Can Combet second-guess the solar market?

As reported yesterday, the Climate Change Authority is recommending the minister responsible for the Renewable Energy Target (currently Greg Combet) be given discretion to reduce the amount of renewable energy certificates awarded to solar PV, solar water heaters and other small scale renewable energy systems.  This could allow the minister to cut the level of support for solar systems in half with just six months notice.

This is proposed in order to prevent a re-occurrence of the massive blow-outs in costs that the small scale renewable energy target (‘SRES') has experienced in the past two years. 

While it is understandable that the Authority (and the government) want to avoid a future repeat of huge cost blowouts, the proposal for containing costs is open to varying interpretation and needs to be changed into a set of rules that are less ambiguous and more predictable.

Based on the current sketch of the proposal, the amount of certificates given to small-scale systems per megawatt-hour of generation could be changed each and every year, with six months notice by the minister based on his/her evaluation of the following combination of factors:

1. Whether the cost of the scheme was expected to exceed 1.5 per cent of electricity consumers' bills;

2. Whether systems across technologies and locations delivered a payback period of less than 10 years on average; and

3. Recent trends in the cost of small-scale renewable energy systems.

Point one is reasonably straightforward and indeed could be defined quite precisely in advance by the government. However points 2 and 3 create broad room for interpretation and heavy reliance on the judgement and quality of information possessed by the minister and those advising him/her.  

Firstly, the choice of a 10-year payback is in itself a questionable metric. This equates to a financial return on solar systems below the weighted average cost of capital for wind farms and large-scale power projects more generally. Indeed it is not much better than the cost of capital awarded to network businesses who face virtually no market risk at all. There doesn't seem to be much logic behind such a benchmark.

Secondly trying to determine ten year payback will be highly problematic due to wide variation in cost and revenue factors.  Within the single technology of solar PV costs vary widely (not to mention all the other technologies eligible under the SRES) depending on:

-- The size of solar system installed;

-- The quality of the componentry;

-- Location; and

-- Even the slant of the roof. 

You could come up with a 10-year payback based on a low cost and low quality system but it might have a high risk of malfunctioning or degrading rapidly – how would this be taken into account? 

Also on the revenue side:

-- Output of systems varies quite significantly depending on whether it is installed in Brisbane versus Melbourne. Installation rates across cities has so far varied quite significantly over time making it hard to nail down an “average” location.

-- Electricity prices can vary significantly depending on the nature of the customer (residential, small business or larger business), their location and then there is the potential for more widespread use of time-varying tariffs and use of fixed demand charges.  

This is quite a complex exercise gathering statistically valid information to make a judgement on what might be an average payback. Even if the government could do this effectively, how are solar PV suppliers and their customers to predict the outcome in advance to make sound investment and contracting decisions?

The SRES is already beset with heavy reliance on the judgement of the regulator and their consultants to forecast the future market of solar PV. Something they've proven incredibly poor at doing with predictions as much as 100 per cent off in terms of system capacity installed. The Authority is now proposing adding another layer of reliance on the ability of government to second-guess the market.

Yet undertaking evaluations of a 10-year payback is completely unnecessary to contain costs. If the Authority thinks society is unwilling to pay more than 1.5 per cent of its electricity bill on supporting solar, then it should use this to set a cap on the number of certificates that could be mandated for compliance in any one year based on a value of $40 per STC. While the solar industry might complain about now being subject to a cap, it's an awful lot better than running a business subject to arbitrary and capricious change. In addition, a cap equivalent to 1.5 per cent of energy bills would still be a bigger market for PV than what is currently expected.  

To avoid any boom-bust situation, if any certificates are created in excess of the cap they could still be used but would have to be banked until the subsequent year. If supply of STCs continued to grow beyond the annual cap then the price would decline, inhibiting further certificate creation.

A slight twist on this could be that if the cap is breached, then in the subsequent year the government could lower the price cap by say $5 but also expand the certificate cap so that the overall cost to consumers remained below 1.5 per cent of bills.

Irrespective of whatever rules are put in place to contain costs, they should operate in a highly predictable manner with minimal room for varying interpretation depending on who is making the judgement and the information that they have at their disposal. This is essential so that businesses and customers can plan ahead and invest and trade with confidence.