Perverse outcomes of ‘green subsidies’ for renewable electricity generation in Australia

The Carbon Tax (price) was ‘axed’ on the 17th July 2014 with an effective date from 1 July 2014.

The carbon tax (price) was one of the ‘green subsidies’ Australian electricity users funded through the price they pay for their electricity usage. The repeal of the Carbon Tax (price) should deliver a saving to the electricity consumer (domestic and business) in their electricity usage costs of approximately 2.6 c/kWhr up to 2.8 c/kWhr. For an ‘average’ household using 10 MW hrs/a this equates to approximately $280/a.

In regard to the continuation of the Renewable Energy Target (RET – both large market (LRET’s) and small market (SRET’s), which is the other major component of ‘green subsidies’), the average household’s electricity bill includes the RET impost of approximately 1.40 c/kWhr to 2.0 c/kWhr. For an average household using 10 MW hrs/a this equates to $140 to $200/a.

The following is a review of how the introduction and continuation of ‘green subsidies’ have impacted upon households and business in the Australian community and the general economic activity for investment and growth.

 

Perverse outcomes of ‘green subsidies’ for renewable electricity generation in Australia

We overview costs and prices of electricity in Australia based on the introduction and continuation of cross subsidies benefiting ‘renewable’ energy electricity generation. Question:  So how do green energy subsidies impact on the market?

Overview of historical electricity prices

Subsidies in any form lead to market distortions.  A market without subsidies finds its own equilibrium where the lowest cost (assuming all other factors are equal) to meet the demand is the natural outcome.  By and large, one can argue that this has been the historical situation for the majority of industry and householders in the Australian electricity market.  It should be noted there have been cross-subsidies operating from time to time, such as a price ‘equalisation’ for country consumers compared to city consumers, as well as for state based subsidies to ‘lure’ large industry users (together with new jobs) to a particular state.  However, these historical cross-subsidies have not had a significant impact upon the average price for electricity paid by consumers, at least when compared to the increased prices recently and currently paid by consumers for ‘green subsidies’

Domestic electricity prices

Figure 1 shows the proportions of Retailer (energy charges) and network charges making up the domestic electricity cost. The Retailer portion includes ‘green subsidies’. The proportions of Retailer (energy) and network charges vary from State to State.

 

Green Subsidies’

In regard to energy (electricity in particular) in almost every western-based economy, various governments of the day have mandated subsidies (in various forms) for electricity derived from so called ‘renewable sources’, such as wind and solar.  The motivation for these subsidies is arresting global warming and associated climate change, although the recent article by Lomberg[1] in ‘The Weekend Australian’ questions the real benefits of this thinking.  Putting aside the relative merit of subsidies for social/environmental purposes, what are the market distortions and resultant economic consequences of these very significant subsidies upon the fabric of the Australian economy?  In the Australian electricity market, these distortions are generally in terms of relative cost inputs. Traditional electricity generators (coal and gas-fired) end up with a higher cost base than they would otherwise have, because they are required to pay money in various guises to the government for carbon produced as a by-product, and to achieve mandated renewable energy targets and so on. So, what are the additional costs in Australia? The actual cost included in electricity bills to the consumer (industry and householders) is approximately:

  1. Renewable Energy Targets (RET’s) range from 1.2 to 1.7c/kWhr;
  2. carbon price (cost) to consumers is generally is 2.2 to 2.5c/kWhr.

Both of the above charges are paid on energy delivered, so the impact is inflated by transmission and distribution loss factors.  In the cities this is about 8%.  In the country it is approximately 15%. (The loss factors depend upon voltage delivered.)  The charges are then inflated with the impact of the GST, at 10%.

Taking an average approach, a typical cost impact is approximately 4c/kWhr up to 5.3c/kWhr, so, on average, about 4.6c/kWhr.  Note that business can recover GST paid whereas domestic users (householders) cannot.

The objective behind these artificial increases in traditional electricity prices is to make them more expensive so that higher cost renewables can compete on a cost basis.  As well, the increased charges provide a source of revenue for the Government.

A large part of the revenues collected is given (in the form of a subsidy) to the high cost renewable electricity generators.  This allows the renewable electricity industry to average down its costs to make them more competitive with the traditional energy producers, which now have increased costs.

So, given this is the policy, the subsidies do what they were designed for, that is, increase the cost base for the traditional electricity generators and reduce the cost base for the renewable electricity generators (by giving them subsidies).  Thus, more and more money is poured into renewable electricity generation projects, which are financially underpinned by a government guarantee (in one form or another) for the term of their projects, resulting in more renewable energy into the market.

What’s the impact on the economy?

In Australia, over the last 40 to 50 years (from the 1960s to approximately 2005), cheap electricity from traditional sources has been one of the essential building blocks for our economic growth.  Relatively cheap coal and natural gas yield cheap electricity.  This has been one of the main drivers for large manufacturing industries to locate in Australia. Large users, such as aluminium producers have established production plants in Australia principally on low cost energy input. This, of course, has had knock-on economic benefits for the local community and the Australian economy overall, such as service industries, skills and jobs which, in turn, has lead to further economic growth and development.  The knock-on economic benefits can’t be understated, since the benefits spill over to education, skills, and general economic growth in new and allied businesses.

One of the other intrinsic economic benefits of the ‘cheap’ electricity has been for domestic users (householders), which allowed them to stretch the family budget further.  Consequently, there have been community-wide economic benefits, flowing on to other products and services, thus creating a round of demand and investment, and skills and jobs that have benefited the economy overall.

Thus, the impact is many fold.  Subsidies distort market outcomes, and hence behaviours.  On the domestic front, householders have seen their electricity bills increase dramatically.  Not all of the increases are attributable to the imposition of the ‘green subsidies’.  Network costs (transmission and distribution) have increased significantly as the respective network providers submit cases each year to the Australian Energy Regulator (AER) for increased capital expenditure, so they have a bigger asset pool upon which to derive an agreed rate of return. Some would argue the rates of return afforded to the Network owners are quite generous compared to the low interest rate economy Australia has been over the last few years.

However, for domestic and small business users, the current cost impact of the ‘green subsidies’ is approximately 4.6c/kWhr.  To put this into perspective, if we look at what the electricity price would have been without these ‘green subsidies’ then we can determine the percentage this impost represents.

Domestic

Average ‘bundled’ (meaning total combined energy, network and other charges) electricity rates vary across each State.  If we back out the ‘green subsidies’ from the average bundled price, the current price to householders for usage varies from around 25 to 30c/kWhr.  So, adding an additional 4.6c/kWhr (‘green subsidy’) represents approximately 15% to 18% additional cost.  For large businesses, which can achieve lower priced electricity prices (energy portion of their cost), the cost impost is up to 30%.  These increases are even more concerning if the network cost portion of delivered supply is excluded, since network isn’t about being in competition with renewable energy sources. That is, if (for households) the additional 4.6c/kWhr of ‘green subsidies’ is taken as a proportion of only the electricity retailer and generator costs (the ‘energy component’ only) then the ‘green subsidies’ represents a percentage increase of approximately 25% to 40%. That is, a 4.6c/kWhr increase on a base energy cost component (without green energy subsidies) of 12 to 18c/kWhr.  In some States this percentage impact is even higher.

Domestic electricity (Retailer portion)

Figure 2 shows the impact of ‘green subsidies’ on the Retail portion (energy) for the domestic user. The Retail (energy) portion has increased by 36% in this example. In some States this increase has been up to 40% and likely higher.

 

Business

For businesses the impact is even higher. Taking into account that business can generally recover the GST proportion, a 4c/kWhr increase on a (non ‘green subsidy’) energy cost of approximately 6 to 9c/kWhr (which includes losses and GST) equates to a 50% to 75% increase in energy only costs!  With network costs increasing at a relatively high rate over the last 4 years the impact of these ‘green subsidies’ has been masked somewhat.

Business electricity costs

Figure 3 shows a typical split between the Retail (energy) portion, ‘green subsidies’ and network for business. In some States the proportion of ‘green subsidies’ to the Retail (energy) component is higher because of lower network and retail (energy) costs.

 

 

Impact of green subsidies on business

Figure 4 shows that with the addition of ‘green subsidies’, the Retail (energy) portion has increased from a base of 7.1c/kWhr (no ‘green subsidies’) to 11.7c/kWhr (which includes ‘green subsidies’), an increase of 65%. In some States, this increase has been 75 to 80%.

 

Impact on the Economy

Increased electricity costs flow through the economy. They manifest into increases in service costs, manufacturing costs, transportation costs, and so on.  They also lead to higher cost inputs when determining investment decisions, growth decisions and even decisions by householders as to how far the domestic budget can stretch.

The impact and outcomes for the national and local community economies vary according to the location of large manufacturing sites, but some of the bottom lines manifest as follows.

  1. Manufacturing has taken a significant hit, and some companies are relocating offshore (not all driven by the singular impact of the ‘green subsidies’), particularly as public announcements of closure or downsizing are very circumspect as to the ‘drivers’. However, investment decisions (which include decisions to stay in business where you are) take into account all costs, the future expectation of costs, and the reliability of the cost base.
  2. If the future cost base estimation is not assured there is a loss of confidence about the future economics of projects, including ‘brownfield’ organic growth or new projects. The sudden introduction of the carbon tax eroded confidence in being able to make sound investment decisions going forward due to uncertainty as to the likely forward cost base.   Additional possible cost increases (and risk) are therefore built into modelling scenarios which can make marginal or medium investment projects appear uneconomic or take on a higher risk profile. The net outcome is less investment than what might otherwise have been, manufacturers and investors delay and/or shelve organic growth projects leading to a loss of skills, jobs opportunities, and so on.
  3. What about beneficiaries of the ‘green subsidies’ and therefore higher costs of electricity? Well, there are those who receive the subsidies: namely the renewable electricity generators, the suppliers of turbines to them, and the general economic activity around the supply and servicing of these new investments.  On balance, the increase in economic activity due to the building of renewable electricity generators and the ongoing maintenance of them is very low, compared to the economic loss of higher electricity prices that the community has to bear.  Other beneficiaries are manufacturers and communities in other countries that do not have the same burdensome cost imposts (‘Green Subsidies’).  Generally these overseas communities have or are securing, cheap electricity from relatively cheap coal fired generators, often from Australian produced coal or natural gas (in the form of LNG).
  4. The climate change arguments proposed by some for implementation of renewable energy to reduce CO2 emissions are many and varied. That CO2 emissions have increased as a result of human endeavour is clear.  However, the impact of renewable energy in a global environment where economic growth is increasingly sought by poorer countries is likely to remain small.  As Lomberg (2014) has stated, renewable energy is actually much more expensive than at first glance because of the need for backup power when there is no wind or sun.  So fossil fuel generators must be constructed and maintained though only operated ‘part time’.  Consequently, renewable energy can only be afforded by ‘rich nations’ that can pay the high costs associated with it if economic growth is to be maintained.  This includes Australia!
  5. The stated aim for the RET was to achieve a 20% renewable energy contribution to the electricity market by the year 2020. However, due to a slowing of overall electricity demand, the current rate of renewable electricity generation will result in renewables contributing around 28% of overall generation by the year 2020. Given the cost of the subsidies for renewables on the end user, it is timely for a review and reduction in the generous support through ‘green subsidies’ into renewables.

In conclusion, the impact of renewables on the economy (particularly in South Australia) is becoming very obvious whereas their influence on the environment is still intangible.

 

[1] B Lomberg (2014)  ‘Gas is greenest in the short term’.  The Weekend Australian, July 12-13, 2014.  Inquirer, p.21.

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Comments

  1. Good article! It appears that even Germany is having second thoughts. As a result of their overly aggressive renewable energy targets, they’ve had to increase their use of coal for power generation in order to keep average electricity prices “under control” and not adversely impact their manufacturing industry. Surely that does not benefit the environment?

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