Merry-go-round confusion

Judging by comments on the net and the press and in general public discourse, it appears that there’s still confusion between the role of the carbon price signal and the role of the distribution of proceeds from revenue raised. The latter has derisorily been referred to as a great big merry-go-round. Here’s an example of one such comment…

A carbon tax would be a useful mechanism if it will generate a price signal that will lead to lower carbon emissions.
If this were the government’s proposal there would be very little that could be said against it. But instead of returning the revenue to the payers, it plans to create a bucket of money that then needs to be distributed.

If the carbon tax were returned to the payers, electricity prices would not dramatically increase, coal producers would be subjected to a levy, but would get a rebate if their coal mines were no worse than the average, and so on.
Instead, the government has set out to do a major redistribution of income, under the guise of doing something about greenhouse gases, but not actually doing anything. The Greens are frustrated, but they are also wedded to a gigantic money-go-around

The key to understanding the distinction here is to remember that it is the carbon price that drives decision making, including capital allocation. It does this by changing the economics of energy supply, incentivising lower emission sources and penalising higher emission sources. The distribution of equity from the government’s sale of permits is merely an allocation of wealth, which doesn’t affect decision-making. You would make the same decision in each case whether you were freely allocated or had to buy all your permits; the only thing that would change is your shareholder wealth, that is the equity on your balance sheet.

That’s where the quote above gets it wrong, and where we can learn from the European experience. The early scheme designers thought, in error, that if you distribute revenue to emitters that they will not pass through the costs and electricity prices will remain low. But any economist will tell you that it ignores opportunity cost. Regardless of whether they have a cash cost or not, emitters will value the permits at the value they could achieve if they sold them at market price. So what happened? The emitters pocketed the permits and passed through the costs anyway, hence the windfall gain.

Philosophically, auctioning vs free allocation comes down to who you think initially “owns” the right to emit CO2. The emitters in the early schemes effectively argued that they had previously enjoyed that right and that therefore an initial allocation to them was logical. Governments are arguing, on behalf of taxpayers, that the right to emit is “owned” by the community, and that it had previously been conferred on industry at zero cost. If it’s owned by taxpayers, then taxpayers have a right to decide how best to distribute this equity through the economy.

Historically, cap-and-trade systems have been based on a very small amount of permits being auctioned; normally less than 5%. This is the basis upon which the US SOx and NOx trading schemes were initiated back in the 1990’s, and is also where the EU ETS is at the moment.

When you hear carbon price detractors say that the EU ETS only raised $2.5b over its history relative to the $11.5b proposed from the Australian carbon price in one year, this is because a very small proportion of the carbon value was auctioned. The actual size of the EU ETS in Phase II is over $100b per year, ten times the size of the Australian scheme. Note that Phase III of the EU ETS envisages a move towards greater use of auctioning rather than free allocation, starting with 100% auctioning to the power sector in 2013. However, you measure the effectiveness of the scheme by the impact of the carbon price and the reduction in emissions relative to what would otherwise be the case, not how much revenue is raised.

So where does the value go if only 5% is auctioned? In these early schemes, most of the permits were freely allocated to the emitters. In some cases this led to “windfall gains” because not only did shareholders of these companies enjoy the value of the permits, but they could also pass on the carbon costs and receive a profit uplift anyway.

Imagine a scenario where there is no revenue collected by government, that the permits are 100% allocated to emitter for free. The emitters would be better off, in aggregate, to the tune of $11.5b. Compare this with the other extreme, where the government sold all the permits (ie under a fixed price ETS or 100% auctioning under a cap-and-trade floating price ETS). There would still be a carbon price (eg $20/tCO2e) but the government would be better off by $11.5bn, and could effectively choose to hang on to this as general revenue. In between these two extremes, you then have the “merry-go-round” to decide where to place this value; it’s effectively a distribution of equity and policy designers around the world have gravitated towards distributing it to those sectors of the community most affected …. lower income households and trade exposed industry. The alternative is to have these sectors face higher costs without any compensation, which would make it extremely politically difficult to implement the scheme.

But regardless of the distribution scenario, there would still be a carbon price and therefore an incentive to reduce emissions. If the merry-go-round or the “bucket of money” is the offending part of this, it’s easy not to have one. But I doubt that such a scheme would be politically achievable.

Comments

  1. To risk hitting the beehive… only six days until the Greens get the balance of power! F*&$ yeah!

    I only hope that Labor and the Greens can settle on a meaningful price (>$20/tCO2) and put some of that merry-go-round money into testing some of Australia’s energy innovations.

    Maybe Worley Parsons will revive their plan for 20 x 250MW solar thermal plants throughout Australia.

    Maybe we could be the first country to transition to other energy sources before we reach peak energy from fossil fuels…

      • I hope so too LBS, but these soulless creatures seem to have a knack of jamming it down our throats – just like Net censorship which is about to begin next month involving Telstra and Optus.

      • You’re right, let’s keep allowing large companies to pollute the planet at the community’s expense.

        Face it, externalisation of environmental costs by corporations cannot go on forever.

      • Jason, in my view the dumping of toxic chemicals into the environment is pollution which should be addressed, and not CO2 which has been in the atmosphere since the creation of this planet and is at a historical low over this period. This is one reason why this tax is so asinine.

        By your definition humans are also pollutants through their process of breathing.

      • I’m with you Nod.

        Real chemical pollutants, mostly man-made, right now, destroying waterways and aquifers, arable soils, the air we breathe – everywhere – particularly developing nations where there are little or no restrictions. Causing long-terms illness or death in countries where any possibility of medical treatment is unlikely.

        Real pollution, right now, wreaking damage on the environment and on the lives of real, living, existing humans – right now.

        What’s more – it’s provable, measurable and surely fixable.

  2. I still don’t understand how it’s a price signal if I’m compensated for the price increase…

    (not an economist, nor do I play one on TV)

    • Carbon E Coyote

      Sidamo, you’re not the only one asking this question and it is critical to understanding how this will all work. Let me spell it out.

      For households, I gave an explanation of this in an earlier piece. In a nutshell, if the compensation is used to offset electricity prices, then there’s absolutely no change in behaviour because the price signal is lost. But that’s not what’s proposed. The compensation is independent of the price signal … you get a lump sum benefit (ie lower tax, higher pension etc) which you can pocket; separately you see the price signal in terms of higher electricity prices. You can choose if you like to spend the compensation on electricity bills, but you could alternatively use it for other household expenditure. The price signal (ie higher electricity price) is the same regardless of whether you got no compensation or full compensation (or over-compensation for that matter).

      For industry, it’s the same principle but I’ll give a worked example. Assume that you are producing widgets that but you emit 10 tonnes of CO2 per year to make it. You have a project requiring capex and opex that would reduce this CO2 output to 9 tonne CO2e per year. The carbon price that makes this worthwhile is $20/tCO2e. In other words, if carbon is less than $20/t CO2e then the NPV of the project is negative and you don’t proceed; if carbon is higher than $20/t CO2e then the NPV is positive (ie the project returns are above your hurdle rate) then you do proceed.

      Now say firstly that you get no compensation in the form of cash or free permits, so you have to pay for each tonne. The decision whether to reduce your emissions depends on the carbon price (as explained above). If carbon is $10/t you don’t do the project and your cash cost is $100; if carbon is $30 you proceed with the project and reduce your cost from $300 to $270,

      Now say that the government gives you 10 tonnes of permits. Your cash cost is zero regardless of the carbon price. If carbon is $10/t you still don’t do the project (because it’s not economic) but your cash cost is zero for the 10 tonnes you emit. If carbon is $30/t then you do the project and have 1 tonne surplus (10t that the govt gave you less 9t required) which you can then sell on the market for $30, so you’re $30 ahead.

      Note how you make the same decision regardless of whether you’re compensated or not. The compensation becomes a balance sheet item where you are better off by the amount of permits awarded * the carbon price. The fact that you have received permits does not affect whether you do the project or not.

      • In your toy industry example I presume you mean NET carbon price, i.e. the price being charged by the guvverment minus the amount being passed on to the consumer by industry.

        Your consumer example sounds suspiciously like one of those dogmatic econ 101 examples that describe rational behaviour on planet economics but bear no relationship to the real world.

      • Ah, but it is the modeller’s perfect world, human behaviour reduced to robotic absolutes providing unparalleled predictive ability…

      • 1. the toy consumer example assumes some portion of industry costs are passed on so the consumer sees a price rise.

        2. what research has been done into the expected amount, i.e. $ per tonne, that will be passed on?

        3. the toy industry example must deduct costs passed on to consumers in #1 from the NPV calculations otherwise the toy models are internally inconsistent

        …but more importantly failing to use a NET carbon price would be real world inconsistent because businesses make decisions based on total real cost (discounted).

      • You’re missing the point.

        Think of the compensation as a line item in a cash flow model of a business. That line item is completely independent from every other line item in a company’s business. No decision the company can make will change the line item and all business decisions are independent of its value. Marginal decisions with regard to production and investment are not influenced by the level of compensation, only the price signal of the carbon price.

      • Rubbish. If my cost of goods rise by $30 per widget, I am out of pocket $30 per widget and would use that number when considering new investment (e.g. to improve efficiency or reduce emissions etc.). If on the other hand I can pass on $20 of the rise in costs I am out of pocket $10 per widget — the necessity to invest is reduced or even eliminated. There is no purpose in using particular costs in an NPV when it isn’t a cost borne by the entity by virtue of the fact it is passed on.

        It is my NET position that informs my decision making about capital investment otherwise the apparent hurdles for new investment are entirely fictitious, devoid from reality.

        So I have lines items for my expenses and line items for my revenue. If I can recover my increased expenses by passing on the costs — which result in increased revenue — then those increased costs don’t effect my decisions because my profitability has not been changed.

        To say that you would only consider one line item, the rise in costs (i.e. tax in this case) without considering increased revenue is ridiculous. …but is presumably the kind of thing one might glean from an economics textbook 🙂

      • Lionel the tax is designed to impact the consumer’s decision not the producer. So producer is out $30, raises prices by $30. Customer is then out $30 and gets compensated by $30. If there is an alternative source of energy that costs $20 they can go with that and pocket $10 extra = WIN!

        I’m on board with that bit, I just don’t know if there is an alternative for consumers to flock to, thereby driving the market that way. It’s nice in theory but is it going to work? Are the power companies going to offer cheaper “green power” for me to go over to?

      • Carbon E Coyote

        The breakeven carbon price that you calculate to decide whether to proceed or not ($20/t in my example) INCLUDES the calculation of whether you can pass on the costs or not. The ability to pass on the costs is an exogenous variable that doesn’t change whether or not you are compensated. The uplift in price of the widget from carbon is determined by the market’s ability to pass through the value of the permit. What Europe showed was that the costs are passed through based on the market value of the carbon permit and have no bearing on whether there is compensation or not.

        It doesn’t change the point or invalidate the example.

      • Deenominator, there is no alternative. That is why the entire idea is completely absurd. It’s like taxings horses in the 1870s in the hope that an alternative will be created. All it would do is make donkeys more cost effective and everyone would be hurt.

        The market will pass on the additional costs until they are in line with the next most inefficient source that isn’t taxed.

        Power will be more expensive, everything will be more expensive, the economy will be less productive.

        Oh, but some people (whom the government sees fit) will receive some ‘compensation’ so that makes it all better.

        How this tax is being peddled as good economic policy on an otherwise brilliant blog is beyond me.

      • Ahhh, I do love the smell of money in the morning!

        Good explaination of what our manufacturing sector can look forward to.

      • “Ahhh, I do love the smell of money in the morning!”

        I assume that would be burning money.

      • Waaaay too complex CEC!

        Lets say the carbon tax increases your electricity bill from $1,000 to $2,000, but the government hands back $1,000.

        Net effect: zero. No price signal right? WRONG.

        The $1,000 cash back is fixed. The $2,000 electricity bill has now been amplified by the carbon tax, so if you use more electricity you’ll get a thumping big bill, and if you use less electricity you’ll save much more than you would have previously.

        Its entirely possible that most households will end up BETTER OFF because the incentive to reduce electricity usage will be much greater, and there’s plenty of low-hanging fruit in most Aussie households.

        Think of it this way:

        Before the carbon tax every kWh saved, saved you 20c.
        After the carbon tax every kWh saved, saved you 40c.

        Geddit?

        Note: Of course, the carbon tax will be so p*ss weak it won’t provide anything like the price signal I’ve described above, but that’s what you get when the debate is so distorted by the denialist lobby.

      • Households can reduce their electricity usage any time they want to and make a saving. What evidence do you have that consumers have responded to higher costs by reducing electricity consumption (and fuel consumption and so on?).

        On planet economics I’m sure the androids there will respond as predicted but we need to model for planet earth.

        Additionally if consumers were to ration their usage to the extent that they pocket the entire compensation, in your example they have halved their electricity usage. This would surely see power plants closing rather than new ones starting wouldn’t it?

      • What evidence do you have that consumers have responded to higher costs by reducing electricity consumption (and fuel consumption and so on?).

        Oh I don’t know … how about small cars massively outselling big cars these days? Diesel cars selling like hotcakes? Ford can’t give Falcons away?

        Additionally if consumers were to ration their usage to the extent that they pocket the entire compensation, in your example they have halved their electricity usage. This would surely see power plants closing rather than new ones starting wouldn’t it?

        Extraordinarily unlikely as that outcome is … ummmm, yes. Closing the dirtiest coal-fired power stations (e.g. Hazelwood) is the goal here after all.

        Would it also be an incentive for power companies to close other coal-fired power stations and replace them with gas or renewables? Hell yes!

        Why is it you free-market loving denialists suddenly can’t understand how markets operate when it comes to pricing carbon?

      • So in answer to my question you have no evidence to show consumers reduce electricity consumption when prices rise or were you just avoiding that question? ..oh, hang you later said it was extraordinarily unlikely that electricity usage would drop so I guess consumers aren’t going to modify their behaviour, or maybe they are or maybe they aren’t or maybe…well I guess this is all very fluid isn’t it and you can do an about face depending on what aspect of consumer response you intend to deny.

        So as electricity prices have been rising in recent years are you saying that electricity usage has declined? Um, no. Unless you can show an inverse relationship between price and usage your assertions about what consumers will do is merely denialist fantasy.

        denialists like you seem to hate producing actual data to support the fantasy about how consumers will behave when subject to a tax increase.

        and yes of course while your at it you can deny that fuel usage per capita is rising despite engine efficiency. By hey, don’t let data get in the way of your ideology.

      • Carbon E Coyote

        The (international) studies show that rising electricity price by 10% reduces electricity demand by about 3%. That’s the long term elasticity of energy demand.

      • CEC this data should be readily available for Australia and at the fingertips of tax advocates. We have a national grid or an east coast grid don’t we?

        Additionally can you please partition it into fixed and variable usage. Some usage is fixed, unless you lot plan on pulling the plug on life support systems in hospitals.

        Unlike some other aspects of economic fantasy there should be quite a bit of data from which to draw from to make usage predictions.

        So what is your guesstimate for how much prices will rise and therefore how much usage will drop?

      • Fanboy,

        Lionel is showing about as much insight into this issue as a chimp has into Quantum Mechanics.

        i.e. nil.

        He seems to be arguing that electricity demand is perfectly inelastic. I don’t know how anyone can argue that, but there you go. Denialists say some truly wacky things some times.

        P.S. I’m an alarmist, not a denialist. Get you’re friggin’ terminology right.

      • Lorax

        “I’m an alarmist, not a denialist. Get you’re friggin’ terminology right.”

        Urrr…what on earth are you talking about. You are indeed alarmingly confused and confusingly alarmed it would seem.

        Chill.

      • Lorax, Adam Smith just provided a link to a report that shows electricity usage projected to grow into the never never. There was a tiny drop in usage coinciding with the reduction in GDP growth while the GFC was going on but other than that, the forecasts are for growth, growth, growth.

        I guess those blokes don’t understand elasticity either. How can usage continue to rise when prices rise? Amazing!

        If we get warmer winters from global warming it seems electricity usage might drop a bit.

      • Mate, I can show you a report that says human population grows forever as well, and one that shows oil consumption grows forever, and one that says we can chop down all the forests, empty the seas of life, and concrete the planet.

        None of it is true.

        “Anyone who believes exponential growth can go on forever in a finite world is either a madman or an economist.”
        — Kenneth E. Boulding, Economist.

      • “The Lorax says: June 24, 2011 at 3:50 pm Mate, I can show you a report that says human population grows forever as well, and one that shows oil consumption grows forever, and one that says we can chop down all the forests, empty the seas of life, and concrete the planet.”

        Yet reports that show that the carbon dioxide tax is great and that so called ‘renewables’ can supply base load power as well as other ‘reports’ from certain international bodies, are all perfectly valid right?

      • I’m still lost 🙂

        If I use 10 tonnes CO2 I presumably get 10 tonnes worth of offset.
        If I then use 9 tonnes the following year, presumably I only get 9 tonnes worth of offset, i.e: my offset reduces in line with my use??
        The net cost of electricity to me in Yr2 is the same as it was in Yr1.

        Or is the plan to continually give me 10 tonnes worth of offset regardless of how I adjust my usage?

      • Sidamo, let me put it this way from a manufacturing perspective.

        Manufacturer A makes a widget. This widget needs materials, which will include some level of carbon tax. The manufacturer consumes electricity in the process which is also subjected to carbon tax. Any packaging such as cardboard shippers would also have some exposure to carbon tax – you can see there is a cumulative effect.

        If manufacture A supplies this widget as an input for manufacture B – the cumulative process continues.

        Who pays for this additional cost in the end – the consumer.

        Since manufacturing in this country is heading down the gurgler anyway, why not give it a big shove by making it even less competitive.

      • Carbon E Coyote

        For generators and coal-miners, it was going to be a once off allocation. That is you get a lump of permits, it doesn’t adjust on your production levels. That’s how it was designed in the EU ETS.

        The EITE design for CPRS was different, it was matched to an industry benchmark intensity. Then it would have the effect of nullifying the carbon price … ie if you get 9 permits for every 10 tonnes, you would see 10% of the carbon price.

      • CEC, it doesn’t matter which way you spin this as it’s only putting ‘lipstick on a pig’.

  3. Like the mining tax, it is just another tax to allow the government to spend more (i.e. buy votes). A recent MP from NZ complained that their carbon tax rate was set too low. It just increased prices of everything a little (i.e. petrol by 3c/l) but did not change any behaviour. Obviously he is out of touch, this is a perfect out come for the government.

    Just waiting for the next tax idea!

  4. Thanks Carbon, a very interesting post.

    I was wondering how the carbon permits might be allocated.

    It might be an entirely different concept, but I remember the fish quota roll-out. There are still many very rich fishermen around who were given free fish quota. Quota that are now worth millions of dollars… A huge windfall gain for them, But a big loss to the community.

    Hopefully something similar won’t happen with this carbon quota? and not too much of the “merry go round money” will be wasted as windfall bribes to the polluters. It seems to me that the community should keep ownership of the majority of the permits.

    You are providing some very sensible information on the carbon economy.

    Thanks

  5. This complicated trading system won’t achieve a damned thing if the overall goal is to reduce the potential rise in temperature and sea level in the next few hundred years. That’s already baked in and subject to automatic stabilisers like cooling trends, peak oil, financial system failure etc.
    If the intent is to blindside the public in the introduction of higher tax and cost throughout the economy, they will get there.

  6. @Deenominator 11:54am

    Are you saying that the purpose, or one of the purposes, of the tax is NOT to get industry to invest in less emissions intensive technologies?!

    @Carbon E Coyote 11:58am

    Well we agree that it is the NET cost to industry that needs to be considered. That aspect effects whether or not an industry has any incentive to change. Clearly if you pass on costs there is no incentive so therefore the only emission reductions that occur must come from consumers.

    re: consumer compensation

    The model falls down here because as I said above it is like one of those toy econom 101 examples that don’t actually work in the real world. On one hand you expect consumers to do some calculations and reduce there energy usage (i.e. CO2 emissions) so as to pocket the difference between their bill and the compensation. But consumers can already act to reduce their energy usage and save money is they so wish.

    And how exactly will consumers reduce their energy usage? All of this seems to ignore elasticity. Are they going to run around switching of lights, driving at the speed limit and reducing acceleration so as to save fuel? What exactly do you envisage consumers doing in this ideal world you imagine?

    • Yep, my understanding is the purpose is to drive change via consumer demand for lower cost (i.e. untaxed) energy, which would provide the incentive for industry to invest in less emission incentive technology. That bit makes sense to me.

      Whether it is going to be enough to do that I don’t know.

      • So consumers are going to demand that industry invest in new technologies.

        So the same consumers that are switching off lights so as to pocket some savings from compensation are, presumably via some ground swell (?), get industry to take notice and think to themselves, geez we should invest in new technologies. Notwithstanding that these are the same industries that have unchanged profitability under these same scenarios by virtue of the fact that they pass on their costs.

        Fair dinkum what a wonderful world economists live in. If anyone else dreamt this stuff up, that is anyone who didn’t call themselves an economist, they would be offered medication.

      • Carbon E Coyote

        It’s not really about customer choice, ie a groundswell of people choosing to buy greenpower. It’s the carbon price that drives the change in industry behaviour, because it changes the economics of energy supply. We all pay more for electricity because cleaner energy costs more.The customer choice comes in when you choose how much electricity you want to use as a result of it costing more.

      • So hang on. above there are some comments saying it is not about industry it is about the consumer whereas you seem to be saying it is about industry and not the consumer.

        So can you advise readers what NET carbon price is required to entice an average electricity producer to build a greener plant and mothball their current plant? This will obviously have to be framed in terms of carbon per MW as per your hazelwood example above.

        Why aren’t consumers choosing to save money now by rationing their energy usage? Consumers can do this at any time.

        Can anyone reading this advise if they know of anyone who is rationing their energy use in order to save money?

        You haven’t explained how consumers will reduce their own carbon footprints. Will they switch off lights, will they drive slower? What are they going to do and what evidence do you have to support it?

        We need real world data about consumer behaviour re energy usage not economic fantasy.

      • You are ignoring the opportunity that the carbon tax creates for new companies to come in and start producing cleaner energy from the ground up.

        If under the carbon tax their price is cheaper than the existing generators, then they will get more revenue and market share. Because as far as electricity goes at least, the consumer cares only about price and availability.

        Electricity generation is kind of tricky too, as it has its own market. With different generators supplying electricity at different prices depending on demand. Eg. a very large coal generator won’t spin up to supply the grid until the demand goes beyond a certain level that makes it worth it for the operators to start the plant. This entire process is basically hidden from the consumer, and managed by the retail/distribution levels. The consumer doesn’t know whether or not they’re getting renewable energy (unless they specify they want a portion of their energy to be renewable on their bill, meaning the retailer will supply renewable energy even when it is above the cheapest price).

        Ultimately it comes down to cost per kWh. If the carbon tax affects the electricity market such that renewables get a larger share because they charge less per kWh then that is your net benefit.

      • Sorry Jason but that is more economic fantasy. We already have (relatively) inefficient energy producers in the market right now. CEC has mentioned Hazelwood. An opportunity has existed for quite some time now for an operator to build a power plant that runs more efficiently than e.g. Hazelwood. It hasn’t happened because the real world is a little bit different from an economic fantasy world. So when costs are even higher somehow these new plants will spring up like mushrooms. That beggars belief.

        power companies and consumers have not reacted in the past they way they will act in the future. We need to coin another catch phrase, kind of like futureboom. But for the moment lets just stick with it being a lot of mass abating

        (http://macrobusiness.com.au/2011/06/leading-the-world/#comment-38673)

      • People can do lots of things. Turn off stuff at the powerpoint, change lightbulbs, simply avoid usage where not essential, insulate, buy more efficient appliances. These activities are net positive but people have historically either not bothered because the saving was so low or because there are upfront costs involved in pursuing them.

        However, the 30% rise in retail electricity prices over the last 5 years has changed this and people are doing pursuing these strategies.

        This Transend report shows that wholesale electricity demand in NSW reduced in 2009/10. This was a result of a number of factors including the demand response to increased retail prices that were implemented by IPART in the proceeding years. The same result is observed in other regions of Australia and is even more pronounced in the 2010/11 data.

        See table 4.2

        http://www.transgrid.com.au/network/np/Documents/APR%2010%2029-6-10.pdf

        If you want more sources let me know.

      • Lionel you’re basically saying that no matter how high the price to produce electricity from fossil fuels becomes companies and consumer will not try to find cheaper solutions?

        Now who’s living in an economic fantasy?

      • Jason, no I’m not saying that at all. I’m saying that scenarios such as those you have outlined have already existed an inefficient plants haven’t been replaced as costs have risen. If you want to extrapolate ad infinitum then sure some point will be reached but infinite extrapolation is fantasy. You need to show why this next incremental increase in costs will be the straw that broke the camels back so to speak.

      • Adam Smith,

        close but no cigar. There was a tiny drop in electricity usage coinciding with a drop in GDP during the post GFC. However looking forward they are forecasting ongoing rises in usage — despite rising increases in prices — which debunks the fantasy scenario doesn’t it?

      • Carbon E Coyote

        Lionel, it makes no sense to replace Hazewlood in a world where carbon is priced at zero. It’s doing a fantastic job at producing a quarter of Victoria’s power supply. It hasn’t been replaced because there’s no economic reason to do so. However, that changes once there’s a carbon price. The economics of keeping it running relative to other options change once carbon is priced.

        This is real world economics and finance, not fantasy.

      • CEC, yes you’re right, opportunities only eventuate if the tax is sufficiently high to render some plants uneconomical. From here we go around in circles about Net costs and so on and how much can be passed on to consumers who apparently are then going to respond to the price signal by significantly reducing electricity usage thereby reducing demand to replace inefficient plants on the grid.

        Let me ask you this, do you envisage a growth in electricity usage after the tax and if not then by how much will usage drop? This follows on from my question above. …and from Adam Smiths link above it appears usgae in NSW has been growing steadily for a decade bar a blip over the GFC and is projected to increase steadily at about the same rate ad infinitum. In other words usage doesn’t appear to be effected much by price based on that data.

      • Carbon E Coyote

        It’s not the lower demand that closes the inefficient plant, it’s the carbon price. Even if there’s zero change in customer demand, the reduced profitability of power production from high emission intensity plant is what closes this plant.

        To answer your question, higher prices will slow the growth in demand (which continues to increase with population growth and economic growth) rather than provide absolute reductions in demand, at least with modest price increases. The main emission reductions are to be had from lowering the carbon intensity of our power supply.

      • The price elasticity of demand for electricity is low. However, it’s not perfectly inelastic. If you raise prices, people do respond. The fact that Kochie is in adds telling people to turn off their plasmas at the wall is probably the starkest illustration of this.

        In electricity, the real impact of a carbon price is changing the investment decisions made in the market towards lower emission generation. A side effect is that dirty incumbents may go out of business and will certainly make a lot less money.

        If you implement a carbon price then it massively changes the investment decision. This decision account for the extent to which carbon costs are passed on. Think of it like this:

        Today I might forecast received electricity prices and costs associated with building a coal plant in a world without carbon and the project is a good investment and better than building the same size gas plant.

        I then do same thing but in a world with carbon. Because carbon is there I forecast that both types of plant make more money due to increased prices caused by passing through carbon. This may also include the impact of reduced demand growth. However, the increase in costs for the coal plant (due to carbon) more than offsets the increase in revenues. Whereas for the gas plant the increase in costs is less than the increase in revenues. So now gas looks like the better investment.

        Note also that you could have any level of compensation here and it wouldn’t change your decision.

      • It’s not the lower demand that closes the inefficient plant, it’s the carbon price.

        well net carbon price but I get that. I mentioned lower demand in terms of demand for new plant to be built.

        So removing the population qualifier we should see a lowering of per capita usage?

      • Adam Smith,

        nice to have some clarity. As an instrument to effect the decisions re: NEW power plants I agree with your comment.

      • This is complete nonsense. There can be no ‘groundswell’ of people purchasing green power if no efficient forms exist. In the end, everyone will just be paying more for much less power.

        What if I don’t want to pay for your so called ‘clean’ energy (actually found to be far more damaging to the environment than coal)? Why should I be forced to pay for something because you deem it more valuable than something else?

        This is nothing more than central planning and you know it. Like I said earlier and many times before, why is an otherwise brilliant blog pushing such economic absurdity?

    • magical energy efficient pixie dust.

      I’ve seen these kinds of static examples all too often, and most purport to achieve emissions reductions with little cost to the economy and consumers somehow being better off (which cant occur in totality).

      There seems to be little consideration of the aggregate effects economy-wide and in particular the economic effect given that our international competitors wont be doing anything remotely similar to our ‘carbon’ tax. This is the kind of projection that the govt has been busily thwarting by narrowing the terms of reference for modeling activities to exclude it.

      The provision of these kinds of static examples may be useful in trying to sway public opinion but it does little to demonstrate the actual effects of a carbon tax on the economy in reality.

    • Carbon E Coyote

      It is not correct to say that “if you pass on costs there is no incentive”. The amount of pass through is set by the market and there a range of suppliers at different emission intensities.

      Take electricity for example. The pass-through will be about $1/MWh for each $1/t of carbon, which is roughly the average intensity of the supply (1tCO2/MWh). If you’re Hazelwood you produce at 1.6t/MWh so can’t pass on all your costs so you see a bid reduction in profit. If you’re a gas-fired station you produce at 0.4t/MWh so see a big uplift in profit.

      So there is a strong incentive to reduce. As I said before, the calculation of whether you do the project or not, or the decision on which plant to build next, already factors in the ability to pass on costs.

      If you’re compensated, you still make the same decision, it’s just that your shareholder wealth is improved.

      • Clearly I’ve misunderstood the way this is supposed to work and will have to get my head around it again.

    • Alex Heyworth

      “Are they going to run around switching of lights, driving at the speed limit and reducing acceleration so as to save fuel?”

      Shit. I already do all these things. Does this mean I am screwed?

  7. CEC, perhaps it would be better if you explained the impact of the carbon tax on the NEM itself, which is basically hidden behind retailers like Origin AGL and most of the public will not understand the inner workings of the market. Competition in the electricity markets are fierce, with retailers doing pretty much whatever they can to get lower prices.

    If you understand the workings of the NEM it’s not hard to see that if a new renewable generator comes in at a lower price point (thanks to a carbon tax), then retailers will jump on it thanks to the pretty much instantaneous supply/demand reactions in that market.

    • The carbon tax/trading scheme will not result in more renewable generators until the price of carbon gets very high (>$50-60/t). Yes it makes renewable generators cheaper relative to coal, but it makes gas plant even cheaper.

      In simple terms, the impact of a carbon price on the NEM will have two broad effects. Firstly, it will change the supply curve of the market in the short run (before investment can respond). A sufficiently high carbon price will lead to gas fired plant being dispatched before coal fired plant. This changes the composition of the supply side of market towards less polluting sources. That said, most of the coal fired plant will still be producing for decades to come (but not making as much money).

      Secondly, it changes the investment decisions in the market. At the moment, without a carbon price, coal fired generation is the cheapest way to meet baseload demand. With a carbon price of ~$30/t or more, gas fired generation is the cheapest. So a company that is thinking of building a new baseload power station would certainly build gas rather than coal. This is in fact already happening. No one is planning to build coal and lots of gas, in many cases peaking gas plant have been built that can be turned into baseload gas once a carbon price is actually happening.

      Secondary effects include increased retail prices and associated reduced demand growth.

      • “…this is in fact already happening. No one is planning to build coal..”

        Looks like quite a few coal power stations are to be built, some data may have changed, but to say no-one is planning to build coal is not correct.

        http://en.wikipedia.org/wiki/List_of_proposed_power_stations_in_Australia

        http://www.crikey.com.au/2010/03/05/australias-love-affair-with-coal-fired-power-hotter-than-ever/

        http://www.watoday.com.au/wa-news/three-power-stations-given-green-light-20100712-107qt.html

        http://www.abc.net.au/news/stories/2011/05/20/3222570.htm

      • Carbon E Coyote

        if you look at the ones in that list that have actually been built, they are the gas plants. the coal plants haven’t been built.

      • I disagree. Have a look at the electricity market operator’s list of proposed projects, as opposed to the speculative links you provided. Note the lack of coal projects and also that the few that are there are at the most initial planning stage.

        http://wwww.aemo.com.au/data/gendata_prop.shtml

        It takes years to get a coal station approved and all of the coal proposals you listed are highly speculative, with the possible exception of WA plant where the economics are quite different to the eastern states and plant that have other synergy benefits such as the Redbank expansion that uses coal tailings.

        The Bayswater B and other NSW baseload proposal were talked up as part of the NSW privatisation last year and are not credible. The development sites were not fuel specific and almost all of those proposed coal sites could, and most likely will, be gas fired.

        Origin, AGL, TRU, IP, ERM, etc have all been building and will continue to build gas fired plant and renewables to meet the renewable target.

        Why would you build a 30 year asset that will most likely get stranded within 5 years?

      • Fair enough – probably influenced by being here in WA and aware of criticism directed at expansion of existing coal power stations and indeed the building of a new one. Still, their on the drawing board, as it were but yes, carbon tax may kill them.

      • Ahhhhh.

        In WA the gas price is much higher relative to coal so you need a much higher carbon price to effect switching. Also, WA coal is crappier quality and so there are limited outside options, unlike NSW/QLD where you can get it to port and sell the coal for a much higher price OS. So there’s a good chance the coal suppliers will drop prices to new power stations ensure they have continue to have customers.

        So yeah, WA probably still has new coal plant in its future.

      • …unlike NSW/QLD where you can get it to port and sell the coal for a much higher price OS.

        right so lets not burn it here, lets let “them” burn it so we can feel proud about doing our bit.

        🙂

        (Is there an icon for ROFLMAO?)

      • That’s true. Carbon leakage is not good. It really comes down to if you think climate change is happening.

        If you do think it’s happening then we should try to mitigate the impact. There is a long history of the developed world leading by example in the area of global public goods – vaccinations, CFCs, deforestation, etc. Pretty hard to pressure the 3rd world to act if you’re not doing anything. Particularly relevant since the developed world have been the main carbon polluters so far. The process of change has to start somewhere and you could argue that the first step was the per capita emissions scheme implemented in NSW in the early 2000’s.

        If you don’t believe then it’s easy to argue that we shouldn’t do anything.

        So are you really saying that you don’t think there’s a problem to solve?

      • Adam Smith

        As I’ve said from time to time on this website, I don’t see this as a alarmer/denier argument. I am happy to take the global warming hypothesis at face value because I think it is largely irrelevant to the tax debate and it enables people to divert the argument into a “your a denier” ad hominem attack when they get corned on an issue.

        You raise some interesting examples. When we (the west developed world) banned the use of CFCs (we did ban them right?) did we continue to manufacture them for export to the third world?

        I just really do not see the point in any of this unless global CO2 levels are reduced and they won’t be because we sell coal as quick as we can dig it out of the ground and that coal gets burnt. It is quite pathetic actually to ban coal power here — which is what is desired — while our coal ends up getting exported and burnt somewhere else. And it has been documented that China will double their emissions in a bit of 10 years if they continue to grow at ~8%. The west might want to feel good about itself but the data shows emissions will accelerate as long as India and China keep growing. Arguments for a tax essentially boil down to being seen to be doing something while failing to consider what happens when emissions soar. Meanwhile emissions accelerate and no one is planning for what happens when temperatures continue to rise.

      • I didn’t feel cornered in any way. Your comments today seem to indicate a wilful misunderstanding of how a carbon tax and compensation would effect businesses and consumers (your comments elsewhere on the site show that you are no fool).

        You raise a good point that the tax in Australia in it’s current form is not going to stop China massively increasing emissions regardless of whose coal they actually burn. The point I was trying to raise is that if you believe those emissions are a problem then surely you need to start somewhere?

        Personally, I believe there are more economically efficient ways to transition an economy to lower emissions intensity than a pure tax or cap and trade scheme. But I’d rather see a tax over nothing as it at least moves Australia towards being in a position to start interacting with the developing world in the hope of getting some globally significant emissions reductions.

      • Adam Smith, I haven’t noticed you branding people you don’t agree with as deniers so therefore any comments about persons/people resorting to that line when cornered is not aimed at you.

        As for needing to start somewhere I’m afraid I disagree. We need to accept the inevitable. We have no control over the acceleration of global emissions, nor will a concerted western effort effect the accelerating of emissions. No one expects China or India or other developing nations to stop their growth, nor should they. On that basis we should stop pissing in the wind and explore adaptation measures.

        And there is no wilfull misunderstanding — I take your point about its effect on new plants, but by and large see this as a pointless exercise.

      • So what your saying is, we should make our efficient power generation more expensive so that it is just as inefficient as everything else? And this is a good thing? Are you really saying this is a good thing?

        Whether or not we are building less coal plants now is irrelevant. Of course making something more expensive to build is going to mean less people build it. The question is why are we doing this?

        What is the point of making something too expensive to build and forcing companies to build something that’s less efficient?

        This whole idea is economic madness, there is absolutely no way you can justify it as good economic policy. It is just plainly impossible.

  8. Alex Heyworth

    It would be interesting for people to get their electricity and gas bills out and find out how much their greenhouse gas emissions are currently. I have just done that and my total for the last year is 17.4 tons (11.5 from electricity, 5.9 from gas). This is for a family of four adults, living in Canberra.

    So at $20/ton I would be up for an extra $350. Hardly going to break the bank in my case.

    Would be interested to know what figures other readers come up with.

    • $350 on your energy usage.

      What about food prices?

      What about fuel?

      What about everything that you buy?

      Prices are going up across the board, not just in power.

      • Alex Heyworth

        Sure, I know that. But most of those effects can’t easily be estimated at the moment, particularly given we don’t know the details yet. I just wanted to know what direct effect it would have on a broader sample than just me.

        Still, no bites I guess. Must be too much work for the rest of you. Maybe I have too much time on my hands.

    • You don’t actually receive an extra $350 of income though.

      This is $350 you will withdraw from other parts of the economy.

      Extrapolate that to the entire population, and withdraw $350 per head from Cinema’s, Restaurants and Discretionary Retail and it will have a marked impact on aggregate demand.

      Owners of Cinema’s, Restaurants and Discretionary Retail outlets might be a bit peeved that they will suffer o the basis of some zealots prescribing to junk science