The AGL-led FiT fight

AGL's latest paper questions the use of feed-in tariffs and argues there are many reasons to support a growing renewables push – but the merit order effect isn't one of them.

Is renewable energy really destined to be only a niche contributor – albeit a large niche – in the Australian power generation mix for as far forward as we are prepared to look?

This is an outlook that drives the more eager of the renewables evangelists to paroxysms of annoyance and to hurling accusations of bad faith at anyone who doesn’t share their vision.

At present nothing brings them out faster than three little words: merit order effect.

Six months ago an interview on Climate Spectator with Michael Fraser, chief executive of AGL Energy and current chairman of the Clean Energy Council, (Australia’s clean power struggle), had the full panoply of the devotees’ rage on display in the posted comments about the company’s views on solar feed-in tariffs.

You can expect more of the same now that AGL has published its latest paper in its long-running economics series, this one focussing squarely on the Queensland feed-in tariff (FiT) – “a regressive form of taxation” – and debunking all over the alleged benefits of the merit order effect.

The paper is written by AGL’s chief economist, Paul Simshauser, Tim Nelson, its head of economic policy and sustainability, and James Nelson, one of its energy market analysts.

The trio note that a 100-fold increase in the installation of household rooftop solar PV systems in Australia has been pumped-primed by “what has been widely acknowledged as excessively generous subsidies” by state, territory and federal governments.

Premium FiTs, they point out, require network owners to levy all eight million households with an additional charge for use of the grid – and the funds are channelled back to the 695,000 residential account-holders who own PV units.

Last year Tim Nelson, Simshauser and another AGL manager, Simon Kelley, demonstrated that, in New South Wales, the PV owners tended to be comparatively wealthy people enjoying a benefit while low income and rental households incurred a cost without anything to show for it.

Since the charge is based on electricity use, the cost recovery process, the AGL economists argued, saw NSW low-income households wearing an effective tax incidence that was 2.7 times the rate paid by the high-income PV owners.

While NSW, Victoria and South Australia have wound back their FiTs, the Bligh government hung on to the Queensland scheme – and the the writers of the report now say that the state’s implied rate of taxation for low-income households is worse than it was in NSW, being 3.4 times higher than for PV households in the highest income bracket.

They estimate that the impact on residential electricity prices in Queensland in 2011 and 2012 is $1.56 per megawatt hour. Last year Queensland power bills rose by about $14 per MWh, so the premium FiT accounted for 10 per cent of the increase.

An added factor is that many low-income households do not have low consumption of electricity.

The AGL economists say 40 per cent of this category of householder in Queensland consume at least the average annual level of power of 7MWh and 20 per cent use more – not because they’re profligate but because of a whole range of factors, including how many people live in a house.

Another adverse factor for non-PV households in Queensland is that while the NSW scheme introduced by premiers Rees and Keneally runs for seven years, Anna Bligh locked in her state arrangements until 2028.

Left unaddressed by Campbell Newman, they warn, Queensland, as the last refuge of a substantial FiT, is likely see another boom of the sort that panicked Keneally in late 2010. They call for the policy to be reviewed urgently.

All of which brings us to the so-called merit order effect, an economic benefit being promoted by the solar industry.

In simple terms, it relates to what happens to wholesale energy prices when a substantial volume of low marginal running cost generation is added to a market.

The AGL report uses the South Australian market, the jewel in the crown of our renewable energy advocates and where 870 MW of wind power has been included in the mix (now standing at 3,700 MW). 

Wind power has a marginal running cost of close to zero.

The AGL trio say their modelling shows that the wind contribution reduces SA spot prices from an average of $75 per MWh without renewable energy to $64 – apparently delivering a gain to consumers of $155 million annually in a market worth $1.5 billion.

However, the system’s average cost over a year rises from $99.75/MWh to $109.75, actually adding a net $116 million to consumer costs.

“The merit order effect,” they say, “can only be transient.”

Tariff reductions will accrue to consumers only if the wind generation drives down long-run marginal costs. 

“In the long run, the effects of introducing high average cost, low marginal running cost generation cannot be price beneficial to consumers.”

The reality, they assert, is that suppressing wholesale prices with a sub-economic technology distorts the competitive market and places risks on the security and cost of electricity prices.

“Developers of new generation capacity will be more likely to hesitate (about) investing the very substantial debt and equity capital (needed) in markets where a government policy intervention results in a non-trivial reduction in operating profits for existing participants.”

And they warn: “Under a worst-case scenario, where thermal plant inmvestments are delayed excessively due to excess feed-in tariff capacity, the wholesale prices may eventually ‘snap’ when (such) investment becomes vital to maintain supply security. The extent of market volatility that comes with such a scenario is not in the interests of consumers, producers or investors."

The merit order effect exists alright, they argue, but the economic benefits associated with premium FiTs are “difficult to trace.”

This is not to say, they add, that policymakers should not introduce policies aimed at increasing use of renewable energy. “There are many sound economic and environmental reasons (for doing so) – (but) the merit order effect is not one of them.”

Keith Orchison, director of consultancy Coolibah Pty Ltd and editor of Powering Australia yearbook, was chief executive of two national energy associations from 1980 to 2003. He was made a Member of the Order of Australia for services to the energy industry in 2004.