October 15, 2011

Grattan Institute

Green Army: Research and Development


Founding Members


Grattan Institute is grateful for the support of our founding members:
  • the Australian Government,
  • the State Government of Victoria,
  • The University of Melbourne and
  • BHP Billiton.
They contributed to an endowment that provides ongoing funds towards Grattan Institute’s programs.

Their support was structured to maintain Grattan Institute’s independence, and is not conditional on Grattan Institute undertaking particular programs or positions.


Contents


Orange Book 2016 — Priorities for the next Commonwealth Government

Budget pressures on Australian governments

No easy choices: which way to Australia’s energy future?
Learning the hard way: Australian policies to reduce carbon emissions


GRATTAN INSTITUTE

  • Orange Book 2016: priorities for the next Commonwealth Government, June 2016.

    Over-arching Considerations


    Fairness

    Under our progressive tax system
    • the top fifth of taxpayers pay 58% of income tax (and 33% of indirect tax) whereas
    • the bottom fifth pay 2% (and 11% of indirect taxes).
    And Australia has the most targeted transfer system in the world:
    • the bottom fifth receives relatively large transfers;
    • the top-fifth receives very little in government transfers.
    [After tax and transfers, Australia has higher income inequality than the OECD average. …]

    Australia has increasingly adopted age-based tax, welfare, and other spending policies, accompanied by recurrent budget deficits, that increase the risk that the next Australian generation will be less well off than its parents.
    These policies also tend to increase inequality within generations over the long term.
    And they undermine incentives by increasing the value of inheritance relative to individual effort. …
    [Grandfathering] unsustainable tax breaks on investments, for example, tends to benefit one generation over the next.
    (p 12)


    Size of Government

    The objectives of economic growth, provision of services and fairness [inevitably] require trade-offs.
    One of the most difficult is that if government provides more services and redistributes more, then it will tend to be larger, which reduces economic growth. …

    [The] Australian government is relatively small for a developed economy … because its welfare system is extremely targeted, while spending on all other categories is moderate.
    While this targeted welfare spend increases living standards, particularly for those in the bottom 40%, [means testing] often creates steeper welfare traps … than under other welfare systems. …

    Australian government spending as a share of GDP has increased over the last decade, largely because [of rising health care spending.]
    The same trend is obvious in all developed economies except Iceland over the last two decades.
    As countries get richer, their governments spend an increasing share of resources on health.
    In Australia increased health spending has correlated with much better health outcomes:
    • life expectancy rose;
    • years of life without a disability increased;
    • amenable mortality halved (deaths from diseases that some of the time medicine can prevent); and …
    • self-reported health improved.
    It is not hard to understand why people in many countries have been prepared to trade off a little extra income in order to live longer, healthier lives. …

    [The cost of Medicare has] increased largely because of [spending on:]
    • [higher] GP rebates and payments,
    • additional mental health care, and …
    • new diagnostic imaging technologies.
    (p 13)

    This increased spending on health in Australia was not matched
    • by structural increases in taxation, or
    • by decisions to reduce spending in other areas.
    Until the Global Financial Crisis, windfall tax receipts from the mining boom covered much of the additional spending.
    More recently the spending has been funded by deficits, which effectively [passes the bill for today's health care on to] future generations …
    (p 14)


    Economic Growth Priorities

    Net national income per capita has declined every year since 2011, because productivity and hours worked have not grown enough to offset the effect of declining resource prices on income.
    (p 15)

    Treasury modelling indicates that a corporate tax cut (replaced by increases in personal income tax) will only increase national incomes (measured by GNI) by 0.6%, even if it increases economic activity (measured by GDP) by about 1%.
    It will also drag on the economy for the first decade of implementation, given the tax lost from foreign investors.
    The tax cut would only start to add back to national income as foreigners gradually invest more in Australia.

    A reduction in income tax funded by broadening the GST base and/or increasing the GST rate would increase incentives to work and invest.

    Taxes on savings are too low relative to other taxes. …

    The capital gains tax discount and negative gearing arrangements mean that other taxes must be higher which impose greater economic costs. …
    Reducing the capital gains discount to 25%, and not allowing investors to deduct losses from passive investments from labour income would better balance the competing considerations. …

    The clearest productivity increase from tax reform would be to replace stamp duties by general property taxes.
    (p 16)


    Economic Geography


    [Most] new housing is [being built] far from the centres where most new jobs are being created.
    [Consequently, the] physical divide between rich and poor is growing as a result.

    [Home] ownership rates [in the younger age groups] have fallen over the last two decades …
    Generous tax breaks such as negative gearing are not helping housing affordability, but they are not the biggest factors in high house prices. …
    At present, restrictive planning practices are denying people the opportunity to live in established areas close to jobs and transport. …
    Replacing stamp duties with a broad-based property levy would make it easier for people to relocate to job opportunities and encourage more productive use of land in our cities.
    (p 21)

    {Policies] designed to shift jobs to outer suburbs or regions could harm national productivity and employment growth as we forgo the benefits of agglomeration in bigger cities.
    (p 22)


    Transport


    [There has been] disproportionate over-investment in the regions over the last decade.
    (p 24)


    Energy


    An economy-wide carbon price through a market mechanism is the best way to reduce emissions to meet Australia’s targets without excessive cost to the economy.
    [Failing this, the] Commonwealth should strengthen and evolve its existing Safeguard Mechanism — a policy that limits the emissions of about 140 of Australia’s highest-emitting businesses — so that it becomes an effective market mechanism.

    By using an already existing instrument, the Safeguard Mechanism, the Commonwealth can avoid a repeat of the chopping and changing of climate change policy that has created such uncertainty for business and the community.
    A commitment to gradually transforming the Safeguard Mechanism into a market-based policy also has the potential to achieve bipartisan support, which has been sadly lacking in climate change policy.
    (p 26)

    Broad bipartisanship would give business the predictability it desperately needs to support the transition to a low-emissions economy.
    A credible, long-term climate change policy would provide incentives for new low-or zero-emissions electricity generation, such as wind and solar power. …

    [The] failure to properly regulate the costs of power networks was a vital factor in prices increasing by 60% in real terms for all customers. …
    In reforming power networks, two issues take priority.
    • First, the process for defining the costs that networks can recover from customers takes too long and encourages networks to overspend. …
    • Second, governments must resolve who will pay for surplus network infrastructure that was built to meet overly cautious reliability standards and grossly inaccurate demand forecasts.
    (p 27)


    School Education


    Australia’s performance in international PISA tests has steadily declined since 2000.
    Differences in outcomes among schools have increased. …
    An estimated 20% of Australian 15-year olds fail to reach a baseline proficiency in mathematics in international tests.
    Our national minimum standards do not highlight those falling far behind.
    For example, a Year 9 student at the national minimum standard operates at the average level of a Year 5 student.
    (p 30)

    The reality of school education means relying on markets is not the best way to improve student learning …

    One year of pre-school education reduces the risk by half that a student will become a low performer at age 15.
    (p 33)


    Higher Education


    [Promoting] STEM courses has contributed to a serious over-supply of graduates with generalist science degrees.
    They now have little prospect of employment in their field, and below-average overall employment outcomes.
    (p 35)

    … HELP is now Australia’s biggest tertiary education program, with loans of about $8 billion per year. …
    Interest costs will grow significantly as total debt is expected to reach $100 billion by the end of the decade.
    (p 36)

    Although public research funding has declined slightly in recent years, over the medium term it has increased significantly — by nearly 60% between 2001 and 2015.
    (p 37)


    Health


    The number of services per person in the lowest-access rural areas is less than half that of the major cities.
    Current responses—such as training more doctors, or paying them bonuses to move to rural areas—haven’t done enough.
    At current rates of improvement, it would take more than 65 years for very remote areas of Australia to catch up to the levels of GP services that big cities have today. …

    Australian patients pay a bigger share of health care costs than patients in almost any other wealthy country, and these costs are rising fast.

    Many people already miss out on health care because of cost:
    • 5% skip GP visits,
    • 8% don’t go to a specialist,
    • 8% don’t fill their prescription and
    • 18% don’t go to the dentist. …
    Instead of shifting costs to patients, we should focus on protecting
    • people on very low incomes, and
    • people with [multiple] health problems.
    (p 41)


    Budgetary Reform


    The big long-term sources of the deficit are
    • spending on health, Age Pensions, [and] aged care that increased faster than GDP, and
    • income tax revenue that fell behind GDP growth due to reduced marginal rates and superannuation tax breaks.
    (p 42)

    The Charter of Budget Honesty should be amended to require governments to bring down budgets that produce a surplus within the [four year] forward estimates. …

    [Reforms] to the Pharmaceutical Benefits Scheme could reduce waste by $320 million a year.
    The largest other potential cost reductions are
    • to increase the age of access to the Age Pension and superannuation, and
    • to target the Age Pension better, particularly by effectively including more of the value of owner-occupied housing in the means test.
    (p 44)

    [On the revenue side] the Commonwealth’s highest priorities should be to
    • target superannuation tax breaks to the purposes of superannuation,
    • restrict negative gearing, and
    • reduce the capital gains tax discount. …

    Many assert that further investment in education and infrastructure could boost economic growth, and that governments should borrow to do so. …
    [However,] there is a real risk … that additional expenditure on infrastructure [would] not increase growth by more than it costs.
    (p 45)

    Would you like to know more?

  • Budget pressures on Australian governments, April 2013.
    John Daley: CEO, Grattan Institute.

    Australian government budgets are under pressure.
    In the next 10 years, they are at significant risk of posting deficits of around 4% of GDP.
    That means finding savings and tax increases of $60 billion a year. …

    Persistent government deficits incur interest payments, and limit future borrowings.
    As a result they can unfairly shift costs between generations, and reduce flexibility in a crisis. …

    On published figures, government budgets are close to balanced.
    But this masks significant problems.
    [This] analysis examines the budgets of the Commonwealth and the three largest State governments as a whole. …
    The greatest [threat comes] from sustained increases in spending, especially in health.
    Over the past decade health expenditure rose by over $40 billion in real terms.
    The ageing population was not the prime cause.
    Rather, people of any age saw doctors more often, had more tests and operations and took more prescription drugs. …

    Smaller government will not necessarily improve Australia’s budget balances.
    Substantial increases in productivity and participation … are also unlikely to solve the problem.
    [Only] tough policy choices can substantially improve government budgets [and this] will require courageous leaders, as well as new institutional arrangements and mindsets.

    Would you like to know more?

  • No easy choices: which way to Australia’s energy future?  February 2012.
    Tony Wood, Tristan Edis, Daniel Mullerworth and Helen Morrow.

    OVERVIEW


    Australia must … change the nature of its electricity supply [if it is to realize the] Commonwealth’s goal [of reducing] Australia’s greenhouse gas emissions to 80% below 2000 levels by 2050.
    [In order to limit the risk of an increase in average global temperature of more than two degrees].

    [We] assess the prospects for seven technologies that generate electricity with near-zero emissions …
    • wind,
    • solar PV,
    • geothermal,
    • nuclear,
    • concentrating solar power,
    • carbon capture and storage and
    • bioenergy. …

    [Existing] policies will not on their own produce the transformation we need.
    The carbon pricing scheme, while a good start, is not enough. …

    Markets must be the primary mechanism by which Australia reduces its emissions.

    To ensure markets work properly, government must also remove barriers to deployment of several technologies, such as transmission connection hurdles and subsidies to incumbent technologies.
    Yet even then, it remains unlikely that enough funds will be invested in the short term to give any of the low-carbon technologies a chance to deliver. … Early movers face higher costs than followers [and] get little reward for paying [those] higher costs. …

    As a result, private sector investment will deliver less than the best outcome for Australia.
    Governments should therefore support research and development in areas of national interest, and demonstration and early-stage deployment of a suite of technology options.
    It is not easy for governments to steer a course between, on the one hand, inadequate support for low-carbon technologies, and on the other, picking winners or favouring one technology over another.
    (p 1)


    HOW WE WROTE THIS REPORT


    This report sets out the findings of the technology assessments and reviews the implications for government policy in terms of developing and deploying low emissions electricity technology.
    No easy choices: which way to Australia's energy future — Technology Analysis … assesses each of the seven low-emissions technologies in detail. …

    This report focuses on the electricity supply mix [and assesses the role of government in developing low emission technologies.]
    [Improvements] in energy efficiency could slow projected energy demand and relax the timeframes in which technology scale-up is required. …

    A second report will examine in detail the range of policy instruments through which this role could be exercised.
    (p 3)


    AUSTRALIA’S FUTURE ENERGY SUPPLY


    2.1 Australia’s electricity sector must change substantially and quickly


    The goal [of reducing Australia’s greenhouse gas emissions by 80% of 2000 levels by 2050] could be achieved in a number of ways, but a large part is likely to come from reductions in Australia’s physical emissions …
    … Australia’s electricity technology supply … is the major contributor to these emissions.
    Other ways to meet Australia's emissions targets are either more risky or less plausible. …

    [It] would be unwise to rely entirely on international emissions permits [as] Australia’s emissions trading partners [might] not recognise high levels of Australian abatement originating in other countries (for instance in Asia or Africa) [and respond by imposing] border taxes designed to level the playing field.

    [We] cannot rely [on] switching to gas-fired electricity to achieve all our emissions reductions.
    [The carbon intensity of coal-fired power stations is between 0.8 and 1.2 tonnes of CO2 for every megawatt-hour of electricity produced.]
    Conventional gas-fired power plants can achieve … about 0.4 tonnes of CO2 emitted per megawatt-hour.
    Australia must achieve a carbon intensity of 0.2 tonnes of CO2 per megawatt-hour or lower if it is to meet its targets.
    (p 4)

    Gas can play a important bridging role, but in the longer-term Australia will need to either retrofit existing coal and gas plants with Carbon Capture and Storage technology (CCS) or replace them with low-or zero-carbon technologies. …

    [Treasury] modelling foresees a major ramp-up of renewable energy from under 10% market share to become the largest source of electricity.
    All of this growth comes from non-hydro renewable sources that currently represent only 4% of current electricity supply.
    CCS is also modelled to rapidly ramp-up, from zero to 30% share, largely from 2030 to 2050.

    [However, m]odelling projections depend on [highly uncertain] assumptions of future technology costs and should not be taken as forecasts.
    (p 5)

    [The] scale and timing of the shift to low-emission technologies will be the same regardless of the costs of the individual technologies.
    [If such] a rapid shift [is to occur] globally and in Australia [the questions are:]
    • what must happen and
    • by when?


    2.2 Current technology cannot meet all of Australia’s electricity supply objectives


    A range of technologies available today can generate electricity at or below 0.2 tonnes of CO2 per megawatt-hour and have significant scale-up potential (excepting hydro, for which little expansion is feasible in Australia). …
    [The] most important task will be to further refine the underlying power technologies such as wind turbine blades, photovoltaic cells and fuel combustion.
    But various resources, capabilities and infrastructure are also needed to deploy new technologies in Australia at competitive cost.
    These include new transmission, pipelines, resource maps, market frameworks, regulations and specific engineering skills.

    At present low emissions electricity costs [between] three to five times the current wholesale price for electricity in Australia of between about $30 and $40 per megawatt-hour.
    (p 6)

    [The] near-term costs for low-emissions electricity are highly uncertain. …
    Two exceptions to this are wind power and some forms of bioenergy.
    (p 7)


    AUSTRALIA’S PORTFOLIO OF NEAR-ZERO EMISSIONS TECHNOLOGY


    It is possible that none of the technologies can produce power at a scale and at costs similar to today’s electricity.

    Wind and solar PV may … become commercial if carbon prices rise to forseeable levels over the next 20 to 30 years.
    However, these technologies [cannot] provide more than about 50% of Australia’s electricity needs without storage technologies whose commercial viability remains uncertain.

    Given the lack of any “sure bets”, Australia should maintain all the options.

    [While] Australian governments need [not] support research and development of every technology … government should support demonstration plants of any technology sufficiently developed that commercial application is within sight.

    There are significant barriers for each technology for which governments are responsible.

    [Better] network regulation, and government assessments of solar and geological resources, are required …

    Without government support beyond a carbon price, none of the technologies is likely to be developed to be commercially competitive, demonstrated, or deployed in Australia.

    The current deployment of wind and solar PV in Australia has depended on government support for financial viability. …

    CCS and nuclear are unlikely to be demonstrated in Australia in the near future unless government takes on most of the material risks of the project.
    (p 8)


    WHY GOVERNMENT SHOULD INTERVENE


    Markets cannot work properly unless government removes barriers to deployment … such as transmission connection hurdles and [existing] subsidies …
    Government regulation of transmission distorts electricity generation markets … in favour of conventional coal and gas generation.

    Even if government removes these obstacles, it remains unlikely that enough will be invested in the short term … because early movers face higher costs …
    Finance costs are higher for [novel] technologies …
    New infrastructure and regulatory frameworks must be developed …
    Resource mapping is inadequate and some technologies lack long-term community support.

    Early movers get little [return] for paying these higher costs. …


    4.1 Government regulatory barriers


    4.1.1 Transmission

    Existing transmission networks and network regulation are designed around the assumption that almost all electricity generators will be large plants close to existing centres of generation. …
    The result is that new wind farms or large-scale solar farms may be located to avoid incurring transmission connection charges when alternatives requiring an improved transmission system might have delivered an overall lower cost outcome.
    (p 11)

    [There are] particular barriers to securing transmission connection, including first mover disadvantage, for key low-emissions technologies such as wind, solar thermal, geothermal and large-scale solar PV [and for] connecting and integrating solar PV within distribution networks, including misalignment of incentives for distributed generation.


    4.1.2 Subsidies for existing technologies

    A 2011 OECD study estimated the level of subsidies for fossil fuels within 24 OECD countries … to be [between] US$45 billion to US$75 billion per year …
    Australian State and Federal Government budgetary support for fossil fuels [is] estimated to be [between US$7.2 billion and $9.3 billion].
    Proposals to reserve a proportion of gas production for domestic use and the New South Wales Government’s recent action to subsidise local coal prices for power generation [at around $300 million per year] are a further example of such intervention.


    4.1.3 Lack of public support

    For nuclear power, there is considerable public concern about the safety of the technology.
    Public concerns with storage integrity have caused CCS projects in Europe to be delayed or cancelled.
    Health concerns have been raised from residents close to proposed wind farms.
    Geothermal plants raise issues about their impact on groundwater, … the interaction of their activities with gas extraction [and] their impact on local geological stability. (p 12)


    4.2 Market failure — in theory


    [Creators] of new knowledge and skills through R&D often find it practically impossible to exclude others from sharing the benefits of their work. …
    Without government intervention, market-driven investment in R&D will be less than would provide the optimal public benefit.
    This is one reason why governments fund university research.

    Thus there is “market failure” whenever a private actor does not take on socially desirable costs because they won’t result in commercial returns.
    [An] early mover incurs costs that [may] benefit subsequent entrants, with the result that followers have lower costs but earn the same revenues.
    [Individual] private actors [may] perceive uncertainty [as a cost] whereas society sees the collective outcome as certain.


    4.3 Market structure — high costs


    Early movers … face higher costs [for:]
    • research and development …
    • demonstration plants and
    • the first few plants constructed …

    4.3.1 Finance

    Financiers [may] incur higher costs in managing [unfamiliar risks or] see the project as higher risk than conventional generation [spurring them] to demand
    • a higher interest rate or internal rate of return …
    • a higher percentage of … equity [financing, and/or]
    • more onerous terms and conditions.
    (p 13)


    4.3.2 Minimum scale

    [Nuclear] and CCS, require an investment in the order of $1 billion even for a demonstration plant. …

    [A European] company would need an enterprise value of over EURO100 billion to take on the risk of financing a 1,000 MW commercial CCS plant.
    … Origin Energy and AGL Energy, the largest listed integrated energy companies in Australia, have market capitalisations of around $16 billion and $7 billion respectively.


    4.3.3 Resource mapping

    [An] understanding the … underlying resource is … necessary to embark on major commercial-scale projects.
    [This] early-stage data acquisition [incurs costs ie] the information will almost inevitably leak out to … future competitors …
    (p 14)

    [Although] government geosciences agencies have already undertaken considerable assessment of CO2 storage potential … five to 10 years of further greenfield storage assessment will be required to underpin commercial projects.
    Similar challenges apply to … geothermal and concentrating solar energy …


    4.3.4 Regulatory costs

    The constructor of the first project … may often be left waiting when a novel problem arises and government takes time to indicate how it will be resolved.

    [Community concerns] may already be reflected in legislation or regulation [such as] the exclusion of nuclear power or the application of buffer zones for wind farms. …

    All of the low-emissions generation technologies have very substantial capital costs [and] anything that delays commissioning [will] substantially [add] to the cost of the project. …

    Even if government succeeds in articulating a regulatory framework well in advance, and avoids delaying the project through any policy decisions that arise in practice, the possibility that this might happen is an additional risk that adds to financing costs …

    Governments can reduce [but are unlikely to entirely eliminate costs] for early movers by providing public information and setting up robust planning and approval processes.
    [For] nuclear energy, the public engagement, political process, and policy implementation is likely to take many years. …


    4.3 Market structure — low rewards


    4.4.1 No premium for early movers

    Because electricity is an undifferentiated product, innovations do not earn more, and intellectual property may not be defensible.
    [From] a consumer’s perspective electricity is all the same, however it is generated.
    (p 15)

    The only exception [being] consumers who are prepared to pay a premium knowing that their power is green.
    In Australia this is [less than 1%] of the total generation market …


    4.4.2 Discounted value of carbon pricing

    Early movers cannot bank the full value of projected higher long-term revenues … because government policy on climate change and energy is [constantly changing]. …

    [Energy] infrastructure investment needs a high level of predictability. …
    [Uncertainty] encourages firms to delay investment to keep options open in the short term in the expectation that they can make better informed decisions later [resulting in] less investment … than is socially desirable.

    [Ideally] government would legislate emissions constraints over several decades [allowing the private sector to anticipate] the likely path of the carbon price over time and the relative merits of investing now or later …
    Speculators would … emerge to arbitrage — or carry the investment risk — between carbon prices today and those likely in the future [and investors] could then understand the potential future pay-offs … in developing improved abatement technologies …

    [In reality,] people cannot confidently rely on carbon prices more than a few years ahead, because:

    1. Even if a parliament were to set an emissions constraint several decades into the future, future parliaments could rescind or alter it. …
    2. The international nature of the climate change problem means that Australian government commitments depend on what other governments do. …
    3. The market in carbon emissions permits is new and establishing a reputation for credibility and commitment … takes time.
      Over time [and with] increasing levels of investment … a particular market design … becomes less vulnerable to arbitrary government policy change.
    4. The energy system … has evolved over 200 years.
      This creates a degree of inertia [that makes it] hard to make the changes that would lead to long-term credibility of emission reduction targets.
    (p 16)

    1. Credibility is particularly hard to establish because the scope of the emissions market is wider, and is being implemented more quickly, than any previous environmental market.
    2. The emissions price will apply to several sectors of the economy, with emissions reductions to be achieved through potentially hundreds of technological or behavioural changes.
      By contrast, the Renewable Energy Target (RET) scheme [which affected] only the electricity generation sector and a small number of technologies … faced uncertainty and limited forward trading, particularly after the 2003 review …

    This does not undermine the rationale for a long-term carbon pricing regime [without which] investment uncertainty would be even greater. …

    The above characteristics mean that the private sector is likely to discount future revenues reliant on a carbon price for many years, and therefore hesitate to make large investments in low carbon technologies. …

    [The Investor Reference Group on Investment Activity in the Electricity Generation Sector] points out that only one merchant or independent base load power generator has been built in the [National Electricity Market] since 2002, and development of a further 22,000 megawatts of ‘announced’ generation projects has stalled.
    [This] is not solely a consequence of carbon price uncertainty [but] due to relatively low wholesale electricity prices and alternate investments in peaking plant to address a range of uncertainties in the electricity system.

    Sub-optimal investment and underperformance of utilities is also occurring overseas …
    (p 17)

    [Surveys] of European carbon market participants show a fall in confidence that there will be a global reference price for carbon in 2020. …

    [The] UK Government concluded that … the carbon price — which has been in place for several years —
    has not been stable, certain or high enough to encourage sufficient investment in low-carbon electricity generation in the UK.

    4.4.3 Systemic under-pricing of carbon

    Governments … tend to underprice the externality of greenhouse gas emissions due to political realities …
    [The] Australian Government was a party to the Copenhagen Accord in 2009 that [aims to stabilise atmospheric] greenhouse gas concentrations … at a level consistent with a global temperature increase below 2 degrees Celsius.
    Australia’s 5% reduction target [falls well short of] this objective.


    4.5 Past experience


    Given the high costs and limited rewards, investment in R&D relative to revenue has always been lower in electricity generating technology relative to other industries such as car manufacturing electronics …
    Given the uncertainties of carbon pricing discussed [and without additional] government intervention, private investment in the development of low emission electricity is likely to be even lower.
    (p 18)

    These issues partly explain why governments have frequently intervened in the energy sector in the past.
    Since the 19th century subsidies, often justified by the need to ensure energy security and affordability, have been used to drive innovation and change …
    [Governments] have often intervened [because] the projects are so large the private sector cannot borrow the necessary funds.
    (p 19)


    HOW GOVERNMENT SHOULD INTERVENE


    5.1 Government interventions to promote an efficient market


    [Reduce] the distorting regulations that disadvantage new emissions technologies unfairly.
    [Remove] a number of barriers to create a “level playing field” between electricity generation technologies.
    [These] actions are relatively low cost …


    5.1.1 Structure emissions cap and associated trading scheme to minimise uncertainty

    [Investors] will discount future emissions prices to reflect uncertainty about whether they will be implemented.
    [Governments address] this uncertainty by using “gateway mechanisms” that set upper and lower bounds on longer-term emissions caps [enabling] investors to plan with greater certainty.


    5.1.2 Map resources

    [Expand] funding of exploration and mapping of solar and geological resources … for solar thermal and geothermal energy and … CO2 Storage.
    [This would overcome] the inability of individual firms to capture the value [from] knowledge that is available to all players.

    [In] oil and gas exploration [geoscience agencies funded] early-stage data acquisition and then make the data available to companies bidding for acreage to be released under exploration and production programs.


    5.1.3 Reduce existing subsidies

    A genuinely comprehensive assessment that included a range of non-fiscal regulatory distortions [has] yet to be undertaken.
    As well as the areas identified in 4.1.2, governments provide a range of other more subtle subsidies [including:]
    • price controls over residential electricity prices;
    • cross subsidies that provide electricity to regional areas below costs;
    • the continuing resistance to roll-out of time-of-use pricing for residential consumers; and
    • contracts to provide electricity below market prices to large industrial facilities such as aluminium smelters.
    (p 20)

    A number of these should be … phased out [immediately, and] the Productivity Commission should [track and review these] subsidies and tax exemptions [regarding] their potential [to undermine] the carbon pricing mechanism. (p 20)


    5.1.4 Reform network regulation

    Recommended areas for change include
    • planning and approving new connections,
    • charging for extensions into regions involving clusters of generators, and
    • inter-regional charging for capacity that delivers benefits across regional boundaries.

    Optimising … small-scale [grid-connected] solar PV … requires the removal of barriers that prevent time-of day pricing, integration with grid management and locational pricing.


    5.2 Government support for low emissions technologies


    [The] private sector will invest less than is ideal from a social perspective when those who develop, demonstrate, and deploy early examples of new electricity technologies face higher costs than those who follow them …

    [Government involvement is required] to promote research and development, demonstration and early-stage deployment.
    [Such] intervention needs to be … based on a full assessment of the market, the technologies and nature of the market failures [so as not to compromise the central policy or lead to unintended consequences. …]

    … Australia’s Investor Reference Group concluded in 2011 that carbon pricing would not be
    sufficient in itself for investors to make commercial decisions to invest in long lived electricity generation and other energy assets [without] an appropriate framework of complementary measures …
    (p 21)

    The recent Global Investor Statement on Climate Change, from a group of 285 investors representing $20 trillion of assets, also called for an
    integrated climate change and clean energy policy framework …

    [Government] interventions must be designed to avoid undermining investor confidence in the emissions market [eg the] sudden and substantial short-run price fluctuations [that ensued] when Australian solar rebates and subsidies introduced in 2008-2009 overwhelmed the renewable energy credit market [the following year.]


    5.2.1 Research and development

    The R&D and innovation market failure [is] a key factor motivating the need for policy intervention beyond carbon pricing. …

    Further R&D would probably lead to significant advances in geothermal, biomass, solar PV, solar thermal and CCS technology; however, it is unclear whether] Australian governments should support R&D in all of these areas. …
    Ideally Australian decisions would be informed by international agreements aimed at knowledge sharing and coordination of R&D …

    [Certain] technologies may become a source of international competitiveness …
    … Australia has had some success in the export of its solar PV R&D. …
    [Other technologies in which Australia might have a comparative advantage] include CCS and geothermal energy.


    5.2.2 Demonstration and early deployment

    [“Market spillovers” including skills, knowledge and development of regulations] also justify government support for demonstration and early deployment of low-emission technologies.
    (p 22)

    The financial market issues … are particularly acute at this stage of technology development.

    [The] demonstration and early deployment stages involves more locally-specific issues and requires more overall funds than at the R&D stage, although risks associated with the technology [as such] will be lower.
    [Government intervention should] be aimed at [reducing] the costs to future players of
    • locally-specific technology development,
    • financing uncertainty,
    • project risk and
    • regulatory definition.

    5.2.3 Rollout

    Once emissions are capped through an emissions trading scheme, there is no case to support technologies beyond addressing the market and system failures …
    {The elimination of … existing schemes would require careful management, including grandfathering of [previous] commitments.}

    It may be argued that setting an insufficiently stringent cap on emissions … justifies an additional mechanism such as renewable energy or low-emission energy quotas.
    [This] would be a poor response.
    The best solution is to set emission caps with environmental integrity, supported by measures that address market failures and barriers.


    5.2.4 Form of government intervention

    Governments cannot support low-emissions technology without, to some extent, implicitly making choices about which technologies are likely to be lower cost in the medium term.
    [However no-one, including government,] can foresee accurately which low emissions technology is most likely to be low cost in the medium term. …
    {… Learning the hard way: Australia’s policies to reduce emissions, showed [that historically], direct government grants to companies to promote individual technologies has a poor track record both in Australia and overseas.}

    In the face of such uncertainty, the best strategy is … to support a variety of options.
    [While this may] not the cheapest way to deploy any one technology, over time it is the cheapest way to deploy the best technologies and the best results.
    (p 23)

    A subsequent Grattan Institute report will discuss the optimal design of government intervention.
    Options [include:]
    • sponsoring the project itself, taking on all of the material risks, through to
    • schemes such as renewable energy certificates that provide a financial reward to the operator of any low-emissions electricity generator.
    (p 24)

    Would you like to know more?

  • Learning the hard way: Australian policies to reduce carbon emissions, 2 April 2011.
    John Daley and Tristan Edis.
    Both Australia’s main political parties are committed to reducing Australia’s emissions to 5% below 2000 levels by 2020. …

    Because Federal and State Governments have tried more than 300 emission reduction policies and programs since 1997, we already have a great deal of information about which programs and approaches work and which do not.
    This report analyses four kinds of carbon abatement instruments:
    • market mechanisms;
    • grant tendering schemes;
    • rebates and
    • energy efficiency standards.
    Based on experience, only an economy-wide carbon price (a type of market mechanism) can achieve the scale and speed of reductions required for Australia to meet its 2020 commitments without excessive cost to the economy or taxpayer.

    [Market] mechanisms, such as a carbon trading scheme, have delivered the greatest emissions reductions and have met targets ahead of time.
    They work because they
    • minimise the need for government to predict the future.
    • … provide certainty, enabling business to invest with greater confidence [and]
    • … provide flexibility by devolving decision making to businesses and individuals, allowing them freedom to choose how to reduce emissions, without government involvement. …

    [Grant-tendering] programs — involving $7 billion in budget funding — shows that they cannot reduce emissions at the necessary scale or speed.
    On average, for every million dollars the government commits to such schemes, only $30,000 of operational projects result within five years and only $180,000 within 10 years.
    Based on experience, government would need to announce an abatement purchasing fund of $100 billion to meet the 2020 emissions reduction target.

    Rebate programs — worth $5 billion in budget funding — have also produced relatively little abatement and are simply too costly for taxpayers per unit of abatement acquired.
    Using rebates to achieve the 2020 emission reduction target would require a budget of more than $300 billion over the next ten years.

    Energy efficiency standards can usefully complement a carbon trading scheme.
    But because they are limited in scope and slow to take effect, they cannot play more than a support role in meeting the 2020 targets.
    (p 3)

    Trading schemes to control pollution were pioneered in the United States to control emissions of sulphur dioxide and nitrogen oxides from coal-fired power stations.
    Under 1990 legislation, emissions were capped across a number of states. …

    When the legislation was introduced, its critics said the generators would find reducing sulphur emissions too expensive.
    [However,] in the scheme’s first five years, the price of reducing emissions was about half the price that had been forecast; [and] in its second five years the price fell to a quarter of the forecast.

    Coal-fired power stations had been expected to comply with the scheme by installing scrubbers that remove sulphur from the plant’s smoke stacks.
    However,
    • [it turned out that] only half of the [number of] anticipated scrubbers were [actually needed,]
    • [they] cost 40% less to install than the original estimates; …
    • they removed 95% of the sulphur rather than the expected 85% …
    • [a] nearly 60% of the emission reduction [was achieved] by using a greater proportion of low sulphur coal … and
    • [the] cost of transporting low sulphur coal fell by 50% as the rail industry invested and responded to the commercial opportunity that sulphur regulation produced.

    By choosing to regulate via a market rather than seeking to select and prescribe the best technology in advance, US regulators allowed for unforeseen innovation that delivered emissions reductions at substantially lower cost.
    (p 16)

    Would you like to know more?

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