LRET “Stealth Tax” to Cost Australian Power Punters $30 BILLION

Judith-Sloan

Judith Sloan: smarter than brain pie.

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As STT has pointed out – just once or twice – the Large-Scale Renewable Energy Target is simply unsustainable: any policy which is unsustainable will eventually fail under its own unfathomable weight; or its creators will be forced to scrap it, in circumstances of shame and ignominy.

We’ll go on to detail just why the LRET is all set to implode (and the wind industry with it) in a moment, but first we’ll hand over to Judith Sloan – The Australian’s top economics and policy analyst.

High price to pay if renewable energy target isn’t amended
The Australian
Judith Sloan
10 February 2015

I GUESS it’s a fair bet that many members of the government have been a tad distracted of late, but one of the problems is that distraction does not solve the policy problems that are mounting.

One of the items of unfinished business that the government hasn’t been able to fix is the renewable energy target. Apart from a few ill-informed activists, everyone, including those from the renewable energy industry, is calling for changes to be made. To be sure, there is not full alignment on what those changes should be, but there is widespread acknowledgment that the RET is not working as it was intended and that the consequences of failing to fix it are extremely unpalatable, including much higher electricity prices down the track.

The scheme was introduced by the Howard government in a very weak form in 2001. It was ramped up dramatically by the Rudd Labor government in 2009.

The scheme is broken into two parts: the large-scale RET and the small-scale RET. Both parts have fixed gigawatt hours to be achieved by 2020. For the LRET the figure is 41,000GWh and for the SRET it is 4000GWh. Electricity retailers are required to purchase renewable energy certificates, on behalf of customers, for the required megawatt hours of electricity generated by government accredited renewable sources.

Back in 2009, there was an expectation that the fixed RET would lead to 20 per cent of all generated electricity coming from renewable sources by 2020. It is now clear that this estimate is hopelessly wrong; indeed the percentage could be closer to 30 per cent and the implications of this overshoot need to be considered.

It is equally clear the LRET cannot realistically be achieved by 2020. The amount of energy presently being produced by renewable sources is only a tad over 16,000GWh. A reasonable chunk of this is hydropower, but there is little prospect of any significant increase in hydropower generation before 2020.

The only feasible form of large-scale renewable energy is wind power, but to achieve the LRET on the basis of additional wind power is not practical. It is estimated that there would need to be about three times the present wind generation capacity in place by 2020, amounting to an additional 2500 wind turbines. It just ain’t going to happen.

To make matters worse, the present and projected oversupply of wholesale electricity is causing havoc with the value of the certificates. There is also an effective capital strike, with no new significant investments being undertaken in any form of large renewable energy project. Several companies in the renewable energy game have taken significant writedowns on the value of their assets.

At the moment, financial institutions are simply unprepared to make the funds available to new projects in the context of a significantly oversupplied electricity market and regulatory uncertainty.

At this stage, it is worth taking a look at the legislation that underpins the RET. The key objects of the legislation are “(a) to encourage the additional generation of electricity from renewable sources and (b) to reduce emissions of greenhouse gases in the electricity sector”. There is also a requirement that the RET be reviewed every two years.

When considering the objects of the RET, the crucial questions are at what cost are the emissions of greenhouse gases being abated and how does this compare with other alternatives.

The Productivity Commission estimates that the costs of the LRET are somewhere between four and 10 times the costs of other policies, with the cost of the SRET higher again.

So at what stage are the negotiations on revising the RET, negotiations that Labor has declared that it is willing to conclude? The government has offered to remove the two-yearly review requirement, which would generate less uncertainty into the future.

But, in the best trade union tradition, Labor’s opening ambit is extreme, involving very little change to the scheme’s present parameters and a ramping up of the SRET.

This is notwithstanding the Australian Workers Union being clearly concerned about how the RET is playing out. Workers in the aluminium industry are among its members; the AWU has estimated that up to 60,000 jobs could be lost if the RET is not significantly revised.

But in a case of mixed messaging, Labor’s assistant Treasury spokesman Andrew Leigh seems to support the scheme as it is configured. Indeed, he has even made the claim that nearly 12,000 jobs would be lost if the RET were to be scrapped.

According to Leigh, the RET is really a form of industry development in which investment is encouraged and jobs created.

I wonder whether he thinks that imposing high tariffs on the textiles industry produced more jobs and investment in Australia overall. He should also recall from his study of economics that tariffs are the equivalent of a tax on the poor. This argument applies with equal force to the RET.

Given the lack of progress with the negotiations and as another year clicks over, should we simply conclude that the RET is bad policy and just move on? The problem with this position is the way the scheme works.

More and more certificates will need to be purchased, including a shortfall charge for electricity not generated by renewable sources. And the rising cost of these certificates will then be passed on to electricity users.

Both retail and industrial customers will face much higher prices, but there may well be very little additional large-scale supply of electricity from renewable sources.

This is in no one’s interests and is why the RET needs to be fixed, now. And this means both the government and the opposition need to step up to the plate.
The Australian

Judith, clearly on a roll, topped up with a few more valid (and obvious) points on the Catallaxy Files.

The clock is really ticking on the RET
Catallaxy Files
Judith Sloan
10 February 2015

I have written today on the RET and the urgent need to fix it. To be frank, I am not quite sure why Labor is playing so hard-ball in this issue. (Yes, I know its pals in the industry super funds with their large investments in the renewable sector will be urging certain action, but actual blue-collar union members are likely to have a different point of view.)

But the clock is really ticking.

Under the Renewable Energy (Electricity) Act, the targets for 2015 are 18,000 GWh, rising to 22,600 in 2016. (I’m talking LRET here.) The current production of electricity from accredited renewable sources is around 16,000 GWh.

Given the current capital strike in the renewable sector, there is very little prospect of these higher figures being met, particularly for 2016.

What then happens is a shortfall charge is payable and this is set down in law (Renewable Energy (Electricity)(Large-Scale Generation Shortfall Charge) Act. The figure is:

$65 per MWh

The effect of this will be to triple the value of RECs and drive up electricity prices to a dramatic extent. Without any change, this will occur within the next 18 months to two years.

Of course, the spivs in the finance industry who are holding the RECs as a bet on the shortfall occurring are just licking their lips at the prospect. But the political (and broader economic) implications of such a steep hike in electricity prices doesn’t bear thinking about.

(It is interesting to ponder why the requirement for two year reviews was put in the legislation. Just maybe, the Labor government thought things might change and the figures would need to be adjusted. This seems to be a point lost on the Labor opposition.)
Catallaxy Files

Nice work, Judith.

Now, never ones to let an opportunity pass, STT feels obliged to put some solid numbers under Judith’s analysis; indeed, in the present circumstances, it would be rude not to.

First, let’s deal with the end cost of the shortfall charge to power punters.

The shortfall charge paid by retailers will be collected by the Commonwealth and be directed into general revenue. So, whatever is filched from power punters can be fairly described as a “stealth tax”.

The cost of the shortfall charge at $65 per MWh compares with the average wholesale power price of between $35-40 per MWh. Therefore, at a minimum, retailers will be paying $100-105 per MWh for power, once the penalty hits (the average wholesale price plus the shortfall charge).

When Judith observes that the effect of the $65 per MWh shortfall charge “will be to triple the value of RECs and drive up electricity prices to a dramatic extent” she’s referring to the current value of RECs (around $34 now) and the effect of the tax treatment of RECs versus the shortfall charge.

The shortfall charge, set at $65 per MWh, is not-indexed (ie it is constant in nominal terms over the life of the scheme). As it is not a deductible business expense (the shortfall charge is treated as a “fine”), the effective pre-tax penalty is, therefore, $92.86 ($65/(1-30%), assuming a 30% marginal tax rate. The penalty is not indexed, so it declines in real terms over the period to 2030. With a little rounding, and allowing for inflation, this means RECs should trade at close to $94; as the shortfall charge starts to bite.

It also means that retailers will be looking to recover $94 in respect of every shortfall penalty charge they get hit with: ie, the $65 per MWh cost of the shortfall charge and the loss of the tax benefit that would otherwise be received were they to purchase RECs.

On that basis, retailers face an effective cost for power of $129-134 per MWh: the average wholesale price ($35-40 per MWh) plus the true cost of the shortfall charge at $94 per MWh, to the extent that the shortfall penalty applies.

Retailers will add a margin to that in the order of 10% (or more), which means Australian power consumers will be paying upwards of $140 per MWh: at least 4 times the average wholesale price. Retailers have already announced that they will simply recover the cost of the shortfall charge from their retail customers (see our posts here and here).

STT hears that Origin, Australia’s largest retailer, plans to add the full cost of recovering the shortfall charge to its retail power bills; and will display that fact on its bills, calling it a “Federal Tax on Electricity Consumers”, or something to that effect.

Of course, retailers could purchase RECs and avoid the shortfall charge. To avoid it entirely would require the purchase and surrender of 587 million RECs from here until 2031 (ie the remaining life of the LRET). Assuming that RECs hit $94, as the penalty begins to apply later this year, the cost added to power consumers’ bills will top $55 billion (587,000,000 x $94). As Origin Energy chief executive Grant King correctly puts it:

[T]he subsidy is the REC, and the REC certificate is acquitted at the retail level and is included in the retail price of electricity”.

It’s power consumers that get lumped with the “retail price of electricity” and, therefore, the cost of the REC Subsidy paid to wind power outfits. The REC Tax/Subsidy has already added $9 billion to Australian power bills, so far.

However, for reasons we’ll come to, Origin (and all of the other retailers) have NO intention of entering Power Purchase Agreements (the usual way in which a stream of RECs is secured by retailers) with wind power generators, now, or at all. And, as Judith Sloan correctly observes (as a result of the former), as no new wind power capacity is going to be built, it will be impossible to get enough RECs to avoid the shortfall charge, in any event.

Now, some more numbers.

Judith says the actual contribution counted to satisfying the LRET is stuck at 16,000 GWh, annually (and, for reasons we’ll come to, will remain stuck there).

Working on Judith’s figure of 16,000 GWh, in the table, the “Shortfall in MWh (millions)” assumes the total contribution to the LRET is 16,000,000 MWh (1GWh = 1,000MWh). The LRET target is, likewise, set out in MWh (millions). As set out below, this means that the shortfall charge will kick in this calendar year; insiders say sometime in March.

Year Target in MWh (millions) Shortfall in MWh (millions) Penalty on Shortfall @ $65 per MWh Minimum Retailers recover @ $94
2015 18 2 $130,000,000 $188,000,000
2016 22.6 6.6 $429,000,000 $620,400,000
2017 27.2 11.2 $728,000,000 $1,052,800,000
2018 31.8 15.8 $1,027,000,000 $1,485,200,000
2019 36.4 20.4 $1,326,000,000 $1,917,600,000
2020 41 25 $1,625,000,000 $2,350,000,000
2021 41 25 $1,625,000,000 $2,350,000,000
2022 41 25 $1,625,000,000 $2,350,000,000
2023 41 25 $1,625,000,000 $2,350,000,000
2024 41 25 $1,625,000,000 $2,350,000,000
2025 41 25 $1,625,000,000 $2,350,000,000
2026 41 25 $1,625,000,000 $2,350,000,000
2027 41 25 $1,625,000,000 $2,350,000,000
2028 41 25 $2,665,000,000 $2,350,000,000
2029 41 25 $1,625,000,000 $2,350,000,000
2030 41 25 $1,625,000,000 $2,350,000,000
Total 587  331 $22,555,000,000 $31,114,000,000

There it is, in black and white, at a bare minimum, the shortfall charge will add over $22 billion to Australian power bills, and up to $31 billion, if the full cost of the shortfall charge is recovered by retailers.  The application of the shortfall charge is, in the present circumstances, a dead certainty.

Commercial retailers have not entered any PPAs since November 2012; and have absolutely no intention of doing so: these agreements run for a minimum of 15 years; and, from a retailer’s perspective, the sole purpose of which is to obtain RECs in order to avoid the shortfall charge.

In the absence of PPAs, wind power outfits will never obtain the finance necessary to build any new wind farms (see our post here).

Retailers, like Origin, are alive to the fact that the LRET is simply unsustainable and, therefore, doomed to fail. Having kept their Mont Blancs firmly in their top pockets for well over 2 years, retailers appear to be quite capable of resisting the offers from wind power outfits to sign up for certain commercial suicide.

You see, this whole scheme (“corporate welfare on steroids”, as Liberal MP, Angus “the Enforcer” Taylor” puts it) is nothing more than a government mandated subsidy scheme, prone to amendment or repeal.

Faced with the political nightmare of trying to explain a massive (and wholly unjustified) escalation in retail power prices, there will be an inevitable retreat from the brink.

Remember that the policy justification for the insane cost of the mandatory LRET is that it would: “encourage the additional generation of electricity from renewable sources”; and “reduce emissions of greenhouse gases in the electricity sector”; and “ensure that renewable energy sources are ecologically sustainable” (see the link here).

With the wind industry on its knees (see our post here), the Federal government will collect some $30 billion from power consumers by way of the shortfall charge levied on retailers. However, there will be: NO additional renewable energy; NO “break-through” on-demand renewable energy technologies; and NO reduction in CO2 emissions (not that wind power generation has any such result – see our post here).

Could there be a government policy any more bereft of merit?

Now, in a little case of déjà vu, STT thinks that there are some significant parallels and important lessons to be learnt from how the Australian wool industry saw its Federally mandated subsidy scheme implode during the 1990s; all but killing the industry and costing growers and taxpayers tens of billions of dollars.

The wool industry’s “cause of death” was the Federally backed Reserve Price Support scheme (RPS), which set a guaranteed minimum price for all Australian wool.

A little background on the RPS

For over 150 years, Australia happily rode on the sheep’s back: until the 1970s the wool industry was, for the Australian economy, the “goose that laid the golden egg”; textile manufacturers from all over the world clamoured for the fibre; which was, for most of that time, the largest single commodity export by value; Australia produces over 80% of the world’s apparel wool. However, as fashions changed (the three-piece wool suit became, well, so “yesterday”) and new synthetics began to eat into its market share, the dominance of Australian apparel wool was no longer a certainty.

Against the backdrop of increasing competition, for the wool industry there was always the perennial issue, not only of fluctuating demand, but also of wildly fluctuating swings in production. Dorothea McKellar’s land of “droughts and flooding rains” meant that a few years of meagre production (and favourable, and even phenomenal, wool prices) would be soon eclipsed by sheds and wool stores overflowing with fibre ready for market (sending prices and woolgrower profits plummeting).

The response to these (often climate driven) marketing “swings and roundabouts”, was the establishment of the Australian Wool Corporation (AWC) and the RPS in 1973.

The RPS would set a minimum price for all types of wool, guaranteeing woolgrowers a minimum return; such that if supply exceeded demand, the AWC would purchase any wool being offered, if it failed to reach the minimum price set (referred to as the “floor price”).

Wool being offered at auction that failed to meet the floor price was purchased by the AWC and “stockpiled” (ie stored), until such time as either supply fell or demand conditions improved; at which point the AWC would offer stockpiled wool to the trade. The aim being the smooth and more orderly marketing of wool over the supply and demand cycle; with higher average returns to growers; and less risk for buyers and sellers along the way.

The scheme worked swimmingly (as designed and intended) until the late 1980s.

The reserve price set under the RPS was fixed in Australian dollar terms. However, with the float of the Australian dollar in 1983 (resulting in a massive 40% depreciation of the dollar between February 1985 and August 1986), maintaining the reserve price without reference to the terms of trade and fluctuations in trading currencies (particularly the US dollar) set the scheme up for a spectacular failure; simply because what goes down can just as easily go up.

During the 1980s, there was a solid increase in demand for wool, driven by demand from the USSR, a then fast growing Japan, buoyant Europeans, and a newly emergent China, as a textile manufacturer and consumer. However, that surge in demand occurred in the context of an Australian dollar trading in a range around US$0.55-75.

During the 1980s, under pressure from wool grower lobby groups, the floor price was continually increased: from 1986 to July 1988 the floor price jumped 71% to 870 cents per kilogram.

That did not, in itself, create any problems: a general surge in demand, relatively low production and a plummeting Australian dollar generated auction room sale prices well above the rising floor price, which reached their zenith in April 1988: the market indicator peaked at 1269 cents per kg, and the market continued its bull run for most of that year, well above the 870 floor price set in July.

However, as international economic conditions worsened, Australian interest rates soared (the consequence of Paul Keating’s “recession that we had to have”) and the value of the Australian dollar with it (hitting US$0.80 by early 1990), the market indicator headed south and, over the next few years, the AWC was forced to purchase over 80% of the Australian wool clip at the 870 cent per kg floor price. Adding to the AWC’s difficulties was a massive surge in production; driven by growers responding to the high and “guaranteed” floor price; and a run of exceptional growing seasons (1989 being a standout across Australia). Production went from 727 million kg in 1983/84 to over 1 billion kg in 1990/91.

Despite worsening market conditions, the AWC, under pressure from wool grower lobby groups, was forced to maintain the 870 cent per kilogram floor price.

However, from around August 1989, international wool buyers simply sat on their hands in auction sale rooms (in May 1990 the AWC bought 87.5% of the offering); and waited for the RPS to implode.

Knowing that the system was unsustainable, the last thing that buyers wanted was to be caught with wool purchased at prices above the floor price which, when the floor price was cut or collapsed, would immediately be worth less than what they had paid for it. Moreover, traders were dumping stock as fast as they could to avoid the risk of a collapse in the RPS and, therefore, a collapse in the price of any wool they happened to hold.

The RPS was ultimately backed by the Federal government. With the buying trade sitting on their hands, those responsible for maintaining the floor price ended up in a staring competition, the only question was, who would blink first: the AWC (or, rather, the government underwriting the RPS); or the buyers?

With the AWC purchasing millions of bales of wool at the floor price the cost of supporting the RPS was running into the billions of dollars: primarily the support came from a grower levy on sales, but, at the point which that soon became insufficient to support the RPS (despite upping the levy from 8% to 25%), support came from $billions in mounting government debt; the buyers had no reason to blink.

Instead, in May 1990, the government announced its decision to retreat to a new floor price of 700 cents per kilogram, and directed the AWC to fight on in support of the reduced floor price. The Minister for Primary Industry, John Kerin boldly asserting that the 700 cent floor price was “immutable, the floor price will not be reduced”.

But, having blinked once, the buyers largely continued to sit on their hands and simply waited for the government to blink again. The stockpile continued to balloon; and with it government debt: by February 1991 the stockpile reached 4.77 million bales (equivalent to a full year’s production); the accrued government debt stood at $2.8 billion; and the cost of storing the stockpile was over $1 million a day.

Faced with the inevitable, the government blinked, again: John Kerin was forced to eat his words about the floor price being “immutable”; on 11 February 1991, announcing the suspension of the floor price. The RPS had totally collapsed; the buyers had won.

The wool industry’s saga is beautifully, if tragically, told by Charles Massy in “Breaking the Sheep’s Back” (2011, UQP), which should be required reading for any of our political betters pretending to know more than the market (eg, the power market).

Which brings us to the lessons and parallels.

The LRET effectively sets the price for RECs: the minimum price is meant to be set by the shortfall charge of $65 per MWh (rising to $94 when account is given to the tax benefit), as the penalty begins to apply on the shortfall (as detailed above). That equation is based on an ultimate 41,000 GWh target.

In the event that the cost of the shortfall charge was reduced, there would be a commensurate fall in the REC price. Likewise, if the LRET target was reduced: the total number of MWhs which would then attract the shortfall charge if RECs were not purchased would fall too; also resulting in a fall in the REC price.

In addition, any reduction in the LRET would simply result in a reduction in the demand for RECs overall: fewer RECs would need to be purchased and surrendered during the life of the LRET; again, resulting in a fall in the REC price. Of course, were the LRET to be scrapped in its entirety, RECs would become utterly worthless.

The retailers, are alive to all of this, hence their reluctance to enter PPAs for the purpose of purchasing RECs; agreements which run for a minimum of 15 years.

Since December last year, Ian “Macca” Macfarlane and his youthful ward, Greg Hunt have been running around pushing for a target of 27,000 GWh; while their boss wants to kill it outright. In the last week or so, the Labor opposition has started talking about a target around 35,000 GWh.

Whether they know it or not – with their public musings about an amended target – these boys have – in the staring competition with retailers – already blinked.

Faced with the inevitable political furore that will erupt when power consumers (ie, voters) realise they are being whacked with the full cost (and some) of the shortfall charge (being nothing more than a “stealth tax” to be recovered by retailers via their power bills), the pressure will mount on both sides of politics to slash the LRET.

That both Labor and the Coalition have already blinked (in obvious recognition of the brewing political storm in power punter land over the inevitable imposition of the shortfall charge) is not lost on the likes of Grant King from Origin, and all of Australia’s other electricity retailers.

Grant King

Grant King estimates the likelihood of
retailers blinking in the LRET stare-off.

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Like wool buyers sitting on their hands in sale rooms during 1990, waiting for the floor price to collapse, electricity retailers need only sit back and wait for the whole LRET scheme to implode.

Like wool buyers refusing to buy above the floor price and carry stock with the risk of the RPS collapsing, why would electricity retailers sign up for 15 year long PPAs with wind power outfits in order to purchase a stream of RECs over that period, knowing the value of those certificates depends entirely upon a scheme which is both economically and politically unsustainable?

However, the similarities between the wool market and the market for wind power end right about there.

There is, and always was, a natural market for Australian wool; the only issue during the late 80s and early 90s was the price that had to be paid by buyers to beat the floor price, set artificially under the RPS.

Wind power has no such market.

Available only in fits and spurts, and at crazy, random intervals, at a price which is 3-4 times that of conventional generation, retailers have no incentive to purchase it.

In the absence of the threat of a $65 per MWh fine (the stick), coupled with the promise of pocketing $94 as a subsidy in the form of a REC (the carrot), electricity retailers would not touch wind power with a barge pole: it simply has no commercial value.

Moreover, with an abundance of conventional generation capacity in Australia at present, retailers are very much in a “buyers’ market”. Overcapacity, coupled with shrinking demand (thanks to policies like the LRET that are killing mineral processors, manufacturing and industry) means that retailers can expect to see wholesale prices decline over the next few years, at least.

With those fundamentals in mind, electricity retailers will simply opt to pay the shortfall charge and recover it from power consumers, knowing that that situation will not last for very long.

Sooner or later, the Federal government (whichever side is in power) will have to face an electorate furious at the fact that their power bills have gone through the roof, as a result of a policy that achieved absolutely nothing.

In the meantime, retailers, like Origin, can simply sit back, watch the political fireworks, and wait for the inevitable and complete collapse of the LRET; and, with it, the Australian wind industry.

Tony Abbott – facing more than a few political troubles of his own at the moment – has talked about the need for his government to “knock a few barnacles off the ship”, in reference to some of the Coalition’s more troublesome policies, in the hope of winning a second term. Well Tony, if you and your team are keen for another stint in power, here’s one mighty big “barnacle” that is just begging for removal: the LRET simply has to go NOW!

turbine collapse 9

Some things are just inevitable.

About stopthesethings

We are a group of citizens concerned about the rapid spread of industrial wind power generation installations across Australia.

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