Napthine protects utilities from the demand doldrums

The Victorian Government has announced that it intends to abolish the Victorian Energy Saver Incentive Scheme, also known as the Victorian Energy Efficiency Target, or VEET.

The scheme will run for one more year with its target slashed from 5.4 million tonnes of CO2 abatement this year to 2 million next year.

The justification for the decision is revealed on page iv of the government’s business impact statement. According to its cost-benefit analysis:

The scheme has benefited residential consumers who have participated in the scheme through decreasing their energy bills; however, non-participating households and businesses have experienced increases in their energy bills. This result suggests that the benefits accrued by consumers participating in the scheme, while outweighing the costs incurred by non-participating consumers, represent a transfer from energy generators and retailers to these consumers through a loss of profits.

Essentially, while energy consumers as a whole have ended up better off, their gains will be outweighed by losses of profit to energy suppliers, leaving the overall economy worse off.

While this justification is likely to raise eyebrows in itself, there are a series of factors surrounding how the government came to its decision which raise serious doubts about its rigour, and the validity of its conclusion that the costs of the scheme outweigh its benefits. This is especially so when another highly detailed study for the Federal Government came to a different conclusion.

The lack of open scrutiny and the bizarre nature of the assumptions underpinning the government's cost-benefit analysis raise concerns that the process was massaged to deliver a predetermined outcome of dumping the scheme.

Cost-benefit analysis omits the cost to taxpayers from Direct Action

First and foremost is that the cost-benefit analysis would have concluded that the benefits of the scheme outweighed its costs with just a single sensible tweak.

The primary reason for the introduction of the VEET scheme was to reduce greenhouse gas emissions, yet the Business Impact Assessment states:

In line with the government’s position that GHG emissions reduction is not a primary objective for the Victorian Government, the value of GHG reductions have not been included in this CBA [cost-benefit analysis].

Now the government claims that even if they did include such a value it wouldn’t change the result. But this is based on an erroneous assumption that the value of avoided GHG reductions is only equal to the expected EU emissions allowance price (about $10 to $12 per tonne of CO2). The European Commission themselves acknowledge that the current EU emissions allowance price does not properly reflect the value to society from avoiding CO2 emissions, and they have been looking to intervene to reflate the price. In addition, the US Government in its own regulatory impact statements uses a central estimate of the value at $US39 per tonne of CO2 in 2015 rising to $55 in 2030 (with sensitivities at the low end of $12 and high end at $170).

Perhaps more practically, the European permit price does not reflect the actual cost Australians will have to pay anyway if VEET is scrapped. The Victorian Government’s logic for not placing a value on carbon emission reductions is that they don’t need to worry about climate change because it’s all taken care of by the Federal Government’s Direct Action scheme. But this scheme will require taxpayers to reach into their pockets to make up for any shortfall in abatement from axing the VEET. According to independent analysis by Reputex, this is likely to cost taxpayers something well north of $40 per tonne of CO2.

If we were to simply include an avoided cost of $40 per tonne of CO2 in the government’s cost-benefit analysis – voila, it now makes sense to keep it in spite of power generators losing out from the scheme.

This is not to mention a range of other questionable assumptions made in the cost-benefit analysis which need to be covered in follow-up article.

The government seems to believe the anatomy of the brain changes at the Victorian state border

However, it seems that the government wasn’t really interested in keeping the scheme from the beginning, hence why they conveniently left out any consideration of the cost of carbon.

This is actually quite openly revealed in the introductory section of the government’s business impact assessment, where it states,

Behavioural factors, such as bounded rationality, have been shown to exist in laboratory settings; however, there is an absence of empirical evidence to demonstrate that they exist in the context of energy efficiency decisions in the market place.

For those unfamiliar with economist-speak, bounded rationality is where people make a decision without properly and accurately considering all the available information relevant to its financial payoff because they:

a) lack time; and

b) our brains just can’t process all information easily into a net present value cashflow and compare it to all the other things we might spend our money on.  

Now if your starting assumption is that bounded rationality is not a problem in relation to energy efficiency, then you pretty much throw out any basis for government to do anything about energy efficiency other than provide information.

Now I find this conclusion all very interesting because back in 2009 I authored a report for the Federal Government Department of Environment entitled, ‘A review of the theoretical and empirical evidence surrounding energy efficiency policy’. This 50-page report detailed that there have been repeated studies since the 1970s analysing households and businesses energy equipment purchasing decisions across items including refrigerators, lighting, water heaters, freezers, air conditioners and other items. These studies suggest that if there isn’t widespread bounded rationality, then people must have a large pool of alternative, low risk sources of investments that give them financial returns in the realm of 100 per cent to even 800 per cent per annum. In addition the report detailed that there are a range of studies illustrating there is widespread ignorance among householders and businesses about how much they pay for energy and what drives their energy consumption.

Now I’d really like to see the evidence the Victorian Government must have uncovered which shows where all these non-energy efficiency investment opportunities exist paying 100 to 800 per cent annual returns so I can make millions.

Now it is true that a lot of the research around the extent of bounded rationality in energy efficiency purchasing decisions was undertaken overseas.  But even with my basic understanding of human genetic variation and cognitive science, I’m pretty sure the anatomy of a person’s brain doesn’t miraculously change the moment you pass over the Victorian border.

In addition there are a number of energy equipment suppliers and energy-efficiency service providers that would be very happy to provide tours of offices, industrial sites, homes and even the local Harvey Norman pointing out examples of where people make odd and sub-optimal energy efficiency decisions.

As just one example, a staff member of one of Australia’s biggest appliance suppliers gave an eloquent and frank explanation of their insights on consumer behaviour at the Doubling Energy Productivity conference a few weeks ago. Their own market research finds consumers give little thought to the energy operating cost implications of their purchasing decisions.  

Why did the government withhold the cost-benefit analysis for six months?

The process as recommended by the likes of the Productivity Commission for making such regulatory decisions is to provide a draft of the cost-benefit analysis and business impact assessment to stakeholders to review and critique. The date listed on the cost-benefit report is December 6, 2013. So the government has sat on this report for nearly half a year, and the first chance stakeholders get to look at the report is after the government has made its decision.

If they had instead followed due process then stakeholders would have had a chance to scrutinise assumptions that seem to be uniformly biased towards underestimating benefits and overestimating costs.

One prime example being to halve the energy savings delivered per energy savings certificate under the scheme. This was a function of experience with stand-by power controllers, yet these are no longer eligible under the scheme.  

Given that the Victorian cost-benefit analysis has come to a markedly different result to a highly detailed analysis prepared for the federal government, the lack of open scrutiny raises serious concerns about whether the government was really interested in anything other than canning the scheme.