Why AGL is mistaken on solar subsidies

AGL's chief economist claims to have pinned down solar subsidies, but they ignore the main 'wealth transfer': network overbuild.

Electricity tariffs. Oh what fun! In Australia it's issue du jour, perhaps not unreasonably given the “creative destruction” wrought on by photovoltaics.

The latest contribution to the debate is a paper by AGL Energy economist Paul Simshauser. The paper claims to have isolated “the incidence of inequitable wealth transfers arising from air-condition and solar PV units”. This is a bold claim and merits discussion.

Simshauser’s approach is to assume the cost structure of the southeast Queensland network is 20 per cent fixed, 20 per cent variable and 60 per cent sunk. He then says that the optimal tariff structure should recover fixed costs through fixed charges, variable through variable and sunk through demand.

He then calculates the network payment for four types of household with or without air-conditioners and PV with a three-part tariff.

He then compares these network charges to the charges with the existing two-part tariff, which he assumes recovers fixed costs through the fixed charge and the remaining sunk and variable costs through the energy charges.

The resulting pair-wise comparison then gives what he says are the wealth transfers.

What to make of this? Well, if you assert you have the right answer (in Simshauser’s case a three-part tariff and known cost structures) and then compare it to the status quo (which Simshauser assumes is wrong) what you get is an answer that, impressive though it sounds, is really no more than an assertion. Likewise the claims made of this, for example that it “substantially increases the efficiency and fairness of the price signal” is no more than an assertion. Harmless stuff, but really, so what?

More significantly the paper seems to be silent on some of the key issues. The problem, surely, is not really about peak demand anymore. We know that throughout the National Electricity Market, distributors have massively expanded capacity over the last few years at the same time that both peak and average demand has been declining. We also know that in both Queensland and South Australia, PV has shifted regional peak demands later in the day, and thereby played a major role in the reduction of the simultaneous peaks. The same has happened in Italy in the summer, where the peak demand in summer now often occurs late at night and, of course, is lower than the peak demands before the rise of PV. PV of course does not deliver at night, but so what ... if the 11pm peak is much lower than previous 4pm peaks and there is plenty of spare capacity.

The essence of the problem, surely, is that households with PV are now paying less for network services than they were before. Network service providers and, evidently, Simshauser as well, call this difference a subsidy (Simshauser also calls it a wealth transfer). But why? Technology has changed and customers with PV now want a different service from their network service providers. Why should network service providers have a right to be paid to meet the demands of yesterday?

There is now plenty of redundant network because declining demand was not anticipated and, as we know well, because network service providers have had an economic incentive to gold plate. If network service provision was contestable, shareholders would have absorbed the deadweight long ago.

With regulated monopoly it is of course much harder, decisions rest with politicians and bureaucrats who will be lobbied this way and that. The allocation of the deadweight is the issue. Underlying the assertion that the problem to be solved is tariff design is the idea that network service providers have a right to be insulated from the actual demands of the people and businesses that use their services. We have done this for too long and the disastrous results are there for all to see. Time to move on.

Bruce Mountain is director of CME, an energy economics consultancy focused on Australia’s electricity, gas and renewables industries.