Saturday, August 02, 2008

Climate mettle about to be tested

An emissions trading scheme has not even started but the Government's hostility to carbon emissions is already choking off the supply of electricity, leading to an inevitable rise in prices.

Coal is used to generate 90 per cent of Australia's electricity, but no business can fund new coal-fired power plants under the existing policy settings.  The last big coal-based power station built with private funding was Millmerran in Queensland, completed in 2002 by a Shell-led consortium.

One other station, Kogan Creek, also in Queensland, has been built with government funding.  No others are planned.

Specifying the carbon price that new electricity generators will pay when the emissions trading scheme begins will not solve the problem either, since the carbon price will be set by politicians each year.  The Government also has yet to decide when key CO2 emitting sectors such as agriculture and petrol are to be included under the cap.  As long as these are excluded, the price will need to be higher for the rest.

The Government also has yet to determine many other elements of an emissions trading scheme.  These include the basis on which a reserve price for carbon will be in place (effectively capping the scheme);  what, if any, compensation will be provided to big emitters and big users;  and whether compensation will be paid to subsidise ongoing production or as a lump sum to allow big coal power producers to close down facilities.

All this is complicated by the sale of the NSW generators.

Canberra does not want to jeopardise NSW Premier Morris Iemma's abilities to raise money from the sale, which also allows the Government to exit an industry that would otherwise make substantial calls on public funding.  But any bidders for the NSW assets will need cast-iron commitments about what their future carbon credit costs will be.

In any case, the value of the assets has already been dramatically devalued by commitments to a future emissions trading scheme.

Before the proposals of Ross Garnaut's climate change report were released, most electricity generators expected to receive free carbon credits.  The green paper dangles these before their noses, though it leaves their value unquantified.  Free credits could compensate the most carbon-intensive power plants for leaving the market, with those remaining being reimbursed for the costs of buying credits by a higher wholesale price resulting from the capacity reduction.

A carbon tax at the green paper's mentioned range of $20 to $40 a tonne of CO2 should make it possible, theoretically, for gas-fuelled electricity generation (with its lower CO2 emissions) to take market share from coal-based power stations.  But gas-fuelled generators would be likely to find their competitive edge eroded because they would face higher gas prices following the increase in demand.  Solar-based renewables would remain uncompetitive in any case.

The sword of Damocles hanging over coal-based electricity power stations is causing supply to tighten by preventing new investment.  Eventually this will be exacerbated as existing stations become obsolete and are scrapped.  And obsolescence will accelerate as businesses see a truncated useful life for their facilities and scrimp on maintenance expenditures.

The effect of the discouragement of new supplies is being progressively felt.  Generators cannot obtain forward contracts because neither they nor retailers know what the future price is likely to be.

These developments have brought an increase in wholesale prices.  Average electricity prices in NSW and Victoria during the past couple of years have been $50 a megawatt hour.  Ten years ago they were about $30 a megawatt hour.  That increase is already equivalent to the tax of $20 a tonne of CO2 that the green paper estimates will mean a -- presumably acceptable -- 16 per cent rise in electricity prices.

But we have seen with petrol that very high price increases have little effect on demand;  it may take a tax on electricity of $100 a tonne of CO2, bringing a 70 per cent price increase, to shave even a modest 10 per cent from demand.

Though the price increases foreshadowed in the green paper are already happening, most consumers are largely insulated from them because their retailers have contracts with generators at the previously prevailing prices.  Soon, however, the higher current prices will be reflected in consumers' electricity bills.  At that stage, the rhetoric about the need for higher prices will meet the reality, and test the support of the Government, the media and ordinary people for a trading scheme designed to bring deep cuts in CO2 emissions.


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