“Many people in Australia, including many in business leadership roles, distrust markets. They fear that market outcomes will be seriously disruptive, and dislike the uncertainty with which market outcomes are associated. There is a deep Australian yearning for the certainties of controls and subsidies. However, while markets are imperfect, the general experience is that they are more effective than any other mechanisms for ensuring that supply is available reliably to meet demand. I see no reason why the electricity market is different from others.”

He’s not bad, this Garnaut bloke. Shows real promise.

Professor Ross Garnaut’s original climate change report, and this series of updates, has been the relentless application of common sense to the problem of climate change. What does the science say? What does it mean for Australia? How do you solve the “prisoner’s dilemma” of international action? What’s the most cost-effective way of achieving emissions reductions?

You can disagree with his conclusions — for example, his recommendation that EITE industries get CPRS-level compensation for an initial period, because that model is ready to go while we await an independent determination on compensation principles — but you can see how he’s arrived at them.

The electricity paper is the usual mixed bag. There’s some things in there for the government to like, but there’s also some uncomfortable truths it may prefer to ignore for the time being. And there’s some myth-busting along the way.

In particular, in a period when politicians are hyperventilating about electricity prices, Garnaut offers a gentle corrective, pointing out we still enjoy relatively cheap electricity compared to other countries, that prices are rising even more quickly in some other countries and, as a share of GDP per capita, electricity costs in Australia are still fractions of what they are in countries like Germany, Japan and the UK.

Like others before him, Garnaut acknowledges network costs — particularly investment to replace ageing infrastructure — are driving costs up. And he knows rising coal and gas prices will continue to drive costs up in the future even without pressure from network costs. But he’s intrigued as to why costs are rising so quickly when demand for electricity has actually fallen since the GFC. He’s not content with the explanations of energy regulators, so he looks further. This has little to do directly with a carbon price, but the issue has caught his attention and he’s like a dog with a bone on it.

Eventually he offers an answer: the current regulatory framework is also driving prices up. We already knew that, partly: the current suite of renewable energy programs, and particularly the Renewable Energy Target which is supported by all sides of politics, is driving prices up by forcing producers to buy more expensive renewable energy programs.

Garnaut wants to nix the RET and other renewables programs as soon as there’s a carbon price.

But he also thinks the current process of assessing and approving electricity price rises is too generous to the monopoly power generators. He thinks they’re encouraged to over-invest and gold-plate their infrastructure. He thinks state governments’ reliability standards, which are politically-driven, are too burdensome. And he shows investment in Victoria and South Australia, where generators are in private hands, has been far lower than in NSW and Queensland.

He proposes a tighter regulatory model in order to minimise the impacts of a carbon price. And he wants a move to a genuine national network, one where it’s easier for new small-scale generators to connect to the grid, intermittent renewable power is available over a wider area, and local demand peaks can be more easily accommodated. He recommends reforms like transmission planning being done by a single body, rather than the states, and an end to state-based, overly conservative reliability standards. This is all stuff that should happen even without a carbon price.

With this sort of national network, according to the paper, any danger of a carbon price somehow causing the a shutdown of emissions-intensive coal-fired baseload capacity is minimised.

Garnaut does, however, accept there may be some unwanted consequences of  a carbon price for the sector. If the owner of an emissions-intensive electricity generator fails to prepare for a carbon price it might have the same effect as the GFC, or major industrial action, and cause a financial crisis that spreads, however irrationally, across the sector, which has no mechanisms to cope with the collapse of “too big to fail” generators. There’s also a small risk that the incentive to replace ageing generation infrastructure may be reduced, leading to large amounts of generation capacity being withdrawn simultaneously. And there have been claims a carbon price will deter new investment in the sector, but Garnaut dismisses it.

How to make absolutely sure of financial stability within the sector? In one paragraph, Garnaut dismisses both the approach of the Rudd government and that currently proposed by the Coalition.

“Analysis of market dynamics reveals that the unconditional grant of free permits to generators does not affect any of the influences on profitability and therefore on any of the decisions that will actually determine whether established plants continue to produce power or whether there will be investment in new capacity. On the other hand, conditional grants would distort the adjustment.”

In fact, Garnaut spends some time demonstrating why the proposal from the Coalition to fund the shutdown of coal-fired power plants (a sort of “loser-picking” to complement the overall policy of winner-picking) will simply drive electricity prices higher — costing customers much more in higher electricity bills than in tax dollars paid to polluters. And he suggests, if it has to be done, that production be closed, not capacity. Elsewhere, he suggests a dirty facility like Hazelwood in Victoria could be kept as a peak-load generator, coming on line at the height of summer when extra capacity is temporarily needed.

Garnaut’s preferred mechanism for market stability is temporary government loan guarantees to reduce uncertainty and interest costs and ensure generator solvency during the transition to a carbon price, rather than handouts and “assistance”. It’s an echo of the approach adopted by Treasury and the Reserve Bank in the face of GFC contagion spreading to our “too big to fail” banks. As Garnaut said, there’s no reason why an electricity market shouldn’t function like any other market.

The trick, though, as Garnaut outlines, is to get it functioning like a proper, national market in the first place. Labor hasn’t been able to do that on water. He shouldn’t hold his breath waiting for it to happen on electricity.

Peter Fray

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