The impact of Direct Action on eastern Australia's energy markets
17 September 2014
Chloe Munro, Chair
Contents
Introduction
Many of you are clients of ours and you'll be familiar with some or all of the legislation we administer.
Essentially we are an independent economic regulator with an environmental objective.
We administer the market and regulatory mechanisms which create incentives for business to measure, manage, reduce or offset carbon emissions and for investment in renewable energy.
We summarise our purpose as "accelerating carbon abatement for Australia".
If there's one thing I hear more from business than any other, it's a plea for policy certainty.
However, the reality is that business interests are the first to argue for change if they disagree with the policy settings.
And the reality is that if events do not pan out as forecast when policies are made, the settings are likely to be re-examined.
As an independent regulator, I can't hold out a promise of policy certainty, but I can offer certainty as to how the polices are applied.
We've built an excellent reputation for the way we go about our job based on active engagement with our clients.
Our first priority is to administer the law as it is. We keep our clients informed at every step about what they need to do to discharge their obligations.
We continue to improve our systems and processes to make it easier to do business with us. We involve our clients in the design decisions and user testing.
We publish plenty of guidance up front and we are open and transparent about the decisions we make.
Where permitted by law we publish data to help decision-making in the market.
Although a lot of change has taken place and more is on the horizon, you can also see a degree of continuity in our schemes.
The National Greenhouse and Energy Reporting Scheme, which is now in its seventh year of operation, is a trusted and authoritative source of information covering over 60 per cent of Australia's greenhouse gas emissions.
National Greenhouse and Energy Reporting data will underpin the operations of the Emission Reduction Fund, just as they underpinned the carbon pricing mechanism.
Just a reminder for National Greenhouse and Energy reporters - we are now coming up towards the 31 October deadline for the 2013-14 reporting year. Information is available on our website on the most recent upgrades to our Emissions Energy Reporting System, including to accommodate legislative amendments. Some of you may have already attended webinars we are currently hosting. Look on our website for more details of these.
I appreciate that the imposition and repeal of the carbon tax have been very significant issues for the energy industry. This has not stood in the way of a constructive relationship with all our energy sector clients and exceptionally high rates of voluntary compliance.
Fortunately perhaps for me, the downstream pricing issues from the carbon tax repeal are the purview of the ACCC and I won't discuss them today.
For the carbon tax itself, we've achieved close to 100 per cent compliance right across the board. We expect this to continue through to the final true-up in February 2015.
Just as the National Greenhouse and Energy Reporting Scheme continues in its current form, so to a large extent does the Carbon Farming Initiative. To date, the Carbon Farming Initiative has had only limited relevance to the energy sector, however it provides the architecture for the crediting arm of the Emissions Reduction Fund and it will have much broader application in future.
Before I discuss what is planned for the Emissions Reduction Fund, I'd like to spend a few minutes on the Renewable Energy Target.
RET Review
First of all, as Ministers have pointed out, the report of the expert panel is a report to the government, not by the government. I don't make any assumptions about how the government might respond to the recommendations or what changes, if any, might be legislated through the parliament.
What is clear, however, is that on any scenario short of outright repeal, the basic architecture would remain in place. The offer of administrative continuity may be cold comfort to those who fear significant discontinuity to their business interests. Nevertheless we do see a role for the Regulator in smoothing any transition that might occur.
So let me just run through the narrative that I believe was established by the report of the expert panel:
- "The panel found that the Renewable Energy Target has broadly met its objectives."
- "The administration of the Renewable Energy Target is generally efficient and meets the expectations of stakeholders".
That's a tick for the Regulator.
Nevertheless, the expert panel sounds a warning based on the un-forecast success of the small scale scheme and the un-forecast decline in electricity demand.
These observations beg the question whether the Renewable Energy Target has been too successful.
I have here extracts from the report:
- "Installations of small-scale systems have exceeded expectations, with output from these systems already exceeding levels anticipated for 2020."
- "Electricity demand in 2020 is now expected to be much lower … the cost of renewable technologies has fallen."
- "The Renewable Energy Target could achieve a 26 per cent share of electricity from renewable sources by 2020."
- "…The economic landscape has shifted…leading to questions about whether the objectives for the Renewable Energy Target remain appropriate."
That is the debate that the RET review has put into play: do the objectives for the Renewable Energy Target remain appropriate?
As I've commented before, the Renewable Energy (Electricity) Act 2000 is predicated on a view that increasing the proportion of renewables in our energy mix is a good thing in its own right or that it will have long term benefits that are not otherwise captured in economic modelling.
This is now up for debate alongside the distributional question. Which players in the industry should wear the impact of change?
The panel report has as its first recommendation:
- "The Renewable Energy Target should be amended in light of the changing circumstances in Australia's main electricity markets and the availability of lower cost emission abatement alternatives."
And here is the link to the Emissions Reduction Fund:
- The report says "a policy targeted directly at CO2-e emissions reduction would be more efficient than a policy such as the Renewable Energy Target that may promote renewable generation ahead of other lower cost abatement opportunities in other areas of the economy. The Government has repealed the carbon tax and is adopting the Emissions Reduction Fund as the primary mechanism for meeting the 2020 target."
The role of the energy sector in carbon abatement
The report of the expert panel is not the first to point out that renewable electricity generation is not necessarily the lowest cost source of carbon abatement. We do expect that the Emissions Reduction Fund will be able to purchase abatement at a lower price than the estimates of the average cost per tonne of abatement from renewable electricity generation.
Nevertheless, policies, including the Emissions Reduction Fund, are required to meet Australia's 5 per cent CO2-e emissions reduction target. Electricity generation contributes over a third of Australia's greenhouse gas emissions. Even allowing for the very modest reduction we've seen over the last couple of years, it doesn't seem likely that Australia's emissions reductions targets could be met without some reduction in emissions intensity of electricity production and consumption.
In 2012, Australia's emissions were 555 million tonnes of carbon dioxide equivalent (tCO2-e), with these emissions sources spread across the economy.
- Electricity generation contributed just over one-third of total emissions (193 MtCO2-e).
- Of the top ten facilities by emissions, only one is a facility which is not a generator.
The dynamics of the energy market more generally will have a profound influence on Australia's emissions trajectory. Gas pricing, network regulation, the disruptive potential of battery technology and the internet of things, along with the rise of the prosumer, will all have an impact. It can't be assumed that all these influences will be benign from an emissions perspective.
I would therefore argue that just as the policy settings for renewables and other climate change measures have been called into question in light of their impact on the energy industry, so the policy settings for the energy industry can, and should, be examined for their impact on greenhouse gas emissions.
As far as I can see, there are three ways in which the energy sector can contribute to the emissions reduction task:
- The first is largely in the hands of your customers – increasing energy efficiency or otherwise reducing demand.
- The second is in the hands of upstream producers – reducing fugitive emissions – which are currently forecast to grow significantly in tandem with growing energy exports. Both of these approaches may be assisted by the Emissions Reduction Fund.
- The third way is to reduce the emissions intensity of your facilities and specifically electricity generation. A step change will require the replacement of old generation capacity with new.
What the RET Review has shown, if it wasn't already well understood, is that while the Renewable Energy Target could incentivise investment in additional renewable electricity generation capacity; it could not incentivise decommissioning of older high emissions power stations.
A number of parties are now musing on this question, including most recently the Chairman of AGL, Jeremy Maycock, and the Chair of the Climate Change Authority, Bernie Fraser. Bernie went as far as to suggest that the Emissions Reduction Fund could play a role in this too.
The Emissions Reduction Fund
The Emissions Reduction Fund is designed to provide incentives to adopt new practices and technologies which reduce emissions.
It has three components: crediting emissions reductions, purchasing emissions reductions, and safeguarding emissions reductions.
Each of these components could have an impact on energy markets, depending on how market participants and their customers take up the opportunities and respond to the safeguard.
Crediting genuine emissions reductions
Projects are eligible to participate if they are meet some basic additionality tests – they're new, they go beyond standard business activities and they are not required by regulation or funded by other government programmes. They also need to comply with a method which allows the abatement to be measured.
When an eligible project submits a report on the abatement it has achieved, it receives one Australian carbon credit unit for each tonne of CO2 equivalent of sequestered carbon or avoided emissions. This is exactly how the Carbon Farming Initiative works today.
Unlike the carbon farming initiative, the Emissions Reduction Fund will be open to a much wider range of methods beyond the land sector. The scheme will apply to a wide range of productivity-enhancing activities such as:
- upgrading commercial buildings
- improving energy efficiency of industrial and other facilities, including power stations
- capturing waste coal mine gas,
- upgrading vehicles and improving transport logistics, and many others.
Proponents of very large projects, which have the potential to deliver more than 250,000 tonnes of abatement per year, can propose the priority development of bespoke methods. This would certainly be necessary for any proposal to retire generation capacity. While overcapacity persists and because of the pooled nature of electricity markets, the measurement question is not trivial.
Purchasing emissions reductions
The Clean Energy Regulator will enter into contracts with project owners to purchase Australian carbon credit units from them over a period of years. We've already consulted with stakeholders on the standard form of these contracts – they're on straightforward commercial terms based on payment for delivery against an agreed schedule.
Most of the feedback has been about contract length –which the government is currently considering – and whether the contract should be firm or non-firm. We intend to allow a modest degree of flexibility in this regard but the contract is not simply a put option. However the contractor is not tied to their own project and can deliver Australian carbon credit units from any source. We have seen a very healthy secondary market develop in our existing schemes and we see a role for it in the Emissions Reduction Fund too.
Turning to price: our goal is simply to buy as much abatement as we can for the funds available.
Purchasing takes place through a process which selects between offers purely on price. The White Paper specifies a simple single-round sealed bid process for the initial auctions. We will have the flexibility to adapt the process as the market develops.
To participate in an auction, you'll need to have an eligible project and agree to the contract terms in advance. We'll assess the credibility of your proposed delivery schedule, before you can register for the auction. This will prevent the auction from being distorted by offers based on highly unrealistic assumptions or projects which have no hope of proceeding. We're planning this step now and we will consult on the minimum information necessary and the best way to capture it.
The auction itself will be a very simple process.
The Clean Energy Regulator will accept offers in order of unit price up to a limit of 80 per cent of the volume of abatement offered at that auction.
Having a cut-off point will enhance competition and encourage bidders to offer the lowest price at which it would be worth their while to carry out their abatement project.
We will pay as bid and as a result we expect to purchase at a range of price points. Large projects will have a significant influence on the average prices and so we will be particularly concerned to see them priced competitively.
Once both the Regulator and the market have better information about prices offered and accepted it is likely that a more sophisticated auction format will be required to force price disclosure.
From consultations, we expect to see a few different business models emerging:
- Specialist aggregators like those operating in the Renewable Energy Target and Carbon Farming Initiative and in the state-based energy efficiency schemes. Energy retailers could potentially become aggregators by offering new energy management products to their customers
- Intermediaries or project owners who anticipate very variable production levels who will operate purely in the secondary market
- Businesses with major facilities that can identify process improvements or plant upgrade that would reduce their emissions, possibly to stay within the baseline set for them under the safeguard mechanism. This could certainly apply to energy industry facilities.
Safeguarding emissions reductions
The third pillar is a mechanism to lock in the gains made through the purchasing mechanism by constraining growth in emissions elsewhere in the economy. The safeguard mechanism will apply only to the largest emitters and will work through the National Greenhouse and Energy Reporting framework. Businesses covered by the safeguard will be required to keep their emissions below a set baseline.
Emissions baselines will be set using data reported under the National Greenhouse and Energy Reporting Scheme.
They will be based on absolute emissions over a historical period. To accommodate factors such as natural variability in emissions, production levels and changes in the types of inputs used, safeguard baselines will be set using the highest level of reported emissions for a facility over the historical period 2009–10 to 2013–14.
The Government has indicated that it will include flexibility to accommodate significant expansions in production, and to establish baselines for new facilities.
The White Paper acknowledges that a separate approach may be preferable in applying the safeguard to the electricity generation sector, as suggested by the Energy Supply Association of Australia. Further consultation will be required on how such an alternative might work. Issues might include how to take into account the outlook for grid-supplied electricity demand and indeed how to take into account any decisions on the future of the Renewable Energy Target.
The general principle of the Emissions Reduction Fund is that entities covered by the safeguard can take advantage of Emissions Reduction Fund funded projects to bring their emissions below their baseline. However if there are special arrangements for the electricity generation sector, there may be some circularity in the measurement of abatement attributable to a single project against the emissions baseline of the sector as a whole. This is one of many issues that will need to be resolved through consultation.
More broadly, consultations run by the Department of the Environment are underway about how baselines will be set and about compliance options. It's in everyone's interests to have well-considered input so that the new mechanisms can work effectively to achieve their aims. I encourage you all to participate actively in those discussions. You will be affected by the end result as much as any other industry.
Australia does have an emissions reduction target and policies are required to meet Australia's 5 per cent CO2-e emissions reduction target and longer term goals. Both the purchasing and the safeguard components of the Emissions Reduction Fund are necessary to shift our trajectory emissions in the right direction.
Conclusion
It remains to be seen what scale of contribution will be made by The Renewable Energy Target in the future. Regardless of this, other aspects of energy policy and importantly, investment decisions made by your industry will also shape Australia's emissions trajectory.
My job is to administer laws that help accelerate carbon abatement for Australia. Eastern Australia's energy markets have been and will continue to be critical to the success of that endeavour.