POLICY BRIEF: Renewable Energy and the Carbon Price Brief prepared for WWF- Australia

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1 REPUTEX ANALYTICS Brief prepared for WWF- REPORT SUMMARY This brief prepared by RepuTex and commissioned by WWF-, examines the relationship between the carbon price and renewable energy generation in. The examination is based on modelling the impact on renewable energy generation should a price and limit on carbon pollution, referred to here as the n Carbon Price Mechanism (CPM), be repealed. The brief includes: Introduction to the relationship between the carbon price and renewable generation Analysis of the carbon price impact on wholesale electricity prices in the National Electricity Market (NEM) Impact of carbon price on national energy market mix and greenhouse gas emissions Summary of the impact of repealing the carbon price on renewable energy generation KEY FINDINGS The Carbon Pricing Mechanism (CPM) and the Large-scale Renewable Energy Target (LRET) are complementary market mechanisms that together support s transition to a low carbon economy. The carbon price helps to make renewable energy cheaper, by making fossil fuels more expensive, and with the help of the LRET, incentivising investment in renewable projects. With the CPM in place, the long-run cost of wind energy in the National Electricity Market (NEM) has become lower than fossil fuel-fired generation. Higher carbon prices, which lead to higher wholesale electricity prices, reduce the price of Large-scale Generation Certificates (LGCs). Conversely, should carbon prices fall, the price of LGCs would have to rise to ensure there are enough renewable credits available to cover the LRET liability of energy companies. Modelling indicates that should the carbon price be repealed, the price of LGCs would be likely to spike to near the penalty (the price of not purchasing a credit), at which point LGC prices would be capped, making the build of further renewable assets uneconomic. In such a situation, investment in renewable energy in would slow, as retailers would opt to pay the penalty price instead of buying LGCs.

2 REPUTEX ANALYTICS To meet the legislated Large-scale Renewable Energy Target (LRET) of 41,000 GWh by 2020, around 7 GW in new wind build would be required from 2013, or around 1 GW of new capacity added each year. Repealing the carbon price would limit investment in additional onshore wind energy, potentially resulting in a capacity shortfall of nearly 6 GW. Large-scale renewable energy development is not currently supported by the alternative Direct Action policy. With carbon pricing in place, even at low prices, we anticipate that the LGC market will continue to support the development of 7 GW of onshore wind energy at LGC prices between $ While wholesale electricity prices would be lower if the carbon price is repealed, retail customers would be unlikely to receive the benefit of these lower prices, as electric providers would continue to pay for the LRET scheme. The outcome of this dynamic would likely be higher retail electricity prices, without the additional competition from wind energy. RELATIONSHIP BETWEEN PRICING AND RENEWABLE ENEGRY Renewable projects are incentivised by the creation of Renewable Energy Certificates (RECs) that equate to 1 MWh of renewable energy. Retail energy companies must purchase and surrender RECs at the end of every calendar year in line with the government s annual renewable energy target. Demand for RECs enables developers to build new large-scale renewable energy projects (which require power purchase agreements (PPAs)). In practice, the most affordable renewable projects are signed for onshore wind at close to $100 per MWh for developments in New South Wales and Victoria. For example, in Victoria this method was used to finance the development the 420 MW Macarthur wind farm that was fully commissioned in 2013 and is now the largest wind farm in the southern hemisphere. As per chart 1, a price on carbon can help to make renewable energy more affordable by incentivising the initial investment in renewable energy projects. The price of renewable certificates for large-scale renewable projects (LGCs) is effectively the difference between the wholesale price and the long run marginal cost of renewable energy (how much it costs to produce renewable energy over the life of the project). While carbon pricing does not directly affect the price of LGCs, it does increase the cost of fossil fuel generation, thereby increasing the wholesale electricity price, resulting in a smaller gap between the wholesale price and the long run marginal cost of renewable energy. In this way, the carbon price interacts with LGC prices. PAGE 2

3 REPUTEX ANALYTICS Chart 1: The Impact of the n CPM on Renewable Energy PRICE WHOLESALE ELECTRICITY PRICE MARKET FAVOURS CHEAPER FUELS The carbon price impacts wholesale electricity prices by increasing the operating costs for high emitting fossil fuel generators such as black and brown coal, and gas. Once renewable capacity is built there are no fuel costs, so the market selects it as the lowest cost energy source. A carbon price imposes a cost on pollution, incentivizing firms to cut emissions in order to reduce their costs. RENEWABLE ENERGY CREDITS INVESTMENT IN CLEAN ENERGY PROJECTS Higher wholesale electricity prices keeps downward pressure on LGC credits, keeping the cost of development in check. Supported by higher wholesale electricity prices and renewable energy certificates, new renewable capacity is built economically instead of fossil fuel fired capacity. The price of LGCs is currently capped at a fixed penalty rate of $65. 1 Retailers who cannot purchase credits for the cap price would likely choose to pay the fixed penalty; this effectively acts as a deterrent to demand for more renewable projects. Consequently, wholesale electricity prices are a critical support for building renewables in order to sign power purchase agreements at levels that are able to support the economics of capital-intensive renewable energy, like large onshore wind assets or large scale solar. 1. The penalty price is $65 per LGC, but may have an effective maximum price of $90 after taking account of company tax treatment. The penalty price is fixed in nominal terms under the Renewable Energy (Electricity) Large-scale Generation Shortfall Charge) Act PAGE 3

4 REPUTEX ANALYTICS PRICE IMPACT ON WHOLESALE ELECTRICITY PRICES IN THE NATIONAL ELECTRICITY MARKET (NEM) As outlined in table 1 below, since the introduction of the carbon price on July , wholesale electricity prices have risen by more than 80% in every state except Tasmania, where the majority of electricity comes from hydroelectric generators. Accordingly, more than half of the value of today s wholesale electricity price is attributable to the carbon price. Despite these changes in the wholesale electricity price, retail electricity prices have increased by less than 10% as a result of the carbon price mechanism. 2,3 Changes in the carbon price have a small impact on electricity bills as wholesale electricity prices are only a minor component of the retail electricity price, which is primarily driven by costs related to distribution, marketing and retail costs. Table 1: Average annual prices (per financial year) Year NSW QLD SA TAS VIC YoY increase 83% 131% 130% 45% 111% Source: AEMO, RepuTex Carbon Analytics Coal-fired power plants dominate s energy generation mix owing to the low and stable cost of fuel at less than $2 per Giga-Joule (GJ). By comparison natural gas can cost upwards of $5 per GJ. This difference in fuel price has historically given coal-fired power an advantage in providing the cheapest source of electricity to fulfil baseload demand in the wholesale electricity market. With a carbon price in place, the cost of CO2 pollution is no longer free, with a carbon cost added to the cost of each MWh generated from burning fossil fuels. As a result, the introduction of the carbon price has significantly changed the levelised cost (price at which electricity must be generated from a specific source to break even over the lifetime of the project) of fossil-fuel fired power plants, which has increased the wholesale costs of electricity. As renewable generators do not incur any carbon liability, the carbon price has worked to enhance the competitiveness of renewables against traditional fossil fuel based generation. As outlined in Chart 2 below, coal fired plants that emit the most CO2 pay the highest carbon cost, in turn raising the total cost of energy from a new coal fired power plant beyond that of the same energy from a wind plant. 2. AEMC, Possible Future Retail Electricity Price Movements: 1 July 2011 to 30 June 2014, December SKM, Modelling the Renewable Energy Target Renewable Energy Target: Report for the Climate Change Authority, December PAGE 4

5 REPUTEX ANALYTICS Chart 2: Levelised cost of energy in with and without the n CPM A$/MWh - No Carbon Price A$/MWh - With Carbon Price CCGT OCGT Coal Wind Largescale PV The introduction of the carbon price has also increased revenues available to renewable generators from the electricity spot and contract markets. Because renewable energy projects are much cheaper to operate as they have no fuel costs, the electricity they generate is more likely to be the first purchased in the national electricity market. This provides additional financial benefits to renewable energy projects on top of the price of LGCs. Chart 3 below summarises how the carbon price, wholesale prices, and large scale renewable energy credit (LGCs) prices interact to make renewable energy more attractive (by meeting the long-term marginal cost). Analysis indicates that without a carbon price renewable energy projects will still be built in 2016 due to increases in large scale REC prices, but by 2020, the REC price on its own (which is effectively capped by the RET penalty price) would not be enough to drive the renewable investments needed to fulfil the RET. PAGE 5

6 REPUTEX ANALYTICS Chart 3: Prices supporting the construction of new renewable energy capacity (per financial year) Carbon price LGC price Wholesale electricity price Marginal Cost of New Renewable Energy A$/MWh FY12 FY13 FY16 with Carbon Source: RepuTex Carbon Analytics Price FY16 without Carbon Price FY20 with Carbon Price FY20 without Carbon Price Resultantly, the CPM and the LRET, via the role of wholesale electricity prices, are complementary market mechanisms, introduced to support s transition to a low carbon economy. The government intended the RET to work with the carbon price to deliver approximately $20 billion of investment in renewable energy by The CPM alone does not provide enough incentive to get the equivalent of 20 per cent of s electricity from renewable sources by 2020 because of legacy capacity that has been mothballed to fulfil future demand growth. Carbon prices would have to be more than double the current carbon tax before they could independently finance the building of this amount of new renewable capacity. Likewise, without a CPM renewable energy projects would more expensive and in some cases uneconomic. PAGE 6

7 REPUTEX ANALYTICS IMPACT OF THE CPM ON NEM GENERATION AND EMISSIONS Due in part to the impact of the carbon price, since July 2012 the n market has witnessed record levels of hydroelectric generation across the NEM, while coal-fired power generation has declined. Over this period, higher wholesale prices have incentivised clean energy generators to produce more power during high demand periods of the day, while in parallel, as baseload demand falls, carbon pricing has reduced the profits of the most carbonintensive generators. In this way, the CPM has immediately begun lowering the emissions associated with every kwh of electricity that is used, and has already begun to alter the shape of the generation mix within the n NEM (see charts 4 and 5 below). Since the introduction of the CPM, NEM carbon emissions have fallen 8 per cent off the back of a 2 per cent fall in NEM generation, with 53 per cent of emissions reductions attributed to marketbased fuel switching and the remaining 47 per cent ascribed to non-market based capacity difficulties at carbon-intensive generators in FY13. The introduction of the CPM played a marginal role in the reduction of brown coal output, with sluggish demand and renewable generation beginning to push marginal brown coal plants (Energy Brix, Northern, Playford, and Yallourn) out of the market. Hydroelectric generators have subsequently taken advantage of high prices to displace capacity left by some asset impairments. This is different to previous periods, such as flooding in April 2012, where hydro generators stored their water and generation gaps were made up by coal and gas plants across New South Wales and Queensland. Extreme weather events in Q1 FY13 also led to a decrease in brown coal generation, including flooding at Yallourn power station, idling of Port Augusta power stations, and the ramping down of Energy Brix. Flooding in the Latrobe Valley decreased generation at Yallourn to 30% percent of its normal operating levels. One of Yallourn s four units remains idled, with generation not anticipated to rise in the foreseeable future. Looking ahead, the trajectory of the n carbon price will be an important input for the market; particularly should the timeline for the commencement of a floating carbon price be brought forward. Should early access to international markets occur, we anticipate a lower initial carbon price to temporarily reverse some of the gains made in FY13 in reducing emissions. This is particularly true for the coal-hydro generation balance highlighted earlier. Despite this, even at low prices, the CPM would support new clean energy capacity before 2020 thought the LRET, ultimately making s energy mix cleaner. PAGE 7

8 REPUTEX ANALYTICS Chart 4: NEM emissions by fuel type FY13 versus FY12 120, , ,000 kt CO2 60,000 40,000 20,000 0 Black Coal Brown Coal Natural Gas Chart 5: Change in NEM generation FY13 versus FY12 40% 30% 20% 10% 0-10% Natural Gas Black Coal Brown Coal Hydro Wind Total -20% -30% -40% PAGE 8

9 REPUTEX ANALYTICS SUMMARY: IMPACT OF REPEALING THE CPM ON RENEWABLE GENERATION According to the Clean Energy Council, installed capacity in wind power in has increased by an average of 25% per year over the past decade. To meet the LRET of 41,000 GWh by 2020, around 7 GW in new wind build would be required from 2013, or around 1 GW in new capacity added each year. This is an ambitious target given a total of 2.5 GW in renewable energy capacity was added in over the past decade. 4 On the other hand, this target represents a development rate of 18% per annum, which is in line with global wind energy growth rates when conditions are correctly incentivized for renewable energy development. Furthermore, an annual growth rate of 18% is half of the average annual growth n wind energy has experienced over the five years to Chart 6: Forecast LGC price with and without the CPM Forecast LGC price, RepuTex (2012 Dollars) Penalty price of $65/MWh (2012 Dollars) LGC price, $0 carbon scenario 80 A$/LGC Clean Energy Council, PAGE 9

10 REPUTEX ANALYTICS As shown in chart 6, should the carbon price be successfully repealed by the beginning of FY2015, RepuTex modelling indicates LGC prices would spike to near the tax-adjusted penalty price of A$85/MWh in 2015, at which point LGC prices would be capped by the declining penalty price in the following years, making the build of renewable assets uneconomic. Even if energy retailers were prepared to commit to projects at costs exceeding the current penalty price, it is implausible that the impact would be significant or widespread. Investment in renewable energy in would slow, as retailers would opt to pay the penalty price instead of buying LGC at prices above A$80. As a result, as shown in Chart 7, the operation of the price cap would severely limit investment in additional onshore wind energy, potentially resulting in a RET shortfall equivalent to 6,000 MW of onshore wind. Since the current alternative Direct Action policy does not impose a price on competing fossil fuelled generation, there is likely to be insufficient economic support to build large-scale renewable generation. Any tenders for emissions reduction funds to build large-scale renewable capacity directly under this policy would need to be in excess of current carbon prices, and are therefore unlikely to be successful in procuring funds. Chart 7: Forecast growth of wind capacity with and without CPM 12,000 NEM Wind Capacity with CPM (MW) Wind Capacity without CPM (MW) 10,000 8,000 MW 6,000 4,000 2, PAGE 10

11 REPUTEX ANALYTICS With carbon pricing in place, even at low prices, we anticipate that the LGC market will continue to support the development of 7 GW of renewable capacity at LGC prices between $ This level of pricing support should be sufficient to generate 25 per cent of electricity from renewable resources 4 (Chart 8). It is also highly likely that renewable energy generators will continue to sell LGCs beyond FY2020 to meet the cost of investment in operating projects and to fund new projects, however, since the price of LGCs is effectively capped by the RET penalty price, a rising carbon price will be needed to finance further renewable development beyond Chart 8: Forecast Energy Mix in 2020 with CPM Wind 15% Other Renewable 3% Hydro 7% Natural Gas 4% Coal 71% Alternatively, repealing the CPM and returning to previously low wholesale electricity prices would stifle clean energy development and favour generation from existing coal-fired generation assets. The lack of pricing support would generate only 14 per cent of electricity from renewable resources 6 (Chart 9). While wholesale prices would be lower, retail customers would be unlikely to receive the benefit of these lower wholesale prices, as electric providers would continue to pay for the LRET scheme as required by the penalty price. The outcome of this dynamic would likely be higher retail electricity prices, without the additional competition from wind energy or the benefit of a cleaner electricity sector. Chart 9: Forecast Energy Mix in 2020 without CPM Wind 6% Other Renewable 3% Hydro 5% Natural Gas 3% Coal 83% 5 & 6. This includes baseline hydro generation that does not receive LGCs, large-scale NEM generation that is eligible for LGCs, and other non-nem and small-scale renewables. PAGE 11

12 REPUTEX ANALYTICS ABOUT REPUTEX RepuTex is a specialist energy and carbon research firm, providing market pricing, forecasting and advisory services to companies in and Asia- Pacific. We are the leading supplier of detailed carbon and energy insights to customers at major power, energy and metals and mining firms in, along with leading capital markets and government organisations across the Asia-Pacific region. With over 150 subscribing customers locally, RepuTex forecasts have become a key reference point for n carbon, power and energy market professionals who rely on our proprietary analytics to support a range of internal decision making and external communications. Established in 1999, we have offices in Melbourne & Hong Kong. CONTACT US - RESEARCH Hugh Grossman Executive Director hugh.grossman@reputex.com Tel: (03) Bret Harper Associate Director, Research bret.harper@reputex.com OFFICE LOCATIONS RepuTex Melbourne 2/F, 443 Little Collins Street Melbourne, Victoria, T: (03) E: reputex@reputex.com RepuTex Hong Kong 1/F, Hoseinee House, 69 Wyndham Street Central, Hong Kong SAR T: (852) E: reputex@reputex.com WEBSITE This report is copyright. Except as permitted under the Copyright Act 1968 (Cth), no part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, whether electronic, mechanical, micro copying, photocopying, recording or otherwise, without the prior written permission of the copyright owner. This report consists of factual information gathered, selected and arranged by RepuTex by the application of methods of selection and judgment which are original and unique to RepuTex. The information contained in the report does not constitute investment recommendations and is not a recommendation to buy, sell or hold shares or securities issued. Information is of a general nature, it has been prepared without taking into account any recipient s particular financial needs, circumstances and objectives. A recipient should assess the appropriateness of such information to it before making an investment decision based on this information. RepuTex disclaims any and all liability relating to the report and makes no express or implied representations or warranties concerning the accuracy, reliability, currency or completeness of information contained in the report. RepuTex does not accept liability for any error, omission or delay in the information or for any reliance placed by any person on the information. RepuTex shall not be liable for any claims or losses of any nature, arising indirectly or directly from use of the information, howsoever arising. PAGE 12