A carbon-priced world is not enough

The federal government's emissions trading scheme will change the behaviour of Australian businesses, especially those in the energy sector. In the short term, the scheme will make gas prices competitive with coal, and investment will shift accordingly. This is the right sort of outcome that the scheme is designed to deliver.

But what businesses will not do, under the current policy mix, is to invest in new, low-emission technologies – at least not to the degree which many hope and expect. As a result, Australia is at grave risk of not being able to meeting its carbon emission commitments by 2050 while at the same time keeping electricity affordable. The carbon price is a good start but it is not enough.

Australia is committed to achieving low-emission electricity within four decades, without compromising security and affordability of supply. Although the purchase of international emission permits may be an attractive part of the solution, a large part must come from reductions in Australia's physical emissions and, in particular, from changes in the mix of our electricity supply.

A new Grattan Institute report, No easy choices: which way to Australia's energy future?assesses in detail the prospects for seven technologies that generate electricity with near-zero emissions. They are wind, solar PV, concentrating solar thermal, geothermal, carbon capture and storage, bioenergy and nuclear power.

The report finds that any one of these technologies has the potential to be scaled up sufficiently to play a role in meeting Australia's energy needs. Yet all face major obstacles to achieving their full potential, and none can deliver the bulk of Australia's needs alone. A mix of technology options is essential, at least until and if a clear winner emerges.

The problem is, we are nowhere near creating that mix. To illustrate the scale of the challenge, economic modelling for the Australian Treasury shows that a likely scenario by 2050 would have as major contributors geothermal power and fossil power linked to secure CCS. Yet today Australia produces none of its electricity from either.

It will be a tough intellectual and policy challenge to steer a course between inadequate support for low-emission technologies and picking winners or unduly favouring one technology over another.

What's more, our track record with policies to either develop technologies or reduce emissions is not good. This was demonstrated in last year's Grattan report, Learning the hard way: Australia's policies to reduce emissions.

The policy challenge has multiple causes. Firstly, there are barriers to deployment of several technologies, such as large-scale solar and geothermal power. These barriers include transmission connection hurdles and existing subsidies. Current regulatory structures tend to favour current technologies and infrastructure to the disadvantage of new technologies with fundamentally different characteristics. For example, the optimal wind, solar and geothermal resources in Australia are not generally close to the existing transmission grid and current regulatory or planning structures for new transmission infrastructure are not designed to help them achieve sufficient scale over time.

Secondly, it is unlikely that enough will be invested in the short term to develop the low-emission technologies that could be lowest cost in the future. This is because early movers face higher costs than followers. Private firms are reluctant to invest in R&D when the new knowledge and skills they might create is immediately shared by others.

Early movers also face higher finance costs when technologies are not well understood by finance markets. This is reflected in higher cost of capital for such projects, a problem amplified in relation to high capital cost investments common to low-emission technologies.

In the case of CCS and nuclear power, the scale necessary to achieve favourable economics can be very high, and there are few energy companies, even globally, that can afford to invest on their own without a very high probability of success.

For several low-emission technologies, such as geothermal and CCS, acquisition of data to understand the underlying resource is vital. Yet the nature of the collected information is such that it is very difficult to protect using existing intellectual property regimes.

Thirdly, early movers get little reward for paying these higher costs. This is partly because electricity is an undifferentiated product so that innovations do not earn more, as they do with mobile phones, for example. Nor can early movers count on high long-term revenues because government policy on climate change and energy is inherently unreliable today and it will take some years for this to change.

In an ideal world, the private sector could confidently rely on legislated emissions constraints over several decades to form a view of future carbon prices and the relative merits of investing now or later. Short-term political pressures, lack of real experience with long-term carbon markets and uncertainty over likely future levels of international action to reduce emissions mean that this confidence does not exist today.

All this means that the existing policy mix will lead to under-investment by the private sector in those technologies that could deliver the lowest cost, lowest emissions in the future.

What, then, must be done? Markets must be the primary mechanism by which Australia transforms its electricity supply. To ensure that its new carbon pricing scheme works properly, the Commonwealth must set clear, long-term emission caps, and regularly review the scheme's functioning. The use of medium-term emission gateways as part of this structure to assist in accelerating technology development has been acknowledged by previous government reviews.

There are actions that governments can take at low cost and carrying few regrets to address the regulatory barriers mentioned above and to expand funding for mapping and exploration of primary resources.

Finally, government intervention is justified to promote R&D, demonstration and early-stage deployment of low-emission technologies. Yet it is essential that such intervention addresses the identified market failures and barriers and that the expected benefits exceed the expected costs.

Governments need to be hard-headed in defining the obstacles to reducing the cost of low-emission technologies in Australia. If further support will encourage development under local conditions or remove barriers to deployment – and if these things can happen at a reasonable cost – governments should provide it. But if further rollout of a technology in Australia will not reduce costs, they should not.

Australia has no quick fixes or easy choices in meeting its energy needs. If Australia is to meet its goal of affordable, secure and low-emission electricity, a broad range of these technologies needs to be given a chance to thrive.

Tony Wood is Energy Program Director at the Grattan Institute.