Oct 20 2022

Simple is best: cutting the costs of cutting carbon

With electricity prices rising around the world, there comes a risk that ambitious climate change action might lose its social licence. A new report from the Productivity Commission sheds some light on how governments can pursue emissions reduction policies without compounding the financial strain consumers are facing.

The findings indicate that Australia’s current suite of carbon policies are not efficient. We take a closer look at these findings and what it means for future carbon policy.  

What does the report say?

Since the previous Federal Government abandoned the proposed National Energy Guarantee in 2018, the absence of a coherent national energy policy has seen states and territories seek to fill the gap. This has led to significant state policy announcements like the NSW Electricity Roadmap, and more recently, the Queensland Energy Plan. Beneath these flagship policies there are also schemes to drive the energy transition like renewable energy targets, feed-in tariffs, energy efficiency schemes, public funding of sectoral abatement projects and tax concessions for electric vehicles and domestically produced biofuels. 

In its 5-year Productivity Inquiry, the Productivity Commission has examined the efficacy of the alternative policies and found their carbon abatement costs are “much higher than likely under explicit carbon pricing”. This finding aligns with the Commission’s broader philosophical message that broad-based explicit carbon pricing mechanisms generally promote least-cost abatement for the economy.

The below table, extracted from the report, shows the Commission’s calculations of the estimated cost per tonne of avoided carbon from some of these policies.

Table 1: Indirect carbon prices in Australia for selected policies

The number that immediately stands out when looking at this table is the high abatement cost of electric vehicle subsidies. In Queensland and Western Australia, this top bound range of the carbon price is an exorbitant $7,205. The Commission explains that the ‘high level of estimates for demand-side EV policies reflects their low near-term abatement benefits, with the emissions intensity of the electricity grid being only marginally lower than that of petrol’.

In other words, the abatement costs are currently high because the uptake of EVs is slow relative to the number of internal combustion engine cars already on the road. Its second point about emissions intensity appears conservative, as research has shown the difference in emissions intensity to be more than just marginally lower. Regardless, the emissions intensity of the electricity grid will continue to improve as the electricity sector rapidly decarbonises.

While this estimated carbon price is high, we should bear in mind that this table is only calculating observed abatement to date. The central purpose of EV subsidies is to incentivise future uptake, which if realised, should substantially lower the carbon price of these subsidies.

The other number of note relates to the cost of small-scale technology certificates. These certificates exist as an incentive to install small-scale renewable energy systems, the most notable being solar PVs. The early installation phases of solar panels had a dramatic impact on the carbon output of the electricity grid as they were able to displace coal-fired power generation during times of the day when the sun was out. However, the carbon displacement value of continued solar PV subsidies today is less clear.

This is because the widespread installation of solar PVs has successfully dinted coal-fired generation to the point of there being little generation left to displace during the middle of the day. This would indicate the present-day carbon costs of small-scale technology certificates is underestimated and no longer proportionate to its carbon value. The Australian Competition and Consumer Commission (ACCC) has previously advocated for the winding down and abolishment of the SRES to reduce its impact on retail prices paid by consumers. The broad political appeal though of solar PV subsidies makes it unlikely, however, that there will be any policy change on this front.

The Commission’s recommendation for a “move on” mechanism

Among other recommendations in the report, the Commission puts forward the idea of introducing a “move on” mechanism. Essentially, this is a clause that would require policymakers to make funding for abatement technologies conditional on meeting pre-defined progress thresholds, as well as introducing formal institutional arrangements, such as sunset clauses, to allow reconsideration and rigorous assessment of the costs and benefits of additional funding. If the pre-requisites are not met, then policymakers should “move on” from that technology.

While this might be politically challenging to execute, it would arguably greatly improve the efficiency of decarbonisation in Australia. Different metrics would need to be used depending on whether the technology is current or prospective.

For current technologies, like solar PVs, the historical impact on abatement is not questioned. It has materially displaced carbon fuels during certain periods of the day. The assessment then would be whether the continued subsidies for this technology are efficient relative to the projected future abatement it can offer. Here, if the efficiency test cannot be met and the costs to consumers are too high, policymakers would “move on” from the subsidy, not the technology itself.

For prospective abatement technologies, the “move on” question focuses both on the subsidy and the technology. Government investment in prospective technology that does not meet their potential can result in significant sunk costs, as well as having the additional side-effect that waiting for these technologies to mature delays consideration of alternative abatement options.

A contemporary example of this is hydrogen. While hydrogen should have a role to play to replace natural gas for hard-to-abate large industrial uses, electrification is a more economically efficient, and immediately available, solution compared to hydrogen for decarbonisation of residential and commercial gas use. With these sectors electrified, there would appear to be no ongoing requirement to maintain a low-pressure gas distribution network.

Yet government is promoting hydrogen blending approaches for the existing gas distribution networks in what appears an unlikely goal to at some future time fully convert the distribution network. Even though these early blends are extremely diluted (typically as little as 3 per cent by energy value), they impose immediate costs and inconveniences on customers due to the change in technical fuel characteristics. The Government support for hydrogen blending then seems to be unnecessarily adding costs and delaying the abatement that can occur now through electrification.

A “move on” clause could avoid or at least mitigate these undesirable outcomes. By placing conditions relating to progress, there is accountability on government to make sure it is meeting Australia’s carbon targets in a manner that is least-cost to consumers and the community.

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