Wind and solar, when available, can deliver power below these levels, but the cost of balancing their intermittency pushes prices back up. Wishing a return to the costs of last century is futile. And returning to public ownership will not change these numbers.

Alan Finkel’s blueprint does not claim that electricity prices will return to where they have been prior to his report. It recognises that prices are increasing. It shows a disparity in prices given certain outcomes. And it points out that future price increases will be higher if investors face continued policy uncertainty. Uncertainty means risk and risk means cost, regardless of whether the investment is in solar, batteries or the latest, high-efficiency coal plants. The 2017 reality is that these risks will remain, and may increase if Australia abandoned its Paris commitments.

Governments can deal with uncertainty in the electricity sector by underwriting investments with power-purchase agreements. The ACT government has used this approach to deliver renewable energy. The UK government has used a similar approach to support a new nuclear plant. But the risk of high, uncompetitive prices is shifted from today’s investors to tomorrow’s consumers.

Finkel’s Clean Energy Target model can deliver the objective as well or better than the alternatives, and it is flexible. For example, the setting of the threshold below which cleaner technologies can generate credits is effectively irrelevant to the objective. A higher threshold than modelled by Finkel would allow cleaner coal plants to generate credits – a reasonable and sensible compromise.

Australia has a history of getting policy wrong when it’s based on forecasting. We should use forecasts and models to test our decisions, but we should never make decisions (policy or investment) that depend on the accuracy of a forecast.

In 2017, Australia needs to deal with higher electricity prices and future uncertainties. Of one thing we can be certain: neither nostalgia nor astrology provides a sound basis for our decision-making.

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