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Renewable energy tariffs, subsidies, targets: are such policies needed under a carbon price?

With the anticipated introduction of an Australia-wide carbon pricing scheme, there have been some calls to rationalise or scrap targeted climate policies, such as renewable energy support schemes, both…

Everyone has an opinion on how best to fund renewable energy. kincuri/Flickr

With the anticipated introduction of an Australia-wide carbon pricing scheme, there have been some calls to rationalise or scrap targeted climate policies, such as renewable energy support schemes, both at the state and Federal level.

For example, the Federal Climate Change Minister Greg Combet has recently questioned the efficiency and equity of state-based solar feed-in tariffs which pay owners a premium on electricity fed back into the grid.

The WA Premier Colin Barnett and the Business Council of Australia have called for the removal of the national Renewable Energy Target. This requires electricity retailers to source a percentage of their electricity from renewables and is, to date, one of Australia’s most successful policies in terms of aggregate greenhouse gas emission reductions.

Picking winners or letting the market decide

There is a plausible reason for wanting to pull back or abandon such programs. Theoretically, a national carbon pricing scheme is the most cost-efficient means of reducing greenhouse gas emissions. The price permeates throughout the economy and allows businesses and households, rather than governments, to choose their best (cheapest) carbon abatement options.

Policies that target emission reductions in specific sectors (such as solar PV) distort this system by pushing resources towards potentially more expensive abatement options.

This is commonly claimed to be the cost of governments attempting to “pick winners”.

The costs of such distortions may be significant. For instance, a recent Productivity Commission report estimates that various clean energy policies in Australia’s electricity sector cost between $44 and $99 per tonne of CO2 abated. Their modelling suggests that the same level of abatement could be achieved with a carbon price of $9 per tonne.

A further complication arises when the government’s proposed carbon pricing scheme transitions to a cap-and-trade system after the third year. Any additional climate policies covering emissions within the scope of the scheme will have no effect on Australia’s aggregate emissions, which would be determined by a national cap.

Policy in the real world

However, for all the simple elegance of the carbon pricing solution, most economists recognise that real-world complications provide a number of rationales for additional government policy action.

These include so-called “market failures” that can undermine the effectiveness of a carbon pricing signal. The best known is the “public good” nature of research and development (R&D) that may lead to private sector underinvestment in new technologies.

Closely related are distortions such as various continuing subsidies for fossil fuels estimated by the Australia Institute to be $9 billion per year and electricity regulations that bias against renewable energy deployment.

There are also other public objectives that may be achieved through supporting renewable energy. These include the growth of “green jobs” and the export benefits from international leadership in emerging renewable technologies.

Renewable energy may also provide greater security against international oil and gas price shocks.

Finally, a robust approach to climate policy may suggest that it is unwise to conflate all mitigation action to a single instrument or level of government. Instruments can fail and governments can “drop the ball”. A portfolio of policies, at different levels of government, may reduce this risk.

Implications for policy design

The significance of these rationales – and whether it is worth the cost of trying to address them - is up for debate.

Certainly they cannot justify a “pay whatever it takes” approach to renewable energy support policies. Furthermore, some arguments may apply equally well to other low carbon technologies.

However, they should caution us when we interpret the apparently very high cost of many renewable support policies. Such studies typically do not account for many of the future benefits that such schemes may be driving.

They also suggest that, ideally, renewable policies should be directed at solving the identified market failures, distortions, and other social objectives.

Thus, for example, grants and loans directed at R&D and demonstration programs for new renewable technologies is the main basis for the increased funding for renewable energy in the recent Clean Energy Future package. This approach is supported by economists such as those at the Productivity Commission and Ross Garnaut.

Much more controversial are schemes directed at the commercialisation end of renewable deployment, such as the national Renewable Energy Target or solar feed-in tariffs. These may be justified as attempting to “make up” for all the residual market failures, distortions and other policy objectives that could not be addressed directly.

However, determining the socially best level of support is difficult, to say the least.

Fair shake of the renewables sauce bottle

Finally, care needs to be taken as to the equity of certain schemes. For example, solar feed-in tariffs have largely been taken up by high-income households. Low-income households lack the financing options to cope with the up-front costs of solar PV technology or are renting and therefore unable to invest.

The funds dedicated to feed-in tariffs could be redirected to support low-income households and help them transition. For example, the UK “pay-as-you-save” scheme provides loans which permanently remain with the property rather than the householder. These provide incentives for those expecting to move. This could be adjusted to deal with tenant-landlord relationships.

A long way from a stable carbon pricing scheme

Australia is still a long way from having a stable, credible carbon pricing scheme, making decisions on complementary policies premature.

If the scheme eventuates, the debate on complementary policies will be a complex one as the simple carbon-price-fixes-all argument clearly does not hold.

There will undoubtedly be a role for public support of renewable energy at the state and Federal level. But there may well be good reason for harmonising, redirecting and scrapping some schemes.

At the same time, we should be very wary of empowering all climate mitigation control into one level of government or into a very limited number of policy instruments.

We need to accept that a robust approach to climate policy may require sacrificing some short term efficiencies in order to achieve a more enduring and successful climate policy outcome.