Generators cashed-in on free carbon permits

The text below is an edited version of the executive summary from the report,

Transitional assistance or windfall profits? The financial impact of the carbon price and compensation payments on Victoria's brown coal generators.

In a report prepared for Environment Victoria, CME undertook analysis of the impact of the carbon price package on the profitability of Victoria's brown coal generators.

This analysis takes account of actual carbon market and electricity market outcomes since the commencement of the carbon price on 1 July 2012 until 31 December 2012.

The purpose of this report is to obtain a deeper understanding of the extent to which carbon price ‘compensation' payments through the Energy Security Fund may deliver “windfall” profits to the Victorian generators that are eligible to receive payments from this fund.

The Clean Energy Act 2011 legislated a package of carbon pricing reforms negotiated by the Multi-Party Committee on Climate Change (MPCCC) in 2011. The package adopted by the Government included significant assistance for industry to adapt to a price on carbon including, controversially, a fund to assist the most emissions-intensive generators adapt to a price on carbon, as well as to pay for the closure of 2,000 MW of Australia's most emissions intensive power stations via a process named Contracts for Closure. The fund established for these two purposes was called the Energy Security Fund.

Energy Security Fund assistance for the most “strongly affected generators” was estimated at $5.5 billion, with most of this accruing to the high emission brown coal generators in Victoria. A break-down on cash payments for the first annual instalment by generator are listed in the table below (note a further four years of assistance would be provided in the form of free permits rather than cash).

Energy Security Fund first instalment cash payments made for 2012 year by generator

The Government's decision to make these payments reflected advice from the Australian Energy Market Commission that without these payments energy security would be at risk. Professor Ross Garnaut disputed this advice. He suggested that the security risks were quite small, and hence that transitional assistance payments were unnecessary. Likewise the Australian Energy Regulator was sceptical that the emission reduction scheme presented a risk to energy security.

We have analysed the change in operating profit to Victoria's brown coal generators attributable to the carbon price, using half-hourly data on actual outcomes in the “spot” National Electricity Market (NEM) for the first two quarters since the implementation of the carbon price package.

We have calculated that Victoria's brown coal generators have been able to pass through an estimated 111% of the cost of the carbon price in the spot market, or a little over 100% after accounting for the cost of emission permits that need to be surrendered for electricity used in the process of generating electricity at the power stations. Our results for the four major Victorian generators are listed below.

Estimated pass-through of carbon costs for the four major Victorian brown coal generators

This is a higher level of pass-through than was expected. Modelling studies conducted in anticipation of the carbon price had predicted different levels of pass-through, although the expectation in most studies (and by the Government) was that generators in the NEM would not, on average, be able to fully recover the costs. In Victoria, the higher emission-intensity generation was expected to be able to pass through around 80% of the emission cost.

It should be noted that the only other published study (that we are aware of) that examined actual outcomes since emission prices have been implemented, by the Australian Energy Market Operator (AEMO), looked at the market as a whole rather than Victoria specifically. In addition their analysis used price data from 1 July 2012 to 18 October 2012 and compared it to average prices in June 2012. Our study compared average prices from 1 July 2012 to 31 December 2012 and compared them with average prices from 1 July 2011 to 31 December 2011 because of the importance of seasonal influences on electricity demand and prices. Consequently their study does not pick-up on the extent of carbon cost pass through achieved by brown coal generators that this study has found.

Our analysis leads to the following conclusions:

1. In the first six months since the introduction of the emission price, generators in Victoria seem to have been able to pass on all of the cost of the emission permits, through higher electricity prices in the spot market. While spot market outcomes may not actually match the actual prices that the generators have received so far, the spot market outcomes are significant since they set the reference price for future financial contracts.

2. As a result of the Energy Security Fund payments and assuming a continuation of the observed pass-through percentage, the Victorian brown coal generators can expect to accrue additional operating profits somewhere in the range of $2.3bn to $5.4bn (Present Value) depending on emission prices in future. The lower end of this range corresponds to lower expected emission prices in future.

3. Even if pass-through percentages fall significantly, Victoria's brown coal generators would still be likely to improve their net profits as a result of the Energy Security Fund payments.

Finally, evidence of the observed pass-through percentages and the price that AGL paid to acquire the remaining equity in Loy Yang A from its GEAC partners, suggests that Professor Garnaut's advice that security of supply risks attributable to the carbon package was small, was sound advice. As such, on the available evidence, the payments made to Victoria's brown coal generators under the Energy Security Fund are perhaps best characterised as windfall profits rather than transitional assistance.

Bruce Mountain is a Director of CME (Carbon and Energy Markets), an energy economics consultancy focussed on Australia's electricity, gas and renewables industries.

CORRECTION: In an earlier version of the preview summary of this article, Climate Spectator had inferred that the report indicated the Government's assistance to brown coal generators was "foolish". We wish to make clear that this was a Climate Spectator editorial interpretation of the report's conclusions and these words should not be attributed to Bruce Mountain or CME.