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Carbon Folly Comes At A Price

HENRY ERGAS From: The Australian July 08, 2013 Illustration: Eric Lobbecke Source: The Australian GOOD on the Clean Energy Finance Corporation, the $10 billion fund established by Labor’s climate change package. Other government efforts at picking winners end up shafting taxpayers. The CEFC is doing so from the start. Not that the CEFC has released much information about its maiden “clean” energy project: the refinancing, announced last week, of Victoria’s $1bn Macarthur Wind Farm. But what is known makes intriguing reading. In theory, the CEFC is intended to address “barriers to funding cleaner energy projects”. But there is no evidence Macarthur couldn’t access capital. On the contrary, private investors offered the final tranche of finance the venture required, albeit at a slightly higher interest rate, reflecting the loan’s risk. Faced with that offer, the parties involved in Macarthur turned to the CEFC which, despite the government’s competitive neutrality obligations, undercut the private bid. That largesse was doubtless welcome; yet the beneficiaries, who fall into four groups, hardly seem natural recipients of Australian taxpayers’ generosity. The first are our cousins across the Tasman, with the CEFC’s intervention allowing New Zealand’s government-owned Meridian Energy to more profitably dispose of its investment in Macarthur prior to its privatisation later this year. A second beneficiary is AGL, Meridian’s partner in the venture. The CEFC previously described AGL as exercising “significant market power” in the purchase of renewable energy, meaning it extracts “super profits”; in adding a public subsidy to those profits, perhaps the CEFC was simply abiding by Matthew 13:12, “For whosoever hath, to him shall be given.” The Matthew principle applies with even greater force to the third recipient of the CEFC’s philanthropy, the Malaysian billionaire Syed Mokhtar al-Bukhary, who bought Meridian’s share. Syed Mokhtar’s links to Malaysia’s ruling party have facilitated the construction of a corporate empire that is investing in renewable energy worldwide. Last but not least is Macquarie Bank, with Macquarie Capital advising on the sale to Syed Mokhtar and managing Meridian’s float. With that cast of characters, the CEFC might have been expected to lean over backwards in demonstrating its intervention’s merits, all the more so as the CEFC’s chief executive and two of its board members are former senior employees of Macquarie, which gained directly from the CEFC’s decision. In fact, the sum total of the CEFC’s public disclosure amounts to a two-page press release claiming its funding will facilitate investment in wind generation. If the CEFC relied on a proper cost-benefit analysis, it hasn’t disclosed it; nor is it difficult to understand why: any reasonable appraisal would disclose a large social loss. That can be seen by undertaking the analysis the CEFC should have carried out. Assume that without the CEFC’s intervention, investment in wind generation would decline an implausibly large 10 per cent. That capacity would be replaced by a gas-fired plant, causing greater carbon emissions. By preventing that shift, the CEFC can claim a social benefit; but even assuming the carbon price understates the social value of abatement by $3 per tonne, that benefit is no greater than $6.6 million a year. However, like all bailouts, the CEFC’s will weaken the incentives for wind projects to be selected and operated efficiently. Even if their efficiency only declines by a mere 5 per cent, the social loss would be nearly four times larger than the $6.6m benefit. And to that loss must be added the higher cost of wind generation per unit of power supplied, further offsetting the environmental gain. The aggregate result is that for each $1 of benefit, the CEFC’s intervention makes Australians $5 worse off. That outcome highlights the extent to which carbon policy has degenerated into a mechanism for redistributing income from taxpayers and electricity consumers to favoured constituencies, imposing steep economic costs along the way. And if the CEFC reflects that phenomenon in microcosm, the carbon tax embodies it on a vast scale. After all, prices in European carbon markets have been far below our initial $23 tax since it came into effect. Abatement could therefore have been purchased internationally at a fraction of the cost the carbon tax has imposed on Australian industry. And the consequences of forcing emissions reductions here that could have been done more cheaply elsewhere have been anything but trivial. Rather, Treasury’s own modelling, adjusted for the absence of an integrated world carbon market, suggests that had our tax been aligned with Europe from the outset, national income would be $3.5bn higher by the end of 2014-15. Moreover, over the same period, households would have paid $4.2bn less in electricity prices, saving $450 per household. Why then has the tax remained at such high levels? Because decreasing it to European prices would have slashed government revenues over the period to 2014-15 by $12bn. It would thus have limited the scope to curry favour through tax cuts and the allocation of free permits, cash handouts and exemptions. And it would have provided a far smaller implicit subsidy to the renewable energy industry, which has been the carbon policy’s most vocal supporter. All that points to a crucial lesson: despite the incessant chatter about “market mechanisms”, this policy is an entirely artificial government construct, lacking any anchor linking the burdens it imposes to any gains it creates. In contrast to normal markets, prices can therefore continue indefinitely at levels which do not balance benefits with costs. And in the penumbra of the cash flows it generates, questionable deals can be struck with private interests at taxpayers’ expense. These deficiencies are not minor flaws; they are integral to the system Labor has set up. Until a clean broom is brought to this area, expect decisions such as the CEFC’s to remain the order of the day. Continue reading

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Carbon Trading Scheme Facing Strife

April 18, 2013 Illustration: Malcolm Maiden. The collapse of Europe’s latest attempt to breathe life into its moribund carbon trading scheme is a hammer-blow for proponents of a global carbon trading system. So much has gone wrong with Europe’s scheme that a global trading regime may be out of reach for decades, even if the carbon price recovers. Europe launched its trading system in 2005, and it quickly became the world’s carbon trading hub, for European permits, but also for ones generated in other markets, including the world’s largest issuer of permits, China. European regulators issued too many permits when they launched the scheme, however. The glut was hidden for a couple of years as Europe and the world surfed to the top of the boom that led to the global financial crisis, but once the crisis hit, it emerged as a potentially fatal design flaw. Europe’s carbon price was above €20 a tonne in 2008, before the sovereign debt phase of the global crisis emerged and Europe plunged into a deep recession. By February this year it was at €5 a tonne as recession conditions kept industrial activity, power generation, emissions and demand for permits down. Then on Tuesday in Brussels, the European Parliament narrowly voted against a plan to shore up prices by quarantining surplus carbon credits, and the carbon price fell to €2.6 or $3.34 a tonne. The plan to ”backload” excess credits by withdrawing them, holding them for about five years and then reinjecting them into a European economy that regulators hoped would by then be growing strongly enough to push demand for permits higher will probably be resubmitted, but there is no great hope that the vote will be different. The collapse in European carbon trading prices directly pressures the carbon reduction regime that the Labor government has launched because the intention is to switch from a carbon tax to a carbon trading scheme in 2015-16, and link the Australian scheme to the European system at that time. Existing and proposed prices for Australia’s scheme are far above those that now exist in Europe. The carbon tax was introduced last year at a price of $23 a tonne, and the government’s budget papers predict a price of $29 a tonne by the time the scheme shifts to carbon trading. If the European price stays down, Australia’s price will be below $10 a tonne after trading begins. Permits will be cheaper than expected, government revenue from the sale of permits will be lower, budget balances will be pressured and the government’s commitment to carbon scheme compensation packages that range from power generators to households will be reviewed. The broader message from the collapse of carbon trading in Europe is, however, that a carbon trading scheme cannot be relied on alone to set a pathway that leads to sustained emissions reduction. In a regime where carbon trading was an ineffective forcing mechanism in this country, for example, the separate target for at least 20 per cent of Australia’s energy to be sourced from large-scale renewable energy sources by 2020 would become a much more important part of the emission reduction equation. Carbon trading is designed in part to be a pathway for the flow of emission credits to where they are needed. Credits are underpinned by a carbon price, and if that carbon price rises they have positive value – are ”in the money” in options market parlance. Emissions reduction in a functioning carbon trading system is therefore not just driven by steps emitters take to reduce their emissions as carbon costs rise, but by ”green” investment rate of return sums that are sweetened by the profitable sale into the trading system of credits earned by renewable energy projects. The collapse of the European price has been so severe, however, that the investment incentive component of the trading scheme has been seriously undermined. Funds in China and elsewhere that were set up to create green projects assumed a much higher carbon price than now applies, and the profitable sale of carbon credits that enabled their projects to hit their rate of return hurdles. They are now stranded, and their investors have retreated. Underlying rate of return sums on green projects could be similarly affected when trading begins if the carbon price is lower than expected, but Australia’s separate target for at least 20 per cent of Australia’s energy to be sourced from renewable energy sources is a partial backstop. Energy prices would be lower without it, but it is a key renewable energy investment forcing mechanism: while it exists, energy companies must either buy or build renewable energy generating capacity. Given that and given the state of the political polls, the Coalition’s attitude to the 20 per cent target is going to be crucial, and so far it is not clear. It has pledged to kill the carbon tax and axe Labor’s $10 billion Clean Energy Finance scheme, but Opposition Leader Tony Abbott was circumspect about the renewable energy target when pressed earlier this month, saying only that a Coalition government would subject it to a ”serious review”. Read more: http://www.theage.co…l#ixzz2QpHmrUr5 Continue reading

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