Scrap the Renewable Energy Target

The AFR leads today with an examination of the current brouhaha surrounding the Renewable Energy Target and the carbon price. The positions of the political parties on this is a nice illustration of how our politics gets in the way of good economic policy. Apparently:

Labor and the Coalition have signalled they are prepared to consider reining in the 20 per cent renewable energy target under pressure from industry leaders, who warn it will eventually drive up electricity prices more than the carbon tax.

Origin Energy managing director Grant King said the target, also known as the RET, will be the main driver of electricity price rises by 2020 because it locks in increasing reliance on more expensive sources of electricity, such as solar panels and wind turbines.

Mr King’s views on the contentious issue have split the industry, part of which is more worried that changing the target would damage prospects for investment after numerous modifications to green schemes at both federal and state levels.

“Given current forecasts for energy demand in 2020, the RET scheme in its current hard-wired form will deliver a lot more than 20 per cent,” Mr King told The Australian Financial Review.

“The community signed on for 20 per cent by 2020. If it is 25 or 30 per cent then it will mean more costs.”

OK, so we don’t want to overdo it. Fair enough. But what about the respective positions of the major parties here? By objecting to the regulatory approach of the RET on the basis that it will raise costs further than otherwise, the Coalition is essentially trashing its entire carbon policy platform, which is to use selective regulation to lower emissions.

Labor, on the other hand, which does favour a market-based solution to drive lower emissions, has left the RET in place for fear of upsetting The Greens. It may be easing back now but scrapping the RET should have been part of the policy from the beginning.

No self-respecting capitalist can endorse the RET when markets are positioned to drive a more efficient (read cheaper for consumers) transformation than a regulated green output target simply by the nature of private enterprise.

This can illustrated by an examination of what is driving the current price rises. As the AFR says:

Prices are being driven higher mostly by investment in transmission and distribution networks, which are having a bigger impact than either carbon or green schemes.

Turning to the second Garnaut Review, this is explained thus:

In most of Australia, the generator market is competitive and therefore wholesale prices are determined primarily by the dynamics of supply and demand. As overall prices have risen in the past three years, there has been an easing in the growth in demand. As well, over the past year, milder weather reduced summer demand and industry sources also suggest that the insulation program and photovoltaic installations have had some effect. There have been price fluctuations, in part because of drought as the costs of water-cooled coal fired power stations rose and because of a reduction in output of Snowy and Tasmanian hydro-electric systems. The end of the drought placed downward pressure on generator prices from mid 2010.

Distribution costs, on the other hand, have marched higher on the back of a surge in investment. Distribution is split into the transmission network and distribution network. Transmission is the extremely high voltage assets— metal towers connecting generators to substations. Distribution is the lower-voltage wiring that brings power from substations to customers. Both are regulated under similar rules.

Transmission network investment over the current five-year regulatory period is forecast at over $7 billion and $32 billion for distribution networks. This represents a rise in investment from the high levels of the previous period, of 84 per cent and 54 per cent (in real terms) in transmission and distribution networks respectively.

These high levels of network investment have been attributed to the need to replace ageing assets, electricity load growth, and rising demand, as well as rising peak demand and changed standards in reliability and service requirements.

This explanation raises questions. Demand growth has been slow in recent times, long before the cooler summer of 2010–11. Why does old investment from the 1950s and 1960s suddenly have to be increased now? Certainly there has been growth in peak demand, but this is avoidable: other countries provide high incentives to reduce energy demand at the peaks, while the Australian regulatory system rewards distributors for growth in peak demand.

And it goes on:

A second explanation for the rising network costs is that several states have recently adopted higher reliability standards for distribution networks. These require additional capital investment by the network businesses in these states to ensure that the higher standards can be achieved within the regulatory requirements.

The setting of reliability standards and service requirements has not been subject to institutional or regulatory reform. It is important that disciplines are introduced that balance consumers’ interest in low prices with marginal improvements in reliability within a reliable system.

This marginal increase in reliability comes at a cost that is paid by all electricity consumers, and not necessarily valued at anything like their cost by many of them.

And on:

The first of these other government policies is the Renewable Energy Target scheme, in which retailers must ensure that a proportion of their electricity supply comes from renewable energy sources. Renewable energy is currently a more expensive source of electricity and therefore adds to wholesale electricity prices. Unlike economy-wide carbon pricing, the Renewable Energy Target does not necessarily encourage the lowest-cost means of reducing emissions. Nor does it encourage innovation: it favours the lowest-cost established technologies that are eligible within the scheme.

And on:

There is a pressing need to revisit the state-owned distributors. There is an unfortunate confluence of incentives that may be leading to significant over-investment in network infrastructure. It is clear from market behaviour that the rate of return that is allowed on network investments exceeds the cost of supplying capital to this low-risk investment. The problems are larger where the networks continue to be owned by state governments. State government owners have an incentive to over-invest because of their low cost of borrowing and tax allowance arrangements. In addition, political concerns about reliability of the network, and about the ramifications of any failures, reinforce these incentives.

A comparison of costs between Victoria, where the network providers are in private hands, and New South Wales and Queensland, where the network providers are in state hands, provides compelling evidence to support this contention. While there are likely to be genuine differences between the states that explain some of these divergences, it is unlikely that these differences explain the majority of them.

Distribution networks are, of course, natural monopolies. So a strong regulatory regime is required to prevent price gouging.

Basically, this is known as “gold plating” infrastructure: unnecessary investment in service delivery that consumers neither need nor wish to pay for, owing to regulatory distortions.

Returning to the RET versus the carbon price, this analogy holds in that the market rather than the government will be driving abatement decisions, ensuring the lowest cost transformation. The likely outcome is a surge in gas generation until innovation and global spillovers bring down the cost of newer technologies.

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