How the RET Review is hurting REC prices

Both AGL Energy and the REC Agents Association have separately released analysis which illustrates how prices for Renewable Energy Certificates – both large- (LGCs) and small-scale (STCs) are abnormally low. 

This appears to suggest that market players apply a discount to the value of RECs, beyond what is dictated by the economics of supply and demand, to account for a perceived risk that the rules around the RET will be changed. Reviewing this legislation every two years is clearly not helping investor confidence.

I'll spare you the mathematical equations from the AGL paper, which work well in impressing public servants, but aren't much good for the rest of us.  Essentially AGL's analysis suggests we will have a shortfall of LGCs by 2015 which then grows very rapidly, requiring new large scale renewable energy projects to be built relatively soon (chart below). This view was shared by the predominant players developing renewable energy projects and major electricity retailers surveyed by AGL.

AGL forecast of LGC supply and demand

Source: AGL Applied Economic and Policy Research (2012)

To make a new wind project viable AGL estimates it requires revenue of $99 per megawatt-hour today. Adjusting for inflation between now and 2015, that works out to $107/MWh. Now there is already futures trading in electricity contracts for 2015 which give a price of $55/MWh. So these projects then require a further $52 from the LGCs to make the projects viable.

As an electricity retailer, instead of agreeing to contract for such a project to get built, you could instead choose to buy LGCs from the spot market today and then save them up to use in 2015. Because this involves locking up cash that you could invest in other activities, you'll discount the value of the LGC below $52 to reflect the return available from alternative investments. This ‘cost of carry' is generally agreed to be about 7 per cent per annum. Discounting back three years from 2015 to today, that should mean retailers would be willing to buy LGCs wherever they are available below $42.

However, the price for LGCs on the spot market today is around $35 to $36.

Also the REC Agents Association points out a similar anomaly with STC prices.

Under the Small Scale Renewable Energy Scheme owners of STCs have the option of selling them in the spot market today, or putting them into a clearing house which offers a price of $40 per STC. But they'll only get the $40 in the event that retailers haven't bought enough STCs to meet their liability from other sources.

Theoretically the SRES target is supposed to be set at a level based on achieving a market clearing price of $40. However if the government sets the target too low, then any surplus is added to the target for the next year. This should mean that anyone who puts their STCs into the clearing house should only have to wait at most two years to get their $40.

According to the REC agents, once you take into account the cost of carry this should mean owners of STCs should only be willing to sell into the spot market at $36. Yet the spot price has varied between $26 and $31.

Both the REC Agents Association and AGL put this anomaly down to the fact that the Renewable Energy Target is subject to a review which could lead to a wide range of changes that could downgrade the target and make certificates less valuable in the future. It's why having a review of the target every two years inhibits efficient and timely investment and needs to be changed.