Contracts for closure: the real story

The real story behind the government's decision to abandon the "contracts of closure” process with brown coal power generators yesterday is that there's not enough gas to replace them.

There was a clearly a big gap between what the generators wanted to be paid to close down their power stations and what the government wanted to pay them, but that was largely because the brown coal generators are still making plenty of money with the $23 a tonne carbon tax and will do even better in future with no floor price and access to European certificates.

In other words, the decision to remove the floor price from Australia's emissions trading scheme from 2015 and link it to Europe increased the net present value of coal-fired power generators beyond the reach of the "contract for closure” offer.

But there's another, even more significant, factor at work: there's not enough gas-fired electricity generation being built, and even if there was there probably won't be enough gas to fire it, which means the competitive position of coal remains strong.

Gas-fired power already has a lower marginal cost than brown coal power because of the carbon tax of $23 per tonne of carbon dioxide, and is therefore being dispatched into the National Electricity Market first.

Here's how the sums work: The cost of production at Yallourn is $6-7 per megawatt hour; the power station emits 1.4 tonnes of CO2 per MWh, so it is up for $33 of tax per MWh; total cost $39-40. The marginal cost of gas is around $28 per MWh and it emits about 0.35 tonnes per MWh of CO2; therefore total cost is now $36 ($28 plus 0.35 times $23), which is less than brown coal.

That, of course, is the purpose of a carbon tax or cap and trade scheme – to change the economics of electricity generation so that less carbon intensive production is dispatched into the NEM first.

The trouble is that no one is building more gas-fired generation to take advantage of this pricing switch, for two reasons: it's likely that the Coalition wins the next election and removes the carbon tax, and there is no confidence in the long-term supply of domestic gas in Australia since virtually all of what's available has been committed to export contracts.

It doesn't even look viable for Australia to legislate for gas to be set aside for domestic use because that would just send the price through the roof. In any case, the Cooper Basin and Bass Strait are running out and Queensland's coal seam gas and WA's offshore gas is either committed to export or too far away from the big power stations on the east coast.

The big problem is NSW's failure to develop coal seam gas in the Hunter Valley, which in turn appears to be largely due to Alan Jones, the radio broadcaster who has been running a very effective campaign against it. It seems that because of him there is no drilling going on, so the process of developing the nation's second largest black coalfield for gas is dead in the water.

As a result there isn't enough gas to replace brown coal electricity for base load power in the long term. In a real sense, therefore, Alan Jones has killed Australia's transition away from coal-fired energy. There is simply no way the LaTrobe Valley can be closed down.

What this means, in essence, is that Australia's per capita CO2 emissions can't fall very much, so our carbon reduction target of 5 per cent will have to be discharged by buying permits from offshore and paying other countries to reduce their emissions.

In one sense this doesn't matter because, in the earth's atmosphere there are no national borders – it makes no difference where, on the ground, the reduction in CO2 takes place. But it does seem a bit pointless if Australia's only contribution to saving the planet from climate change is to pay more for electricity, while still belching out CO2 from the world's "dirtiest” power stations. No wonder the Greens are spitting woodchips.

Meanwhile the proportion in the NEM of the most expensive power – wind and solar – is being forced upwards by the Renewable Energy Target. The RET was announced to be 20 per cent by 2020, but actually it was expressed as a fixed amount (45,000 gigawatt hours) in the legislation, not a percentage.

Because of the GFC and cooler weather, that is now up to 27 per cent by 2020, not 20 per cent. That's why the Climate Change Authority has been asked to review the RET scheme.

And then there's the forthcoming election, with the party that's ahead in the polls irrevocably committed to throwing out the ETS and paying firms to reduce their emissions.

But a Coalition government won't be able to afford the closure of the LaTrobe Valley either – the NPV of the power stations is actually likely to increase under their "direct action” plan because they will go back to a marginal cost of production of $6-7 per MWh and back to being dispatched into the NEM ahead of gas.

Then again, if the Coalition removes Australia's ability to reach its (the Coalition's) 5 per cent reduction target by paying other countries to do it through an ETS that's linked to Europe and China, then how else are they going to do it?

It's like watching a slow motion train wreck really.

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