Isramart llc: CLIMATE SPECTATOR: Can a carbon tax cut it?

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How will a carbon tax ensure that the consumers and buyers of electricity will behave in a way that will enable a change in the generation portfolio – one that will produce lower carbon emissions over time? (At least, I assume, that is the problem we are trying to solve by introducing a carbon tax.)

It is a fundamental principal of economics that, in driving change, consumers will ultimately choose the best alternative to meet their needs at an affordable price.

Take, for example, the tax increase imposed on “alcopops". Despite causing a rise in prices, sales in these pre-mixed alcoholic beverages have increased, with well-funded teenagers continuing to buy them as a sign of status – an unintended consequence of pricing a product that makes it even more sought after. And for those who can no longer afford alcopops, according to reports in The Age, some have switched to the perceived best alternative – the drug known as “ecstasy” – a further unintended consequence of a tax solution to a problem.

As for the NBN, the genie is out of the bottle – it is not just the $43 billion commitment required from government funding to build the network. People are now realising that there may be significant costs to pay each month from their own pockets to be connected to the high speed service.

Not surprisingly, early results from the NBN trial indicate that the majority of consumers are opting for the lower cost, lower speed broadband connections, either because that is all they need or all they can afford.

So, back to the question of a carbon tax.

For illustrative purposes only, and to explain what may need to happen, these are approximate current prices required by different forms of power generation to be viable – Coal, $40/MWh; Combined Cycle Gas, $80/MWh; Wind, $120/MWh; New technology Solar Thermal, $180/MWh. And, a renewable energy certificate (REC) is around $40/MWh generated.

Using these rough numbers, the price of coal-generated power would effectively need to double before it started to make sense to replace coal-fired plants with gas for large-scale baseload power (today, gas has been typically deployed to provide power during times of peak, only, which commands a higher price per MWh). This baseload price increase on coal can be readily achieved by applying a carbon tax – noting that there will be a tax, as well, on the gas plants as they also emit carbons (albeit less than a coal plant).

All good so far. But even once the tax is in place, it doesn’t necessarily mean plant owners will start decommissioning coal plants and replacing them with gas fired plants – it just means that coal’s effective output price will then be about the same as a gas plant. We also still need the generation capacity from the existing coal plants to “keep the lights on,” as it would still take years to replace any of the coal capacity with yet-to-be-built, new gas-fired plants.

At price parity, buyers of electricity won’t care about the difference between power generated from a coal plant versus a gas plant and therefore will be neutral to switching. But what they will notice is that the cost of the majority of the power supplied to the buyers has just doubled, as it will be inevitable that the cost of the taxes will be passed on to them while supply is constrained. These costs will, in turn, be passed on to their customers.

Some may argue that the electricity market is sufficiently competitive and would prevent generators from passing on the costs of the carbon tax – generators relying instead on government compensation for their losses. That may be true at the margin, but we are dealing with a vast capacity-share of coal that would require a large quantum of tax applied to be game changing. Such a tax level could be far to great to absorb and be compensated for – and any lesser tax will not change the game.

For the renewable energy generators, they are still on the edge to achieve viable economics. If the base wholesale price moves from $40/MWh to $80/MWh as a result of the carbon tax, wind farms can get a look-in when the REC is added to that revenue, for a total price received of $120/MWh for wind energy – equating to their required revenues to be viable. But the REC scheme will not be around forever and its certificate price is volatile.

With the current REC scheme, a large-scale solar thermal plant is still short by about $60/MWh, making it very difficult, if not impossible, for solar projects to obtain power purchase agreements, even if a carbon tax is implemented at the levels suggested above.

Ironically, we are effectively paying $500-$600/MWh for roof-top generated solar via various grant and REC multiplier schemes, but no such scheme is in place to provide appropriate revenues for utility scale solar generation, even though it is much cheaper.

So, while it seems logical that generators emitting carbons pay a fee or tax for the pollution they generate, thereby making lower- or zero-emitters more cost competitive, the magnitude of the tax to force change to the existing portfiolio could be very significant – possibly in the order of effectively up to $100/MWh on a coal-fired plant – before the supply side portfolio will make meaningful change in a timely fashion.

Taxes at this level could have a crippling effect on our economy and family finances. Customers will not only be paying for the higher costs of gas-fired and renewable energy plants, they will also be paying the new taxes that are passed through on the existing and significant coal-fired portfolio as well as existing and new gas plants. No responsible government can afford to introduce taxes of this magnitude. But, anything less may result in no change to the portfolio.

One can see why it may take a great deal of time to ever get to a consensus on an appropriate carbon tax design, even just in Australia. A simpler model may be to tax new facilities only, and manage an orderly transition of the existing portfolio.

So, where does that leave us, in solving the problem of changing our generation mix to reduce carbon emissions within a reasonable time-frame? Are there other solutions for the shorter term?

Last week, construction commenced in California to build the world’s largest new technology solar thermal plant. Three years in planning and permitting, the first of the three tower-based units for this plant is expected to be generating power by the end of 2012 – with all three units expected to be fully commissioned by the end of 2013. The plant will have just under 400MW of capacity and will supply power to meet demand the equivalent of 140,000 homes. The project is the first of many being developed in the US.

There is no carbon tax involved here. Rather, the state regulated utilities have been mandated to change their mix of generation portfolios by certain deadlines – for California, the requirement is to have 33 per cent of the total generation capacity sourced from renewable energy plants by 2020. The utilities are allowed to blend the mix of costs from the various generation sources into their final pricing to customers.

While their customers will ultimately pay more for electricity, they are only paying the additional costs for the change in the mix of generation and are not being “double dipped” with a carbon tax.

The clear benefit of the California model, supported by appropriate federal programs including debt facilities for new construction, is that tangible activity is occurring and will result in a meaningful change to California’s generation portfolio by the 2020 deadline, with significant reductions in carbon emissions as a result. It is not clear that we have such a path to achieving a similar change here in Australia.

As carbon tax committees and roundtables are formed, hopefully our government will consult with the policy makers and industry players that are enabling these tangible changes to occur in other jurisdictions, in addition to the local incumbent players that will be affected by mechanisms such as a carbon tax. It will be important to have a clear understanding of the problem that needs to be solved by a tax or by alternative mechanisms.

There will no doubt be an appropriate time to introduce a carbon tax across the board to keep in check the balance of generation required to both meet the needs of electricity demand and the need to minimise output emissions.The design of any such program will need careful scrutiny of the details by practical experts to ensure the outcomes are the desired and required results.

But in the short term, a more direct approach is likely to be required to efficiently and economically transform the generation portfolio. Otherwise, the level of tax required to force changes may well see all of us turning to drugs as we open up our power bill!