Maintaining the commons

Maintaining the commons

In defence of renewable energy targets

The carbon price is not enough to incentivise renewable energy farms. Brian Robert Marshall

Power prices are a hot political topic at the moment. While politicians argue about who is to blame for higher prices, the renewable energy target (RET) is also being reviewed.

The RET has been the focus of considerable debate since the introduction of the carbon pricing scheme. Critics of the target argue that it is redundant or that it interferes with the working of the carbon pricing scheme leading to a distortion of market processes. Australian industry groups, such as the Australian Chamber of Commerce and Industry, highlight the costs to consumers and other energy users and are calling for it to be abolished.

There are undoubtedly aspects of the RET that need fine tuning. But it is not redundant, it corrects market distortions rather than distorts the market, and the cost of the target pales in comparison to network costs and the costs of exorbitant profit margins in the electricity supply industry.

The renewable energy target is not redundant

The renewable energy target ensures that 20% of Australia’s electricity supply comes from renewable sources by 2020. By requiring electricity retailers to purchase renewable energy certificates (RECs), the large-scale renewable energy target (LRET) creates an incentive for additional electricity generation from wind and solar farms (there is also a small-scale renewable energy target (SRET) encouraging roof top renewable energy).

While the carbon pricing scheme also creates an incentive for renewable energy, it is not enough to meet a target of 20% by 2020. In general, the carbon price only causes switching between coal-fired and gas-fired electricity generation.

In fact, according to the Garnaut Review, a carbon price of around $40 would be required to create enough incentive for renewable generators to enter the market. But a carbon price at this level is unlikely in the foreseeable future. The Australian carbon price will revert to the international price in 2015 (currently around $AU8 and subject to significant price collapses) as domestic producers offset a significant amount of their emissions by purchasing international carbon credits. The promised three-year floor price at $15 would help but this is currently under threat from industry and the sudden need to pass additional legislation.

The renewable energy target corrects market distortions

Critics of the RET argue that we should simply leave it to the market to decide how carbon emissions are reduced to the desired levels and not have a target for renewables at all. For example, the Independent Pricing and Regulatory Tribunal (IPART) argues that the RET is distortionary if it leads to a greater level of renewable energy generation than the carbon price would deliver.

However, rather than distorting market processes, the RET corrects market distortions. The first distortion it helps to correct is the external cost created by carbon emissions and the emissions of sulphur dioxide and nitrogen oxide. Fossil-fuel producers and therefore electricity retailers (and electricity users) have not paid the full social cost of their output (or consumption) in the past. Creating a standard for renewable energy internalises this social cost.

The carbon price also works to internalise this externality. But there is nothing to suggest that it, nor even the current RET, does enough to completely correct the distortion. In contrast to IPART’s implied assertion, the carbon price is not an “efficient” price. It is merely the assumed worldwide price needed to meet what is considered to be a reasonable target of 550 ppm of carbon dioxide in the atmosphere.

Second, the RET corrects the market distortion created by past (and current) government subsidies. These have created technological lock-in to a system of fossil-fuel generation. The RET helps to break this market distortion by encouraging renewable energy over and above the carbon price’s incentive effect.

The RET also helps to overcome other market distortions, such as the lower financing costs of fossil-fuel generators and the uncertainty created by a fluctuating carbon price. Renewable generators can guarantee a price and demand and are more likely to invest and innovate.

The costs of the renewable energy target are minimal

Of course, the RET, like a much higher carbon price, does add to household electricity costs. As the review process continues, you will hear a lot about this from players in the electricity generation industry, industry associations and climate deniers. The estimate is that the LRET adds around $32 per year per average customer: it’s around 1-2% of the total yearly electricity bill. The cost of the SRET is higher, at $64 per year, but this will come down as the controversial solar credits scheme is phased out.

In my previous post I pointed out that costs such as these pale in comparison to questionable increases in network upgrades. They also pale in comparison to the extraordinary profits received by electricity generators, network owners and electricity retailers and the impact of market manipulation on electricity prices by big fossil-fuel generators.

The RET could also reduce prices in the future. This will occur if renewable energy generators develop better technology which reduces their unit costs of production (economies of scale). For example, the recent Australian Energy Technology Assessment report highlights the dramatic reduction in costs of solar PV technologies in the last three years due to the rapid increase in global production of photovoltaic cells.

This will be especially important if the carbon price does rise in the future to the levels the government predicts. In this case, an established wind and solar energy system will reduce the costs to consumers. Without the RET, these technologies would not be ready, or advanced enough, to take over from fossil-fuel generators.

Finally, because renewable energy generators have low marginal costs of production (but high capital costs) they can change the merit order in the national electricity market thus reducing wholesale electricity prices. This has already occurred in Germany, which has a greater proportion of renewables. Solar power, for example, has its peak generating capacity during the afternoon peak-load time and they can supply the market at low prices.

This has reduced peak-time electricity prices by up to 40%. That, in turn, has reduced the profits of fossil-fuel generators.

Perhaps this is where the issue lies.