Carbon scheme design may unnecessarily drive up energy prices

31 August 2011

The Federal Government’s decision to force electricity generators to pay for emissions permits worth billions of dollars up to three years in advance of when they actually emit could increase retail prices significantly, according to independent research commissioned by the Energy Supply Association of Australia (esaa).

Interim esaa CEO Clare Savage said electricity generators will need to lock in future prices for carbon in order to continue to offer retailers and large customers future electricity contracts.

However, the Government’s proposal in the Clean Energy Future package that generators pay for these emissions permits years in advance of when they’re actually required is designed to get cash in the door early to prop up the Commonwealth Budget. This risks avoidable rises in electricity prices in addition to the carbon price.

Ms Savage said ACIL Tasman modelling shows that even a 5 per cent reduction in electricity contracting could result in at least a 10 per cent increase in retail prices in a single year for small users (households and small businesses) and up to a 15 per cent increase for large users.

 “Generators currently contract around 80-90 per cent of their electricity, which creates market stability and as a result, ensures lower prices for consumers. If generators can’t afford to pay years in advance for future emissions permits then they will have to reduce their electricity contracting.

“This modelling by highly respected economic modelling firm ACIL Tasman indicates with fewer future energy contracts being entered into, the likely result will be a more volatile and expensive electricity market and higher electricity prices for consumers,” Ms Savage said.

“As with other key inputs, such as coal and gas, it is only fair generators should be able to enter a contract to purchase future emissions, and pay for the permits when they actually need them,” she said.

“Forcing generators – who will already be heavily impacted by the carbon price – to pay for permits in 2012, that they won’t receive revenues to pay for until 2015, is an unfair and unjustifiable cash grab.

“If generators can’t secure a future price for their carbon emissions then it will be harder to price and sell future electricity contracts and this approach by the Government could force the typical prudent generator to forego future electricity contracting, with potential implications on its forward generation fuel purchases.

“This is an added risk to energy affordability the Government could fix with the stroke of a pen, by simply agreeing to amend its Clean Energy Future legislation to ensure permits are paid for by generators when they receive them – in the year they actually emit the carbon” said Ms Savage.

The ACIL Tasman modelling is available on the esaa website: http://www.esaa.com.au/content/detail/national_electricity_market_modelling_ACILTasman.

Ends.


Media contact:    Caroline Page     0421 103 089
The Energy Supply Association of Australia seeks to positively influence government policy decisions to ensure that Australia enjoys the benefits of a safe, secure, reliable, sustainable and competitively priced electricity and natural gas supply.
esaa’s 40-plus member businesses have more than $120 billion in assets and infrastructure investment plans worth over $49 billion over the next five years. The Association is fuel and technology neutral and member businesses have investments across a wide range of fossil fuel and renewable generation technologies.


Background
Electricity contracting, usually at least 3-5 years in advance, is a critical feature of the National Electricity Market (NEM) to manage risk and uncertainty around potentially volatile spot prices. Generators require the ability to hedge spot prices to underpin financing while retailers need to be able to offer fixed price retail contracts to end users. Both generators and retailers need to lock in revenues/costs respectively to ensure they can meet their financial obligations.
esaa has long held concerns that carbon pricing could reduce contracting levels in the electricity market through asset value impairment and inappropriate permit auction design. This is because:

• Asset impairment could affect counterparty willingness to contract with generators.
• Generators’ financial positions may mean they lose their licence to trade electricity financial products and hence their ability to trade directly in the electricity spot market.
• Generators will not have the cash flows to settle permit contracts years in advance of when they receive revenues and when the emission liability occurs. Generators may be unable to lock in a future price for carbon and therefore be unwilling to offer fixed price forward electricity contracts.

Reduced contracting could lead to wholesale market instability and higher prices for consumers. This issue has been picked up qualitatively in a number of recent reports, including advice from the Australian Energy Market Commission and the Government appointed Investment Reference Group.
esaa has contracted ACIL Tasman to undertake a quantitative study into the impact of reduced levels of electricity contracting on electricity prices in the NEM.

The study considered a reference case to 2020, which includes the Clean Energy Future carbon price, and three sensitivities simulating lower contract levels. The three sensitivities were:

• A 5% reduction in contract volumes as a % of demand across all regions across all years of the projection.
• A 10% reduction in contract volumes in Victoria and a 5% reduction in contract volumes in all other regions as a % of demand across all years of the projection.
• A 15% reduction in contract volumes as % of demand across all regions across all years of the projection.

The results are striking.
While we would not expect reduced contracting levels to persist for more than a year or two (there would be incentives on all sides to resume contracting as soon as practically possible), even just a 5% reduction in electricity contracting could result in at least a 10% increase in retail prices in a single year for small end-users and up to 15% increase for large-end users. This is in addition to the carbon price. If contracting was to unwind any further than this the potential price rises could be double or even four times this. In addition, the market is forecast to be significantly more volatile.
At least part of the answer is simple.
The Clean Energy Future Bill should allow electricity generators to contract with the Government for future emission permits and settle those contracts when they receive the permit in the year they actually emit the carbon. This would be consistent with how other key electricity generating inputs – such as coal or gas – are currently settled.
For the Government – with a much lower cost of capital than the energy industry– to risk unnecessary price rises and require payment upfront and years in advance of when the permit is actually required represents serious policy failure.