Ignore Abbott, renewable energy certificate prices should rise

In spite of Abbott's negative rhetoric on renewables, the outlook for renewable energy certificate prices that underpin big solar and wind power projects is likely to be far brighter than the market currently recognises.

The key barometer of the health of the renewable energy sector, particularly wind power, is the price of large-scale renewable energy certificates or LGCs. These certificates are the currency through which the electricity retailers comply with the large-scale Renewable Energy Target and make up more than half the revenue a wind farm earns (the other component is the underlying price for wholesale electricity).

On the day prior to Clive Palmer’s press conference with Al Gore, LGCs plumbed a low of $21 on the spot market. The market had only ever gone this low once before, in early 2007 when the final RET target was just 9500 gigawatt-hours.

The day after the Palmer-Gore press conference they surged to as high of $32, but then subsided and just yesterday changed hands at $28.70.

This is way too low and does not reflect the economics of renewable energy projects nor the political situation surrounding the Renewable Energy Target. Instead it reflects how the market is punch drunk from one bad piece of news after another enveloping the scheme in a cloud of uncertainty.   

To help provide a rough benchmark to assess LGC prices, a wind farm needs somewhere between around $85 to $100 per megawatt-hour of electricity generated over a 15-year investment life for it to represent a viable investment. Currently, futures contracts in wholesale electricity for 2016 are trading between $32/MWh in Victoria to a high of $46.65/MWh in South Australia. To make up the difference to $85/MWh they need an LGC price of at least $38.35 ($85 minus $46.65). But in reality, most projects probably need something around $50 or more because SA (with high wind speeds and high power prices) faces transmission constraints.

Now, it’s certainly true that the balance of evidence available suggests the government is very keen on scaling back the Renewable Energy Target. Just yesterday, in spite of the government’s own commissioned modelling finding the RET is likely to leave electricity consumers with lower overall bills, Tony Abbott told ABC Radio’s AM program:

…obviously, the point I've been making pre-election and post-election is that the renewable energy target is very significantly driving up power prices.

But don’t get too carried away with this rhetoric. Abbott’s polling results are now so dire, this may well be an attempt to shore up his leadership by pandering to his climate sceptic supporter base rather than a reflection of what the government believes is saleable to the general electorate.

So rather than broad rhetoric, let’s look at specifics.

Complete repeal of the scheme with existing holders and producers of LGCs left stranded appears highly unlikely.  Even as Joe Hockey was decrying wind farms as “utterly offensive”, he also told Alan Jones that they couldn’t leave those holding contracts high and dry. After all, the people on the hook are power retailers and banks – hardly the enemies of the Coalition. Also, in response to questioning from Climate Spectator, Environment Minister Greg Hunt told an audience of several hundred in May that no matter what comes out of the RET review, the scheme will continue.

A hint of what the worst case could be is shown by ACIL Allen’s modelling scenarios. They were told to model the case where existing renewable energy projects were grandfathered using a fixed nominal price of $40 per LGC. This suggests a worst case for LGCs nearly 40 per cent higher than the prevailing spot market price. 

However, the outlook for LGCs is probably better than that. The Coalition backbencher letter petitioning for aluminium to be exempted from the RET referenced this as part of a move to reduce the RET to reflect 20 per cent share of electricity usage. It seems likely that the signatories include some of the most vociferous opponents of the RET. Yet even they appear to be conceding the government can’t completely walk away from its election commitment.

While such a reduction in the target would be devastating to renewable energy project developers, it would still require construction of new renewable energy projects.

The chart below illustrates the supply of LGCs from existing projects (red line) and demand for LGCs under a scenario where the target was moved to a 20 per cent market share as per ACIL Allen’s estimates (blue line). Even though there is a large build-up of surplus LGCs from prior years overhanging the market at present, these are insufficient to fill the gap between demand and existing supply. This annual gap by 2020 is about 10,500 GWh. To fill the shortage of supply requires something close to 3000 megawatts of wind to be committed for construction in the next three years.  

Source: Climate Spectator analysis

This capacity will certainly not get built with an LGC price close to current spot prices.

According to ACIL Allen’s modelling, LGC prices could be expected to rise above $40 and peak at $60 in real terms under a 20 per cent market share target (red line in chart below). This could be thought of as the 'mid case'. However, there’s room for upside. If Clive Palmer is true to his word and blocks any change to the legislation then an LGC price closer to the black line is reasonable. This represents a premium more than 90 per cent above the current spot price.

Figure 2: ACIL-Allen forecast of the LGC price under different target settings for the RET

Source: ACIL Allen (2014) RET Review workshop preliminary modelling results

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