Averting an energy policy crisis

Business Spectator

The federal government's draft white paper on energy, released by the Resources and Energy Minister Martin Ferguson today, is a compelling document because it depicts in some detail the ad hocery that characterises energy policy and the urgency to develop more coherent approaches to tackling energy costs and security.

It is a sector characterised, perhaps because of the historically heavy state involvement, by ageing infrastructure and inconsistent, complex and sometimes counter-productive regulation.

Even without the extra layers of complexity and uncertainty created by the passage of the government's carbon tax legislation and the associated billions of dollars earmarked for renewable energy technologies, the sector was badly in need of better and more consistent regulation if energy security was to be ensured at a reasonable cost.

The carbon tax debate had a chilling effect on investment in new generating capacity and, despite the legislation, will continue to do so because of the federal opposition's promise to repeal the tax and to replace it with its own direct action program.

It's not that there hasn't been investment in the sector – the white paper says $10 billion a year has been spent since 2007 – but that has been effectively catch-up investment and the updating and replacement of existing infrastructure and capacity rather than investment in new capacity. The paper says, for instance, that since 1998 only $12 billion has been spent on new electricity generation compared to the $80 billion it says could be required over the next 20 years.

In fact, the scale of investment in new generation, transmission and distribution the white paper estimates could be required by 2030 is staggering. Including increased gas production to support electricity generation, it could be about $240 billion.

Retail prices are already being forced up by the increased investment, having risen 40 per cent in the past three years. They are expected, even before the carbon tax cuts in, to spike even more sharply next year and continue to rise over the next decade.

The carbon tax will have a profound effect over time on the nature of generation, with conventional coal-fired generation, which now accounts for about 75 per cent of generation, playing a diminishing role as gas and renewables displace it. The paper says gas could expand to count for 44 per cent of generation by mid-century.

In the near term, the impact on investment from the carbon pricing debate and the distortions created by both the existing and proposed heavy subsidies, mandating schemes and feed in tariffs for renewables (the Gillard Government, for instance, has earmarked $17 billion for clean-energy technologies) has distorted the pricing signals for new generating capacity.

There are gas peaking plants being built and on the drawing boards, but not the big combined cycle plants necessary to produce reliable baseload energy.

The energy security/pricing picture is further complicated by the fact that while there is plenty of gas both onshore and offshore – and a massive pipeline of developments underway – most of that gas is destined to become export LNG. To the extent that it isn't, the option of selling gas into the export market will ensure that domestic gas prices closely reflect that optionality. A future government could mandate that some of that gas is available for domestic supply, but it will be more expensive.

It is obvious that the sector needs better regulation and more efficient national outcomes from both the regulatory impacts and the investment that is occurring and that will occur in future, although Ferguson is keen that the outcomes should be market-determined.

One of the absurdities of the current market – and a major distortion to investment – is the amount of peaking capacity that has been built. That is, of course, a natural response to the air conditioning phenomenon. The paper cited a 104 per cent increase in peak energy demand in Brisbane in just over a decade, against an increase in households of only 35 per cent.

As it says, that means capacity is being built that may be used only a handful of times a year – it referred to estimates that 25 per cent of retail electricity costs are derived from peak events that occur over a period of less than 40 hours a year.

In the US there is an entire industry – which refers to its approach as ‘'demand response" – that has developed over the past decade or so to address that very issue.

By aggregating industrial users (industry accounts for about 83 per cent of Australia's total energy use) and introducing technology and techniques to monitor and adapt their energy uses the ‘'demand response'' firms effectively pay the companies to not use energy during peak periods and then effectively sell that withdrawal and lowering of demand to retailers. One of those US firms, EnerNOC, recently acquired a beachhead in Western Australia, but has encountered regulatory obstacles to rolling out its business model on the east coast.

Virtually regardless of any reforms governments introduce, and even without the impost of the carbon tax, retail energy prices are rising and will continue to rise. Better regulation and the removal of distortions to sensible and efficient investment decisions might dampen those increases at the margin.

Of greater consequence is the energy security issue. Despite the Greens' aversion to coal and gas-fired generation they – and increasingly gas – are going to be needed as sources of reliable baseload supply for decades to come. The current renewable technologies can't provide that.

In fact, as the ever-pragmatic Ferguson noted, unless renewables do become capable of producing efficient and reliable energy in the future, nuclear might become the only viable carbon-friendly outcome.