DRIVING INVESTMENT IN CLEAN ELECTRICTY

Revised 11 April 2013

This post is essentially an extract from Submission 572 to the Senate Climate Committee (John Davidson - April 2009).

It considers the issues involved in driving major investment in clean-electricity and compares one "case specific" approach with emission trading and carbon tax comprehensive schemes.  A case specific approach  is an approach  developed for a particular opportunity to reduce NCP (net carbon pollution).  In this example, the case the approach selected was the use of regulation and contracts for the supply of cleaner electricity   The attraction of this particular strategy is that it is able to deal with the issues associated with the clean up of electricity, gives a very predicable growth in clean electricity capacity, satisfies most of the needs of the various stakeholders and only requires the average price of electricity to ramp up slowly in line with average costs.  Problems with both the emission trading and carbon tax approach include much faster price increases, a much less satisfactory resolution of stakeholder concerns and a far less predicable rate of investment in clean electricity.
Note:  A different approach  may be appropriate for driving minor investment such as the installation of rooftop solar cells.
Breaking News: Since I first started talking about competitive tendering, the ACT introduced their "Reverse Auction" for driving investment in utility scale solar.  I don't know all the details of their system except that it is a competitive tendering system.

I have now found this article in the Australian (Giles Parkinson 7 Sept 2012) that announced that the ACT auction process had reached the point where the first contract has been awarded to  Spanish group FRV for a lower than expected fixed price of 18.6 cents/kWh for 20 yrs.  This price may seem a bit high but, based on Qld experience it should actually reduce ACT power bills by replacing more expensive sources of day-time power.

Submission 572 argues in favour of the case specific approach rather than the "one answer fits all" approach used by both emission trading and carbon tax schemes.  The key feature of the specific case approach is that it allows quite different strategies to be used to handle different opportunities to reduce NCP.  To get a better idea of how this might work in practice see Simple action plan anyone?


2.1: Background:

Electricity generation accounts for approx. 50% of Australian greenhouse emissions. In addition, some proposals for cleaning up other sources of emissions will be more effective when cleaner electricity is available; e.g., the use of plug-in hybrid cars. Some of the reduction in electricity related NCP (Net Carbon Pollution) will come from reductions in per capita consumption of electricity. However, serious investment in clean-electricity will be required in order to meet 2050 NCP targets. This investment may include investment to reduce NCP for existing dirty-electricity generation as well as the construction of new, clean generating capacity.

Special features of the electricity industry that may influence the design of schemes for driving major investment in clean-electricity include:
1. The total investment will be so large that it will need to be spread over decades.
2. Years will elapse between a decision to build extra capacity and this extra capacity coming on line.
3. It will take many years to pay back investment in power generation.
4. The cost of cleaning up electricity is expected to continue dropping as a result of new technology and improvements to existing technology.
5. Generating plant life can be over 20 years.
6. Almost all existing dirty-electricity production will have to shut down or be cleaned up by 2050 if NCP targets are to be met.

7. The order in which dirty-electricity capacity is shut down will not simply depend on emissions/kWh or costs. The choice may need to take account of:
a.   Impact on transmission losses and grid investment requirements.
b.   Vulnerability to localized failures.
c.   Ability to complement the future mix of clean power sources. There is often a trade-off between efficiency and ability to respond to variation in demand.
8. Location of new plant may have to take into account factors other than investors’ return on investment including:
a.   Overall cost effectiveness, not just cost effectiveness of the new plant itself.
b.   Impact on transmission losses and grid investment requirements.
c.   Vulnerability to localized failures.
d.   Benefits of geographic spread on variation in total wind, solar and/or tidal power output.
9. Technology selection may have to take into account factors other than investors’ return on investment including:
a.   Potential impact on what happens in other parts of the world; e.g., many countries would welcome a low cost way of reducing NCP from coal fired power stations.
b.   Overall cost effectiveness.
c.   Minimizing transmission losses and grid investment requirements.
d.   Vulnerability to localized failures.
e.   Matching time and seasonal variation of total clean-electricity output to consumption patterns.
f.   Benefits of trialling new technologies such as combinations of heat storage with solar thermal.
a.  Potential impact on emissions from other sources; e.g., CO2 sequestration offers the best chance of serious reductions of emissions from cement and steel production.
g.  Impact on the Australian coal industry.

2.2: Criteria for a Good Scheme:

Features of a good scheme for driving major investment in clean-electricity include:
1. Investors will be seeking certainty re future sales and prices.
2. Customers will be looking for:
a.   No large, sudden jumps in the price of electricity.
b.   Low average prices.
c.   Price certainty.
d.   Reliable supply:
i.      Additional capacity sufficient to meet growing demand.
ii.     Enough surplus dirty-electricity capacity retained to provide a capacity safety margin.
2. Dirty-electricity producers will be looking for:
a. Certainty re:
i.     Order in which dirty-electricity generators will be shut down.
ii.     Approx timing of these shutdowns.
iii.    The extent to which a plant would have to reduce NCP/kWh to delay or avoid the need for shutdown.
b. Reasonable profits during the running down of dirty-electricity production.
3. The government should be seeking a system that would:
a.   Not have the potential to destabilize the economy.
b.   Have a positive effect on employment and economic growth.
c.   Have a positive effect on NCP reduction efforts outside of Australia.
d.   Give government control of the rate of clean up.
e.   Give government the option of putting limits on technology, location, ownership, operation etc if required.
f.   Provide a reasonable compromise between the needs of customers, investors and dirty-electricity producers.
g.   Include provisions for ongoing planning, research and development.

2.3: One direct action (Case specific) Alternative*:

The following suggestion would satisfy most, if not all of the above requirements. This particular alternative assumes that private enterprise would build, own and operate clean-electricity production*. Details:
1. The government would control the rate of cleanup by periodically issuing competitive tenders for the supply of clean-electricity.
2. If required, tender documents would put limits on technology, location, capacity etc as well as the extent to which this might be achieved by clean up of dirty-electricity.
3. The pricing formulae and sales guarantees would be agreed to during tender negotiations. Note that:
a.   The agreed pricing formulae may be different for different contracts.
b.   Sales guarantees and pricing formulae may hold for only a limited amount of time or cumulative power output.
4. New regulations would require that preference normally be given to clean-electricity, provided that it was offered at the agreed price.
5. A similar approach may be used if the proposal involved a partial cleanup of an existing dirty-electricity plant.
6. A plan would be developed for the running down of dirty-electricity production.
7. Pricing formulae and sales guarantees may be negotiated for part of the production from dirty-electricity producers. Prices may also be negotiated for standby time and maintaining the option of restarting a plant.
8. It may be necessary to modify the existing marketing and pricing system to fit in with the above changes.
9. Ongoing planning, research and development might be financed by a small electricity levy or simply be part of a larger system.

The above suggestion provides a satisfactory way of dealing with the issues raised in section 2.2 above. In particular:
1. It avoids the need for destabilizing price shocks.
2. Preference is given to clean-electricity.
3. Prices will only ramp up slowly in line with the average cost of production.
4. Prices will be kept low because:
a.   Competitive tenders are used.
b.   Future price agreements can take advantage of improving technology without affecting earlier price agreements.
5. It provides certainty to potential investors.
6. Power shortages will be avoided.
7. It has the potential to provide a reasonable deal for dirty-electricity producers.
8. It gives government control of the rate of cleanup and the option of placing limits on location, technology etc.
9. It will stimulate the economy by providing steady investment opportunities and green jobs.

*NOTE: No claim is made that that the above is the best case specific alternative for driving investment in clean electricity.


2.4: Emission Trading Scheme:
A comparison of ETS with the case specific scheme described in section 2.3 led to the startling conclusion that ETS would be inferior to the case specific scheme for all of the criteria listed in section 2.2 above. In some cases, the extent of this inferiority was very significant. In particular:
1. ETS depends on “putting a price on carbon” to drive change. As a consequence:
a.   There must be a potentially destabilizing jump in the price of electricity before investment in clean-electricity can be justified
b.   Decisions re location, technology etc. will be made by investors on the basis of return on capital.
c.   Decisions re the shutting down of dirty-electricity capacity will be determined on the basis of intense competition between these producers. The result may not be optimal in terms of the total electricity supply system.
2. The price of carbon is determined by the price of carbon permits traded in a carbon permit market. As a consequence:
a.   Potential investors in clean-electricity would be exposed to future price related risks due to:
i.     Short term variations in carbon permit prices resulting from:
•       Problems matching supply and demand for clean-electricity.
•      Speculator activity and the normal vagaries of the permit market. The price of EU carbon permit prices had dropped from a 2008 high of €30 down to only €8 per metric tonne CO2 by 25 Feb 2009 (1). This is equivalent to a drop from 6.4¢ to 1.7¢/kWh* ex generation plant. See attachment A1 for details.
ii.     Drops in longer term average permit prices due to the development of more cost effective ways of producing clean-electricity.
b.   Investment in clean-electricity will tend to follow economic cycles due to the price of permits dropping during periods of lower than average growth. (It would be better if investment was counter-cyclic.)
3. The government limits the number of new permits issued each period to match a NCP cap that ramps down to the 2050 target. As a consequence, there is a risk of artificial power shortages or restraints on growth if the investment in cleaning up electricity has not been large enough.
*NOTE: The World Business Council for Sustainable Development (2) commented recently that “European carbon prices are now far below levels which can, on their own, make expensive, low-carbon energy technologies competitive with fossil fuels such as coal, gas and oil.”
The effect of some of these problems might be reduced or avoided by special arrangements; e.g., passing laws that allow governments to specify the location of new wind farms. However, the potentially destabilizing price jumps, uncertainty re the price of carbon and high level of investor uncertainty are fundamental features of ETS.

2.5 Carbon Tax Scheme:
A carbon tax based scheme (CTS) will avoid the problems that arise with ETS as consequence of depending on markets to set the price of carbon and the use of a NCP cap. However:
1. The problems associated with “putting a price on carbon” will be the same as for ETS.
2. The price of carbon (tax rate) is set by the government. If set too low, there will be no investment in clean-electricity. Too high and the price of electricity will be higher than necessary.
3. CTS provides no mechanism for controlling the rate of clean-up.
4. Carbon taxes might be reduced in response to the development of lower cost methods of clean power production. However, the threat of future tax reductions would be seen as an additional risk by investors. (Unless compensation for the effects of tax reductions was agreed to before the investment was made.)

2.6 Conclusions – Driving Investment in Clean-electricity:
The case specific scheme described in section 2.3 was clearly superior to both ETS and CTS for driving major investment in clean-electricity.

5.0 REFERENCES:
1.  Reuters: “Leave falling carbon prices alone, say experts” 25 Feb 2009
2. World Business Council for Sustainable Development:
“U.S. gives cap-and trade
boost for climate treaty” 27 Feb 2009
3. Australian Bureau of Statistics: 4605.4 “Australian Transport and the Environment”
4. Australian National Greenhouse Inventory
5. Public Transport Users Association: “Myth: Cars are Becoming More Fuel Efficient”
6. Gizmag
7. Australian Uranium Association Publication: “Uranium, Electricity and the Greenhouse Effect”