The carbon pricing mechanism (the Mechanism) will have particular implications for the power industry. This paper focuses on the implications for power, including in particular:
- The impact of the Mechanism on electricity prices.
- How the Mechanism will assist the power industry transition to a carbon price.
- Implications for how electricity will be generated following the introduction of the Mechanism.
- Implications for the renewable energy industry.
Moving away from coal
The key driver of the Mechanism's impact on the electricity sector in Australia is the encouragement, through a market-based scheme, of the movement over time to lower carbon emitting power generation and the increase in the efficiency of the use of electricity. That will comprise a range of measures, including: the closure of the highest carbon emitting generators (brown coal power stations); the encouragement of carbon capture and storage (through existing measures); the development of additional gas and renewable energy generators; and the implementation of energy efficiency measures.
Whilst the Mechanism does not provide for any additional investment in carbon capture and storage technology (which is supported through existing programs such as the Carbon Capture and Storage Flagship Program), a Clean Energy Finance Corporation will be established to invest in renewable energy, low pollution and energy efficiency technologies. Further details on the Clean Energy Finance Corporation are set out below.
The Government hopes to drive approximately AUD$20 billion in investment in renewable energy by 2020 and treasury modelling forecasts that large scale renewable energy, excluding hydro, will be 18 times its current size by 2050, with 40 per cent of electricity generated from renewable sources by 2050. In addition, treasury estimates that gas-fired electricity will increase by over 200 per cent by 2050.
Whether the initial price of AUD$23 per tonne is high enough for the development of sufficient gas-fired electricity generation in south-eastern Australia is a matter for debate (some have suggested that the carbon price needs to be significantly higher than AUD$23 to drive new gas fired power development). However, the initial importance of the Mechanism is that there is a clear cap trajectory out to 2020 and beyond, allowing for investments to be made now based upon expectations of future carbon prices. Regardless, until the Mechanism alone demonstratively drives significant investment in renewable energy, complementary measures such as the Large-scale Renewable Energy Target and other policies will be required to further develop the industry.
Electricity prices in Australia
Reflecting the availability of cheap and abundant coal reserves, Australia relies heavily on coal-fired electricity generation and, accordingly, the electricity sector is Australia's largest source of greenhouse gas emissions. A study undertaken by the Australian Bureau of Agricultural and Resources Economics in 2011 shows that black and brown coal currently represents approximately 75 per cent of Australia's total electricity generation output with gas and oil representing approximately 17 per cent and renewable energy representing only approximately eight per cent.
There has been considerable debate on current and anticipated increases in the retail cost of electricity and how the pricing of carbon might affect that. It is generally understood that the key drivers for these increases include:
- More rigorous licensing conditions and other obligations for network security, safety and reliability.
- Load growth and rising peak demand.
- New connections.
- The need to replace ageing assets (given the majority of the networks were developed between the 1950's and the 1970's).
While it is anticipated that the imposition of a carbon price will also increase retail electricity prices through its impact on the electricity price in the wholesale market, treasury modelling indicates the increase will be approximately AUD$3.30 per week (on average) in 2013 across households – far less than the increase in prices which can be ascribed to the rising costs of transmitting and distributing electricity. In respect of wholesale electricity prices generally, treasury modelling indicates that:
- Without a carbon price, wholesale prices would rise strongly to 2030, driven by rising gas prices and new, higher capital cost plants entering the market to meet demand.
- With a carbon price, the additional costs imposed on fossil fuel power plants will have an immediate impact on wholesale electricity prices (as changes in the prices of coal and gas have an immediate impact on prices), making them approximately $18 per MWh higher on average over the first five years. Deployment of cleaner, more expensive technologies would then cause electricity prices to continue to increase over time (as, conversely to changes in the prices of coal and gas, changes in capital costs of new generators have a greater impact over time, as new generation capacity is required).
Transition to a carbon pricing mechanism
Any facility that produces at least 25,000 tonnes of direct carbon dioxide equivalent (CO2-e) emissions per year will be included in the carbon pricing scheme, unless exempt. The Government estimates that around 500 companies will be directly affected (including fossil fuelled electricity generators due to the emissions intensive nature of their business).
The Mechanism includes a number of Government assistance measures designed to assist the power industry transition to the introduction of a carbon price.
Power industry assistance
The Government will allocate free carbon permits to various industry sectors to assist them in transitioning to a carbon price. Assistance is designed to supports jobs and Australian industry, and also to ensure that emissions are not exported overseas if industry moves offshore. Eligibility for assistance will be based on an emissions intensity and trade exposure test. The domestic power industry does not fulfil the "trade exposure" aspect of this test, which includes meeting the threshold of having "a demonstrated lack of capacity to pass through costs due to the potential for international competition". The stationary power industry will not meet this threshold because it is not exposed to international markets for electricity.
The Government will however provide assistance to coal-fired generators under its "energy security measures". For "highly emissions-intensive" coal-fired generators (those with emissions intensities of more than 1tCO2-e/MWh of electricity), the Government will provide an assistance package of AUD$5.5 billion to assist in adjusting to the introduction of the carbon price. This assistance will take the form of cash in the first year (2012/13) and free carbon permits in subsequent years (which will be provided in equal annual instalments over the five year period to 2016/17). Eligibility for assistance will be dependent upon compliance with "power system reliability requirements" and on generators adopting clean energy investment plans to reduce their emissions.
The Government has outlined that generators may exit the market and still receive their administrative allocations if they satisfy the Australian Energy Market Operator that there is alternative capacity in the market available to meet demand, or where they have invested in new lower-emissions replacement capacity themselves. It is likely that the Energy Security Council (see below) will have a role in determining whether there is alternative capacity in the market, however as yet there is no criteria outlined which must be taken into account in making such a determination.
Closure of existing generation capacity and establishment of Energy Security Council
The Government will also seek to initiate a tender process to negotiate the closure of approximately 2000 MW of some of Australia's most emissions-intensive generation capacity (particularly coal-fired power generation) by 2020. Eligibility for participation in this process is limited to coal-fired generators with an emissions intensity of greater than 1.2t CO2-e per MWh of electricity on an "as generated" basis. In particular, it is likely that the Government is targeting Port Augusta's Playford B and Victoria's Hazelwood power stations, two of Australia's most energy intensive power stations. The market will be closely monitoring the implementation of any buy-out, including timeframes, the development of replacement generation capacity and consequential implications for wholesale electricity prices.
Medium term financing uncertainty has also been an issue of significant concern for emissions-intensive generators (particularly brown coal-fired power stations). For those generators that are not subject to Government negotiated closure, the Government will establish an Energy Security Council to advise on systemic risks to energy security arising from the financial impairment of any market participants. Further assistance dealing with financing uncertainties includes:
- Government loans provided for the purchase at auction of future vintage carbon permits for the first three years of carbon permit auctions.
- The consideration by Government of making loans available where generators need to refinance their debt, but finance is not available from the market, based upon advice by the Energy Security Council.
In both of these cases, loans will be priced on terms that encourage generators to obtain private finance where possible.
Duration of the assistance
It is also important to note that the Government assistance measures described above are not permanently enshrined, rather they are subject to ongoing assessments as to the continuing need for them. The Productivity Commission will review the impact of the Mechanism on the competitiveness of 'emissions intensive' industries in 2014-2015, and from then on at regular intervals consistent with the timing of general scheme reviews. A review may also be conducted earlier at the request of the Government. Companies may also request a review of their sector under guidelines that are yet to be formulated. Following such a review the Productivity Commission may suggest changes to the rate of assistance received, however the final determination as to the assistance measures will rest with Government.
In addition, as the carbon price increases over time, particularly as we move into the floating price period, it is widely acknowledged that these Government assistance measures are likely to be reduced. The factors relevant to this consideration include the trade exposure of the relevant industries and the risk of "carbon leakage" (the risk that industry and emissions will relocate overseas).
With the expected introduction of the Mechanism on 1 July 2012, State and Territory governments will need to consider the future of a range of regulatory schemes currently in operation in their jurisdictions. In particular, consideration will need to be given to existing carbon pricing schemes, gas and renewable target schemes, and direct renewable energy subsidisation programs.
It is widely recognised that as the federal carbon pricing policy is imposed, the state-based carbon pricing and gas fired generation target policies will fall away. The process through which this occurs will require coordination between the Federal Government and relevant State and Territory governments. Generators subject to state schemes should seek clarity as to the process through which this is to occur.
There is also debate, in the media and industry, as to the extent to which the introduction of the carbon price will negate the need for the direct subsidisation of renewable energy technologies, such as through solar feed in tariffs or other direct support mechanisms. The Federal government has made clear that it intends to continue the Large-scale Renewable Energy Target (LRET), Small-scale Renewable Energy Scheme (SRES) and other existing policies as the Mechanism is introduced. This is likely because there is a distinction to be made between the policy aims of the two kinds of policies. That is, the Mechanism is designed to drive lowest cost abatement of emissions economy wide, whereas the renewable energy support mechanisms are designed to accelerate the introduction and development of renewable energy technologies.
Considerations for the renewable energy industry
The Government has also announced a number of initiatives which are expected to encourage the further development of the renewable energy industry and increase demand for renewable products including:
- The establishment of the Clean Energy Finance Corporation (comprising experts in banking, investment and clean energy and low emission technologies) to invest AUD$10 billion over five years from 2013-14. The Corporation will invest in the commercialisation and deployment of renewable energy and enabling technologies, energy efficiency and low-emission technologies. This will not be a grant program. Rather, funding will be provided through equity investments, loans and loan guarantees. Details of the investment criteria and levels of investment will be key to the success of this program, with quite different criteria and levels being required for differing renewable technologies.
- The establishment of an independent body called the Australian Renewable Energy Agency which will administer the existing AUD$3.2 billion worth of funds that have or will be allocated to existing government grants programmes (such as the Solar Flagships scheme) which support the development of renewable energy technologies.
Issues that the renewable energy industry will need to monitor include:
- the impact of the Mechanism on the Renewable Energy Certificate (REC) price - a price that, while still suffering from the overhang of small-scale RECs in the market, may become more volatile, particularly in the flexible price phase due to the changing differential between the increase to the wholesale pool price of electricity (through the imposition of the carbon price) and the reduction in technology costs (see below)
- the consequences arising from the expiry of existing schemes, particularly the Mandatory Renewable Energy Target scheme (which includes both LRET and SRES) in 2030, which while still some time away is still within the horizon of longer term debt profiling, and
- technology costs, particularly how these will change with the significant scale-up in renewable technology investments in China under the new Chinese Government "5 year Plan" which focuses heavily on renewable power and its expansion.
Please see Carbon pricing mechanism snap shot: key features, certainty and flexibility for further details of the measures being implemented in conjunction with the Mechanism.
What this means for you
The Mechanism has the potential to significantly affect the power industry over the coming years. As indicated above, although only 500 businesses are expected to be directly liable under the scheme, the imposition of a carbon price may significantly increase the costs of emissions for energy intensive industries such as the power industry. To mitigate the impact of the Mechanism, businesses operating in the power industry will have a range of options available to them.
Pass through of costs
Entities that are directly liable under the Mechanism or that buy or sell energy intensive goods or services should review the 'change in law', 'change in tax', 'carbon cost pass-through' or other like clauses in their existing contracts and consider:
- whether they are contractually able to pass through the additional costs that are imposed through the Mechanism
- whether they are commercially in a position to pass through such costs (considering matters such as the effects of the pass through on competitiveness).
On the one hand, customers will wish to ensure that the relevant clauses incentivise the supplier to minimise the costs to be passed through under the Mechanism (for example, by including provisions requiring the supplier to use all reasonable endeavours to minimise these costs in accordance with good industry practice). A customer will also wish to ensure that, where a supplier provides services to a number of other customers, the increased costs are allocated in an equitable manner.
On the other hand, suppliers will wish to ensure that the relevant clauses:
- Provide for the ongoing, periodic assessment and pass through of both direct and indirect costs (as distinct from traditional change in law clauses which reflect the assumption that the cost impact of the change in law can be estimated up front and then applied over the unit price of the relevant goods and services).
- Capture costs that are imposed on, or assumed by, another entity within the supplier's group (such as the supplier's holding company).
Entities that are directly liable under the Mechanism will need to develop policies and procedures setting out how they intend to manage that liability including determining:
- Which entity within the corporate group has operational control of the project or facility.
- Whether it is entitled to and appropriate to transfer that liability under existing corporate structures and joint venture agreements. Currently, the Mechanism allows for the operator to apply for a liability transfer certificate to transfer liability to another member of its corporate group, a person outside of its corporate group that has financial control over the facility or in respect of an operator of an unincorporated joint venture, to the joint venture participants in proportion to their interest in the facility.
- How to manage and mitigate that liability (for example, through the purchase of carbon permits or domestic or international offsets in the most cost effective way).
- Whether the costs associated with that liability can be passed through under the various contractual arrangements entered into with third parties.
- Whether any of the financial assistance measures detailed by the Government are available.
The directors and officers of such companies should also ensure that the company has in place strategies to manage that liability including by investing in lower emission or renewable energy intensive technologies.
Continuous disclosure under the ASX Listing Rules
Finally, listed entities should consider the extent to which the Mechanism will affect their existing or planned operations, and whether that information should be disclosed to the market in compliance with ASX Listing Rule 3.1.
If you would like further information about the impact of the Government's Clean Energy Future package on the power and renewable energy industries, please contact a member of the Australian energy team.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.