Blog | 20th Apr, 2011

Mark Wakeham in the Climate Spectator

There are two debates swirling around a price on pollution in Australia. First there’s the vitriolic tug of war between the public interest and big polluters, fanned by Tony Abbott and certain shock jocks who will stop at nothing in using the ‘carbon tax’ to damage the Gillard government.

Elsewhere there is a more polite and complex debate that accepts that charging Australia’s 1000 largest emitters for their pollution is the most economically efficient means of reducing pollution across the economy. This debate is about how to design a price on carbon so that it delivers the maximum public and environmental benefit. This is the question before the MPCCC (Multi-Party Committee on Climate Change), and one of the key sticking points for negotiations will be how to treat electricity generators and their calls for compensation, with the ALP and Greens poles apart on the issue.

Last time around, the Rudd government’s CPRS offered $7.3 billion worth of compensation with very few strings attached via the Electricity Sector Adjustment Scheme (ESAS). Compensation was based on emissions intensity so, perversely, the most polluting power stations were thrown a lifeline in the form of free permits for the first 10 years of the scheme. This arrangement prompted Professor Garnaut to write, “Never in the history of Australian public finance has so much been given without public policy purpose, by so many to so few.”

This time around, the generators are seeking at least as much compensation as was on the table in 2009. However there are two key developments since the CPRS that diminish the case for generator compensation even further.

Firstly, this time around we’ll have no cap on emissions, at least in the first years of the scheme, and with no trading scheme the generators are seeking fistfuls of cash rather than pollution permits. While ESAS was heavily criticised, it was argued by some that it had little environmental impact because the cap would ensure that the emissions reductions were delivered. However under a fixed levy, with no immediate cap, compensation for electricity generators will soften the price signal, present a barrier to new entrants and lead to inferior environmental outcomes.

Secondly, over the past two years the price of black coal has increased significantly, transforming the economics of electricity generation. For instance, in March 2009 the average price of exported Australian thermal coal was $US65.36, while in January 2011 it was $US141.94 per tonne. Coal costs are a major cost of production at power stations with exposure to internationally traded coal prices. While these operators are still profitable, they are much less profitable than power stations with long-term coal contracts or cheap coal supplies.

With the introduction of a price on carbon, if the black coal power stations cannot raise their sales price due to competition with lower cost brown coal producers, their operating profits will be heavily hit and production could be reduced or plants closed.

So even though the whole purpose of introducing a price on pollution is to encourage cleaner generation and replacement of old plants, it may be that the first power station closures are not the most polluting power stations since the emissions-intensive brown coal power stations have significant fuel cost advantages.

Under a cap-and-trade scheme this might be viewed as an economic outcome with no environmental consequences. However under a fixed levy it is a perverse outcome that does not maximise emissions reductions. This risk is greatest with a low carbon price, as the lower the carbon price, the greater the competitive advantage of brown coal generators.

If government provides assistance to generators based on historical emissions (as under ESAS) this issue will be magnified. The likely outcome would be that large amounts of compensation would be given to the most polluting power stations to continue operation even though they were likely to continue operating anyway. Significant wealth transfers will take place with little or no public benefit and a sub-optimal environmental outcome.

Without a cap, the most sensible approach would be to rule out any compensation for electricity generators to ensure that the price signal delivers the desired emissions reduction outcome.

However if the government is hell-bent on making some compensation available for generators at the expense of households, renewable energy development and climate programs, this money must be used to close our most polluting power stations and maximise the emissions reductions of the scheme.

Paying generators to retire power stations has been proposed previously in Australia. As part of their climate change white paper, the Brumby government in Victoria was planning a competitive tender into which generators could bid to retire coal plants. Power stations would bid against each other to access ‘closure funds’ which would put downward pressure on the total cost of any compensation.

A similar approach nationally, whereby generators can access compensation but only as part of a closure plan, would reduce the perverse environmental impacts of compensation. In this way the scheme could facilitate the replacement of the nation’s most polluting power stations like Hazelwood, Morwell and Yallourn in Victoria, Munmorah and Redbank in NSW and Playford in SA.

If this approach was taken, it would be critical to earmark significant funding to develop new industries and retrain workers in coal regions to soften the job loss impacts of power station retirement.

Finally, returning to the politics of the issue; community perception about the proposed price on carbon will be critical to the scheme’s acceptance. A clear signal that power stations like Hazelwood will be replaced as a consequence of a price on carbon would be a tangible demonstration that the price on pollution is cleaning up and modernising our electricity supply.

Research commissioned by Environment Victoria in 2009 showed that support for actions to reduce emissions was highest when there was a tangible result, like replacing Hazelwood power station, Australia’s least efficient electricity generator.

The MPCCC has a huge task before it to broker agreement on the design of a price on carbon. Over the next two months it will need to hang tough and withstand the pressure of the naysayers and doom-mongers. However it will also need to develop new policy approaches to build consensus.

Thinking on electricity sector assistance needs to go back to the drawing board to ensure that the scheme delivers for the environment and the public interest. Otherwise the price on pollution will meet with the same public indifference that befell the CPRS. As Einstein said, “Insanity is doing the same things again and again and expecting different results”. The last thing we need in the price on carbon discourse is more insanity.

This article, publiched in the Climate Spectator on Wednesday, 20 April 2011, is based on an Environment Victoria submission to the Federal Multi-Party Committee on Climate Change which was developed with the assistance of Bruce Mountain of Carbon Market Economics. Check it out here