Australia’s Wind Industry Under Siege: LRET Subsidy Set to be Slashed (Again)

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Subsidy won’t generate target
Australian Financial Review
Ben Potter
10 March 2016

Less than a 10th of the wind and solar generation capacity required by the renewable energy target this decade is under construction, which could force the Turnbull government to renegotiate the controversial scheme with the opposition.

Significant shortfalls under the cross-subsidy scheme loom as early as 2017. Electricity retailers have to pay a penalty of about $93 for every megawatt hour by which they miss the target.

A subsidy of nearly $80 a megawatt hour, on top of the $40 to $60 generators are typically paid in the National Electricity Market, has not been enough to drive more wind or solar farm investment.

Only 532 megawatts of new wind and solar projects are under construction, Bloomberg New Energy Finance says. Some of this has been bought by the ACT and won’t be available to meet RET targets.

“This year is make or break for the renewable energy target,” Kobad Bhavnagri, head of Bloomberg New Energy Finance in Australia, said.

“At the very least, 1 gigawatt [1000 megawatts] of new projects need to obtain financing this year to demonstrate that the system is working, although much more is needed to meet the target.”

The Coalition government and the opposition agreed less than a year ago to reduce the target to 33,000 gigawatt hours from the Rudd government’s target of 41,000 gigawatt hours.

Industry Confusion

Revisiting it so soon would revive the uncertainty the renewables industry complained of during the last review.

“If everybody thinks the government is going to change something, then people will hold off, waiting until the government changes something,” Grattan Institute energy program director Tony Wood said. “So everybody sits there looking at each other and [wondering] who is going to blink first.”

A spokesman for Environment Minister Greg Hunt said there were no plans to revisit the RET.

“The target is rock solid,” he said. “We will not be changing it.”

Mr Bhavnagri said recent announcements by AGL Energy and Origin Energy to back new renewables were grounds for optimism. But “market conditions are still challenging”.

Energy retailers are reluctant to write long-term power purchase deals for new renewables projects because the electricity market is over-supplied.

Banks reluctant to finance

That makes banks reluctant to finance the projects, even though the combined price that a new wind or large-scale solar farm gets from renewable energy credits and the National Electricity Market is now $120 to $130 a megawatt hour – more than the generating costs of most new wind farms.

The RET was designed to work with a carbon price that would take over as the driving force for investment as the carbon price increased, allowing the RET to be phased out.

But the repeal of the carbon price in 2014 left the RET as the only incentive for wind farms, although government financing is still available for solar farms. But no post-2020 RET target has been set and RET subsidies – known as renewable energy certificates or RECs – expire in 2030.

New wind farms take at least two years to build, meaning they can count on little more than a decade’s RET subsidies for an asset with a 25 to 30-year life.

“You can not bank these RECs beyond 2030 and there is no carbon price in place to take over,” Mr Wood said.

“That means things could get quite nasty and the government has no real levers except name and shame.”
Australian Financial Review 

Ben Potter is fast heading towards STT’s top accolade of ‘STT Champion’; and is well in the running for next Year’s STT’s Australian of the Year Award – For Excellence in (Proper) Journalism.

For the effort above, it’s almost ten-out-of-ten for Ben, who, we are reliably informed, is an avid STT follower – where else would anyone find the true facts about the greatest economic and environmental fraud of all time, dished up day-after-day?

Well, at least among Australia’s serious dailies, the AFR – thanks to Ben’s efforts – gives their readers more than enough material to reach the inevitable conclusion that the Large-Scale RET is doomed, and the wind industry along with it.

Ben’s well-researched efforts stand in stark contrast to the wind industry backed propaganda, dished up by the likes of The Australian’s Sid Maher, who seems happy to simply reprint the drivel drawn up by Patrick Gibbons, a wind industry lobbyist planted in Environment Minister, Greg Hunt’s office.

Ben makes only a couple of minor missteps, first is his suggestion that the “RET was designed to work with a carbon price”.

To suggest that there was any ‘design’ behind the LRET, a $55 billion subsidy scam, and a tax on CO2 gas, that could only ever destroy viable electricity grids and power markets, is, in the first instance, to flatter those policies, as being the product of some kind of rational deliberation; in hindsight, it will be used as a form of exoneration by policy ‘designers’ (read ‘idiots’) who (not equipped with even the most basic knowledge of power systems, economics or markets) will later claim that they “couldn’t see it coming”.

Indeed, when the Labor-Green Alliance introduced the CO2 Tax on top of a, soon to escalate, LRET, Australia’s commercial retailers immediately recognised that having both would lead to even more rapid and punishing power price rises than one would have done, without the other. Hence their push to kill both: CO2 Tax first (successful), and then the LRET (partially, but soon to be wholly successful).

The other point Ben fails to nail is when he says that “no post-2020 RET target has been set”. In fact, the Large-Scale RET is set by s40 of the Renewable Energy (Electricity) Act 2000 (here): the annual target hits its peak of 33,000 GWh in 2020 (33,850 in 2020, to be precise); and continues to run at 33,000 GWh each year thereafter, until the end of 2030.

Which brings us back to young Gregory Hunt. Greg’s hysterical claims that the LRET “target is rock solid” and that “we will not be changing it,” have the ring of history about them, and sound a lot like the story of King Canute holding back the tides (without the wit to recognise, as the Danish King did, that such was really in the hands of God).

But, more apt is precisely the same type of claim made by then Minister for Primary Industries, John Kerin, when, after having been forced by recalcitrant wool buyers to massively slash the Floor Price for Wool under the Federal Government backed Reserve Price Scheme, Kerin valiantly asserted that his new floor price was “immutable”. It wasn’t. Due to the obvious parallels with the inevitable collapse of the LRET, the RPS story is worth repeating, again.

For nearly 4 years, the wind industry, its parasites and spruikers have been wailing about the requirement for policy ‘certainty’. What that wailing is really about, is a plea for the Federal government (read ‘taxpayer and power consumer’) to underwrite a politically toxic policy, that has already been slashed from an ultimate annual target of 41,000GWh to 33,000GWh, for precisely that reason.

In 2015, faced with the fact that the target could never be met, both Labor and the Coalition were forced to cut the target before the shortfall penalty inevitably took effect. But that was simply to stall the LRET’s ultimate collapse: the same factors that the likes of Infigen, Pac Hydro and Trustpower/Epuron moan about, and identified by Ben Potter above, are still in play.

Ben’s analysis is spot on: there will be no increase in wind power capacity; the $93 per MWh shortfall penalty will apply; and the Federal government will be forced to cut the target, once again.

It’s the fact it was cut once that has commercial retailers (we don’t count the ACT Government) refusing to sign Power Purchase Agreements (PPAs) with wind power outfits; and, therefore, bankers refusing to lend to wind power outfits for construction of any new capacity. And, as with any ‘business’ that relies for its very existence on a piece of policy, what the government once did, can be just as easily undone – in full.

What kills the LRET – and the wind industry with it – is the same set of forces that led to the demise of the Australian wool industry. The lessons and parallels drawn from the implosion of its Federally mandated subsidy scheme during the 1990s – all but killing the industry and costing growers and taxpayers tens of billions of dollars – are obvious to anyone with a sense for markets and a little economic nous (which obviously excludes Greg Hunt).

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 $93 when account is given to the tax benefit), as the penalty begins to apply on the shortfall (as detailed here). That equation is based on an ultimate 33,000 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 further 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.

In December 2014, Ian “Macca” Macfarlane and his youthful ward, Greg Hunt started running around pushing for a target of 27,000 GWh; and their boss, Tony Abbott made clear that he wanted to kill it outright. There followed overtures from the Labor opposition pitching for a target around 35,000 GWh.

Whether they knew it or not – with their public debate on what an amended target should be – in the staring competition with retailers – these boys 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 – the “penalty of about $93” mentioned by Ben Potter – (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 – once again.

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.

And for retail power buyers the choice of sticking with permanent recalcitrance has been made even easier: with the previous PM Tony Abbot making it plain that he would have cut the LRET even harder, were it not for a hostile Senate; and Labor’s Bill Shorten pushing for an entirely ludicrous 50% LRET – that would require a further 10,000 of these things to be speared all over Australia’s rural heartland. Where there was once ‘bipartisan’ support for these things, the major parties are diametrically opposed.

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With the politics of the LRET already on the nose, 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 fixed by PPAs which is 3-4 times that of conventional generation, retailers have no incentive to purchase it.

In the absence of the threat of the $65 per MWh fine (the stick), coupled with the promise of pocketing $93 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. And, for the first time in almost 20 years, a sharply declining Australian economy is a fast looming reality: unemployed households have an even tougher time paying rocketing power bills.

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.

Current PM, Malcolm Turnbull might mouth platitudes about ‘renewables’ and ‘innovation’, but his chances of leading the Coalition to a second term in power are tied to fundamental ‘mum and dad’ policies like electricity costs. The opinion polls show that voters have already turned on Turnbull, quickly rumbling him as someone overburdened with his own political vanity, but equipped with all the courage of a mouse and the spine of an aging jellyfish.

Power prices matter; and in a battle between Australia’s Big 3 Retailers and the LRET, STT’s money is firmly on commercial self-interest.

As we’ve pointed out before, the big retailers plan, apparently, to exhaust the pile of RECs that they’re sitting on at present, while building a few large-scale solar power facilities, in order to obtain the RECs needed to avoid the shortfall charge; and to wait for the politics to turn gangrenous. As soon as the LRET gets scrapped, the plan is to sell the panels back into the residential roof-top market.

The cost of the LRET – and all that comes with it – to retail customers is at the heart of what’s driving retailers’ efforts to crush the LRET; and the wind industry with it.

This might sound obvious, if not a little silly: electricity retailers are NOT in the business of NOT selling power.

Adding a $45 billion electricity tax to retail power bills can only make power even less affordable to tens of thousands of households and struggling businesses, indeed whole industries, meaning fewer and fewer customers for retailers like Origin, AGL and EnergyAustralia.

The strategy adopted by retailers of refusing to ‘play ball’ by signing up for PPAs will, ultimately, kill the LRET; it’s a strategy aimed at being able to sell more power, at affordable prices, to more households and businesses.

And it’s working a treat, so far.

The wind industry’s incessant daily whining about “uncertainty”, is simply a signal that the retailers have already won. While the likes of Pac Hydro, Trustpower/Epuron and Infigen will continue to work themselves into a lather about their deservedly miserable fate, in the meantime, the commercial retailers 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. In, what has become, a permanent wind power investment ‘drought’ only the retailers have the capacity to survive.

Moreover, the scale and scope of South Australia’s wind power disaster isn’t going away; and, because its unstable grid and rocketing power prices are the direct product of a policy already under siege, SA’s worsening calamity signals precisely the kind of political threat to the LRET that vindicates the position taken to date by power retailers and bankers; and ensures that they will have nothing further to do with the wind industry from hereon.

With all that in mind, Greg Hunt’s table thumping about his “rock solid” LRET will find itself in history’s annals of wildly courageous political assertions, right alongside John Kerin’s “immutable” wool Reserve Price Scheme.