How the federal government can get to NEG 2.0

by Tony Wood

Published by Australian Financial Review, Tuesday 21 August

The good ship NEG had almost unanimous support from the energy sector’s suppliers and customers. Yet it has been deliberately run aground by the captain and his mutinous crew. Australians are left to wonder what can be salvaged from the wreck, and what the grounding means for investors and consumers.

There were times, not so long ago, when Prime Minister Malcolm Turnbull and his Energy Minister, Josh Frydenberg, looked like steering that National Energy Guarantee through treacherous waters, with sceptical Labor states and the ACT on one side and deeply unhappy Coalition colleagues on the other.

Safe passage for the NEG would have required two parallel and desirable actions. The Commonwealth would have set, in legislation or regulation, an emissions reduction target for the national electricity sector. And the COAG Energy Council of the nation’s energy ministers would have imposed emissions and reliability obligations on the electricity retailers.

Labor governments in Victoria, Queensland and the ACT had placed several demands on the Commonwealth, primarily about the inadequacy of the emissions reduction target and how it could be increased by a future government. The demands themselves were reasonable, although it would have ultimately been preferable for the council to focus on the NEG framework and for federal Labor to prosecute more ambitious targets in federal Parliament.

But that debate is now academic. An emissions reduction target has been abandoned, and a mechanism to ensure reliable supply is more uncertain than ever.

What’s next for NEG?

So what should, or at least might, happen now?

The next steps will be determined overwhelmingly by the machinations of the Coalition parties. But in the meantime, there is a government and there are energy producers and consumers for whom consequences flow from the NEG wreckage.

First, Frydenberg should seek to secure COAG Energy Council agreement for the mechanics of the NEG’s emissions obligation – but no target – and for the NEG’s reliability obligation. Alternatively, he could drop the emissions obligation entirely and seek support for the reliability obligation only. The first option would simply leave the emissions obligation with no teeth until a future government can provide them. The second option would at least meet the needs of the market to ensure reliability is secure despite the coming wave of new investment in intermittent supply and the closure of coal-fired power plants, notably Liddell in NSW. The Australian Energy Market Operator has emphasised the need for this mechanism, or an equivalent, by the end of 2018.

Second, the federal government has committed to adopt several recommendations of the Australian Competition and Consumer Commission’s recent report on electricity affordability, although with an added touch of steroids. In the policy void created by the demise of the NEG, political necessity requires a stronger focus on lower prices. Frydenberg and his state counterparts must manage the risk that highly prescriptive actions to lower prices in the short term could deliver precisely the opposite in the longer term. Direct regulation of retail prices might deliver lower margins for retailers, but could just lead to higher wholesale margins and little if any net gain for consumers.

The large integrated energy companies have reported substantially higher wholesale profits as tightening of supply led to higher prices. An effective market with clear policy direction delivers this outcome – but also provides the signals for new investment to drive down costs and flush out inefficient profits. The ACCC’s recommendations on the operation of the wholesale market, and the sort of concerns raised in a recent Grattan Institute report on gaming of the market, justify rule changes. But threats of forced divestiture look like an extreme response to a non-existent problem.

Third, the federal government has left the field on climate change. Yet its leaders have consistently argued that Australia is a country that meets its international commitments. It is hard to see how the government can square that circle. In the meantime, renewable energy investment, driven by the Commonwealth’s Renewable Energy Target and actions by the Victorian, Queensland and ACT governments, look certain to deliver the sector’s 26 per cent emissions reduction target early next decade. Beyond that lies profound policy uncertainty – and the consequential threat to investment in any technology.

Wrecking the NEG doesn’t mean the lights will go out. Prices, and emissions, should continue to fall. And it is possible that the next federal government may find the ingenuity to craft and deliver NEG 2.0. Investors, consumers and all concerned for the planet should hope they do.