Australia’s Runaway Renewable Energy Crisis: the Product of Government, Not Market Failure

Australia’s Runaway Renewable Energy Crisis: the Product of Government, Not Market Failure

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Governments’ renewable energy push to blame for crisis
The Australian Financial Review
Ben Potter
7 April 2017

The energy sector is in disarray because of government failure, not market failure, former Productivity Commission chairman Gary Banks says.

He told Infrastructure Partnerships Australia the spectacle of South Australian Premier Jay Weatherill blaming the private sector for high energy prices and blackouts “took the wind out of my sails”.

He said government policies subsidising wind and solar energy at the expense of established coal and gas-fired power stations were primarily responsible for the “energy crisis” afflicting South Australia and increasingly the eastern states. “The inconvenient truth is that the increasingly high prices for increasingly unreliable electricity are a direct consequence of the increasingly high utilisation of renewable energy required by government regulation,” Mr Banks said.

“Energy markets are admittedly complicated things. However, the logic is unassailable that if a cheap and reliable product is penalised, while expensive and less reliable substitutes are subsidised, the latter will inevitably displace the former. No amount of sophistry, wishful thinking or political denial can change that.”

Other experts such as CME director Bruce Mountain say soaring gas prices are at least equally to blame for a doubling in wholesale electricity prices in the last year or two because gas peaking plants set the marginal price for electricity when the wind isn’t blowing and the sun isn’t shining.

But Professor Banks, now with the Melbourne Institute of Applied Economic and Social Research, said the costs of shifting from established, cheap and carbon-heavy coal power to low carbon energy had been compounded by governments choosing an “anti-market path, one violating basis principles of demand and supply”.

“The energy crisis is self-evidently not the result of market failure but of government failure,” he said.

Professor Banks said policy was going from bad to worse with the Turnbull government calling the competition watchdog on to the “alleged misdemeanours” of the energy retailers, the threat of regulatory intervention to withhold gas exports for domestic use, the prospect of billions of dollars of taxpayers’ money being used to fund “clean coal” power and the “nation building expansion of the Snowy Hydro scheme “that had been rejected as uneconomic in the 1980s”.
Australian Financial Review

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Energy crisis a blunder of governments, not a market failure: Energy policy
Australian Financial Review
Gary Banks
7 April 2017

Even by today’s standards, the misleading, disingenuous and partisan nature of the energy policy “debate” seemed to have plumbed new depths. So be it, I thought, it’s no longer my job to call out such things. But then a state premier went and made the following observation:

“We’ve got market failure. We know there is an investment strike. The private sector just isn’t building power generation.”

I must confess that this took the wind out of my sails – if you’ll pardon the analogy. The electorate was being told by a political leader that the problems they were experiencing – high prices, failing supply and costly emergency measures – had nothing to do with the government. It was the fault of the private sector and its perverse refusal to invest in power generation.

The inconvenient truth is that the increasingly high prices for increasingly unreliable electricity are a direct consequence of the increasingly high utilisation of renewable energy required by government regulation.

Energy markets are admittedly complicated things. However, the logic is unassailable that if a cheap and reliable product is penalised, while expensive and less reliable substitutes are subsidised, the latter will inevitably displace the former. No amount of sophistry, wishful thinking or political denial can change that basic economic reality.

Changing the mix of energy use away from low-cost but emissions-heavy fossil fuels has of course been the whole point. While Australia’s own actions can have no discernible impact on global carbon emissions, let alone on Australia’s climate, there is broad support for the idea that playing our part is a precondition for a joint international endeavour that could. This requires a leap of faith, but it is a legitimate policy objective, even if a particularly costly one for this country given its resource endowments.

The resulting costs and difficulties have been greatly compounded, however, by governments choosing a policy path that is essentially anti-market, one violating basic principles of demand and supply. The energy crisis is self-evidently not the result of market failure but of government failure.

The 18th century literary sage Samuel Johnson remarked that “a man is never more innocently employed than when engaged in making money”. The actions of private investors are not hard to understand. They will generally not invest in a project unless the returns are likely to be sufficient to cover the costs and provide an adequate return on their capital – given the risks involved and the alternatives on offer. Following regulatory interventions, returns from fossil fuel generators have gone down, while the risks of investing in them have gone up. I suppose the consequent reluctance to invest could be called a “strike”, if one needed an emotive term, but it is really just a rational response to the forces at work.

Unlike government enterprises, private companies cannot be relied upon to provide cover for a government’s policy mistakes. In that light, the SA Treasurer’s lament that privatising ETSA was “the worst policy blunder in the history of South Australia” may have not only been a big call, but more revealing than intended.

In blaming the private sector for Australia’s energy problems, there is a real risk that the policy mistakes that led to it will be compounded by further policy mistakes, rather than leading to corrective actions that acknowledge regulatory error. We seem destined to end up in a third or fourth-best world, as economists express it, when the first or second best were well within reach.

Thus we observe at the federal level the threat of regulatory intervention to withhold gas exports for domestic use – while at the same time state and territory governments ban or curtail exploration and production. We even see governments re-entering the energy business. South Australia is to spend a lazy half billion dollars on a new gas generation plant. The Commonwealth is contemplating investing in clean coal generation using its $5 billion northern infrastructure fund, the minister responsible declaring “the only people who can get rid of sovereign risks are the sovereigns”!

Then there was the dramatic announcement of a “nation building” expansion of the tri-governmental Snowy Scheme that had been rejected as uneconomic in the 1980s. Following the WA election, Western Power must also take its place on the privatisation “no go” list.

To add to the irony, we are seeing a new wave of interventions to help the very firms which emission reduction policies were intended to drive out of business. The Portland aluminium smelter, perhaps the most intensive user of electricity in the country – an operation requiring heavily subsidised power even when it was cheap – has received substantial additional taxpayer support to help forestall the inevitable.

The intervention spawned by the failure of energy/carbon policy accordingly looks to become a self-perpetuating process. It is disturbingly reminiscent of the conventional industry protection dynamic of times past, in which assistance to import-competing firms imposed costs on downstream users and exporters, who in turn demanded (and often received) assistance of their own.
Australian Financial Review

Gary Banks is spot on! This disaster was not only deliberate, it was always perfectly avoidable and the culprits are well-known and easy to apprehend.

Where Gary gets to the heart of the cause, he is yet to grapple with the full cost of the consequences, which is where we are more than happy to assist. We’ve set out the cost of the Large-Scale RET before and, for Gary’s benefit, we’ll set it out again.

The LRET target is set by s40 of the Renewable Energy (Electricity) Act 2000 (here). A retailer who fails to satisfy the target by surrendering RECs purchased from renewable generators faces the ‘shortfall charge‘, a $65 per MWh fine for each REC the retailer fails to surrender, short of the designated annual target.

At the present time, the total annual contribution to the LRET from eligible renewable energy generation sources is around 16,000 GWh (depending on the weather, of course); and, because retailers will not enter PPAs with wind power outfits, is effectively stuck there interminably.

The REC price is, due to the impact of the shortfall charge, expected to hit $93, and, due to the taxation treatment of RECs versus the shortfall charge, the full cost of the shortfall charge to retailers is also $93. RECs are tax deductible as an expense; the penalty is a fine and, therefore, is not tax deductible. The shortfall charge is currently fixed

Retailers have indicated to STT’s sources that they will be recovering the full $93 cost of the shortfall charge. Using that figure applied to the current LRET target, we’ll start with the cost of the shortfall penalty.

In the table below, the “Shortfall in MWh (millions)” is based on a total contribution to the LRET from eligible renewable sources of 16,000,000 MWh (1GWh = 1,000MWh). The LRET target is, likewise, set out in MWh (millions).

Year Target in MWh (millions) Shortfall in MWh (millions) Penalty on Shortfall @ $65 per MWh Minimum Retailers recover @ $93
2017 26.031 10.031 $652,015,000 $932,883,000
2018 28.637 12.637 $821,405,000 $1,175,241,000
2019 31.244 15.244 $990,860,000 $1,417,692,000
2020 33.85 17.85 $1,160,250,000 $1,660,050,000
2021 33 17 $1,105,000,000 $1,581,000,000
2022 33 17 $1,105,000,000 $1,581,000,000
2023 33 17 $1,105,000,000 $1,581,000,000
2024 33 17 $1,105,000,000 $1,581,000,000
2025 33 17 $1,105,000,000 $1,581,000,000
2026 33 17 $1,105,000,000 $1,581,000,000
2027 33 17 $1,105,000,000 $1,581,000,000
2028 33 17 $1,105,000,000 $1,581,000,000
2029 33 17 $1,105,000,000 $1,581,000,000
2030 33 17 $1,105,000,000 $1,581,000,000
Total 449.762 225.762 $14,674,530,000 $20,995,866,000

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Between 2017 and 2031 the total target could be satisfied by the issue and surrender of 449.762 million RECs. However, with only 16 million RECs available annually there will be a total shortfall of 225.762 million; with only 224 million RECs available to satisfy the remaining 449.762 million MWh target over the life of the current LRET.

Under the current LRET, with RECs hitting $93 as the penalty begins to apply, the total cost added to power consumers’ bills will nudge $42 billion (449,762,000 x $93), as set out in the table below.

Power consumers will end up paying for the shortfall penalty collected by the Federal government, and for the cost of the RECs issued to wind power outfits – in relation to collecting the cost of the REC Subsidy from power consumers, Origin Energy’s Grant King correctly puts it:

[T]he subsidy is the REC, and the REC certificate is acquitted at the retail level and is included in the retail price of electricity”.

It’s power consumers that get lumped with the “retail price of electricity” and, therefore, the cost of the REC Subsidy paid to wind power outfits.

To give some idea of how ludicrously generous the REC Subsidy is, consider a single 3 MW turbine. If it operated 24 hours a day, 365 days a year – its owner would receive 26,280 RECs (24 x 365 x 3). Assuming, generously, a capacity factor of 35% (the cowboys from wind power outfits often wildly claim more than that) that single turbine will receive 9,198 RECs annually. At $93 per REC, that single turbine will, in 12 months, rake in $855,414 in REC Subsidy.

But wait, there’s more: that subsidy doesn’t last for a single year. Oh no. A turbine operating now will continue to receive the REC subsidy for another 14 years, until 2031 – such that a single 3 MW turbine spinning today can pocket a total of $11,975,796 over the remaining life of the LRET. Not a bad little rort – considering the machine and its installation costs less than $3 million; and that being able to spear it into some dimwit’s back paddock under a landholder agreement costs a piddling $10-15,000 per year. State-sponsored theft never looked easier or more lucrative!

The REC Tax/Subsidy, including that associated with domestic solar under the original RET scheme, has already added more than $14 billion to Australian power bills, so far.

At the end of the day, retailers will have to recover the TOTAL cost of BOTH RECs AND the shortfall charge from Australian power consumers via retail power bills.

And that’s the figure we’ve tallied up in the right hand column – which combines the annual cost to retailers of 16 million RECs at $93 (ie $1,488,000,000) and the shortfall penalty, as it applies each year from now until 2031, at the same ultimate cost to power consumers of $93.

Year Target in MWh (millions) Shortfall in MWh (millions) Shortfall Charge Recovered by Retailers @ $93 Total Recovered by Retailers as RECs & Shortfall Charge @ $93
2017 26.031 10.031 $932,883,000 $2,420,883,000
2018 28.637 12.637 $1,175,241,000 $2,663,241,000
2019 31.244 15.244 $1,417,692,000 $2,905,692,000
2020 33.85 17.85 $1,660,050,000 $3,148,050,000
2021 33 17 $1,581,000,000 $3,069,000,000
2022 33 17 $1,581,000,000 $3,069,000,000
2023 33 17 $1,581,000,000 $3,069,000,000
2024 33 17 $1,581,000,000 $3,069,000,000
2025 33 17 $1,581,000,000 $3,069,000,000
2026 33 17 $1,581,000,000 $3,069,000,000
2027 33 17 $1,581,000,000 $3,069,000,000
2028 33 17 $1,581,000,000 $3,069,000,000
2029 33 17 $1,581,000,000 $3,069,000,000
2030 33 17 $1,581,000,000 $3,069,000,000
Total 449.762 225.762 $20,995,866,000 $41,827,866,000

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Whether it’s RECs being generated by current (or additional) wind power generation, or the shortfall charge being applied, retailers will be recovering every last cent of the combined costs of BOTH from all Australian power consumers through retail power bills: we are, of course, talking about AGL and not the Salvation Army.

In the cutting British satire, Extras, the hapless Andy Millman (Ricky Gervais) is always foiled by his gormless but lovable side-kick, Maggie Jacobs (Ashley Jensen).

Maggie, when she’s not inadvertently ruining Andy’s romantic hopes and/or acting career prospects, poses puzzling rhetoricals such as “would you rather be trampled by elephants or eaten by lions?”

Following Maggie’s lead, STT poses the following:

“would you rather have your economic future destroyed by a $42 billion electricity tax, designed to subsidise the construction of another 6,000 of these things; or a $90 billion electricity tax, designed to subsidise the construction of another 12,000 of them?”

Unfortunately, unlike Maggie’s death by elephant or lion conundrum, with STT’s poser there isn’t any way of avoiding one or the other.  Here, it’s the ‘choice’ being offered by Malcolm Turnbull and Josh Frydenberg; or as Maggie might put it, “would you rather be run over by a steam-roller, once or twice?”

Federal Labor’s 50% target would automatically double the LRET Tax/Subsidy/Penalty (set out above) to a lazy $90 billion or so.

But that is just the tip of the iceberg.

To build wind power capacity to meet a 50% target requires more than 12,000 of these things and a completely duplicated electricity grid.

Even satisfying the current 33,000 GWh target – will cost at least a further $80-100 billion, in terms of extra turbines and the duplicated network costs needed to hook them up to the grid: all requiring fat returns to investors; costs and returns that can only be recouped through escalating power bills: Ian Macfarlane, Greg Hunt & Australia’s Wind Power Debacle: is it Dumb and Dumber 2, or Liar Liar?

In the post above we looked at the additional costs of building the wind power capacity needed to avoid the shortfall penalty – including the $30 billion or so needed to build a duplicated transmission grid.

That is, a network largely, if not exclusively, devoted to sending wind power output from remote, rural locations to urban population centres (where the demand is) that will only ever carry meaningful output 30-35% of the time, at best. The balance of the time, networks devoted to carrying wind power will carry nothing – for lengthy periods there will be no return on the capital cost – the lines will simply lay idle until the wind picks up.

Network owners have no incentive to build the whopping additional transmission capacity required to accommodate new wind power capacity; and nothing like the capacity needed to send a further 17,000 GWh into the grid to meet a 33,000 GWh target, let alone Labor’s 50% target which more than doubles that figure.

The South Australian Labor government spent much of 2016 begging for taxpayers in other states to stump up around $4 billion to build extra interconnectors to direct reliable coal-fired power to SA from Queensland, NSW and Victoria – in an effort to avoid more wind power collapses resulting in load shedding and statewide blackouts. But, funnily enough, SA’s neighbours aren’t that keen to bail them out.

Moreover, even if investors were prepared to – in a Field of Dreams, “build it and they will come” moment, – throw money at a duplicated grid, the returns demanded by those investors can only be recovered from retail power customers. Which is yet another reason why retailers are out to wreck the LRET and the wind industry with it.

Which leaves Australian voters with one of Maggie Jacob’s rhetoricals.

“Which would you rather vote for: a party of ostensibly business friendly economic conservatives, run by energy illiterates, looking to destroy an entire economic system by pandering to the idiots that occupy the lunatic fringe?; or a party of Union backed thugs, out to reach the same result in less than half the time?”

It’s a conundrum for Australian voters, to be sure.

josh frydenberg

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