Assessing the Relative Efficiency and Cost Effectiveness of a Stationary Energy Emissions Intensity Requirement

Transcription

1 January 2003 Final Report to the CoAG Energy Market Review Assessing the Relative Efficiency and Cost Effectiveness of a Stationary Energy Emissions Intensity Requirement Final Report

2 The Allen Consulting Group Pty Ltd CAN Sydney 3 rd Floor, Fairfax House, 19 Pitt St Sydney New South Wales 2000 Telephone: (61 2) Facsimile: (61 2) Melbourne 4 th Floor, 128 Exhibition St Melbourne Victoria 3000 Telephone: (61 3) Facsimile: (61 3) Canberra Level 12, 15 London Circuit Canberra ACT 2600 Telephone: (61 2) Facsimile: (61 2) Perth Level 25, 44 St Georges Terrace Perth WA 6000 Telephone: (61 8) Facsimile: (61 8) Online Website: i

3 Caveat This report, Assessing the Relative Efficiency and Cost Effectiveness of a Stationary Energy Emissions Intensity Requirement 2003, was produced by The Allen Consulting Group Pty Ltd with funding from the 2002 COAG Energy Market Review. The assumptions, models, analysis and conclusions presented in this report represent the views of The Allen Consulting Group and associated consultants. The report presents consideration of some of the many complex issues and options arising from an examination of an emissions intensity requirement. The analysis contained in this report does not prejudice or pre-empt consideration of future jurisdictional or Commonwealth energy and/or greenhouse policy. The assumptions, models, analysis and conclusions in no way represent the final views of the COAG Energy Market Review panel, funding jurisdictions, or the Commonwealth Government. ii

4 Table of Contents Executive Summary & Conclusions 2 Executive Summary 2 Conclusions 6 Chapter 1 9 Introduction Terms of Reference Project Context Outline of Report 10 Chapter 2 11 Greenhouse Policy Options 11 Key Points Existing Policy Framework Alternatives to the Current Policy Mix Policy Design Issues 22 Chapter 3 25 Economic Impact of Policy Alternatives 25 Key Points Modelling Approach MMA: Electricity Sector Modelling CoPS: General Equilibrium Modelling CoPS Modelling: Comparison of Four Policy Alternatives Cost of Abatement 52 Chapter 4 53 Implementation Issues 53 Key Points Introduction Extending An Emissions Intensity Requirement to Other Sectors Transition to an Emissions Trading Regime Emissions Intensity Requirement vs Emissions Trading Trade Exposed Businesses 60 iii

5 Appendix A 64 MMA Modelling 64 Appendix B 98 CoPS Modelling 98 Appendix C 154 International Case Studies 154 UK Emissions Trading 154 Emissions Trading in Canada 155 Emissions Trading in Denmark 156 iv

6 Abbreviations AGO CH 4 CO 2 e CoAG CoPS DSM EPA ERC ETS FCCC GDP GES GGAP GHG GSP GWh MMA MMRF GREEN MRET Mt N 2 O NEM NGS PJ SO 2 Australian Greenhouse Office Methane Carbon dioxide equivalent Council of Australian Governments Centre of Policy Studies Demand Side Management Environment Protection Authority Emission Reduction Credits Emissions Trading Scheme Framework Convention on Climate Change Gross Domestic Product Generator Efficiency Standards Greenhouse Gas Abatement Program Greenhouse Gas Gross State Product Gigawatt Hour McLennan Magasanik Associates Monash Multi Regional Forecasting Model Mandatory Renewable Energy Target Million tonnes Nitrous Oxide National Electricity Market National Greenhouse Strategy Petajoule Sulphur dioxide 1

7 Executive Summary & Conclusions Executive Summary This report was produced by The Allen Consulting Group with funding from the 2002 COAG Energy Market Review. The assumptions, models, analysis and conclusions presented in this report represent the views of The Allen Consulting Group and associated consultants. The analysis contained in this report does not prejudice or preempt consideration of future jurisdictional or Commonwealth energy and/or greenhouse policy. The assumptions, models, analysis and conclusions in no way represent the final views of the COAG Energy Market Review panel, funding jurisdictions, or the Commonwealth Government. The project brief required The Allen Consulting Group to assess the relative efficiency and cost effectiveness of a stationary energy emissions intensity requirement. 1 The objective of the task was to contribute information and insight to assist in exploring the implications for the energy sector and the domestic economy as a whole of introducing a national emissions intensity requirement. These implications were to be assessed relative to the major policy alternatives, namely the current greenhouse policy mix and a system of national emissions trading Greenhouse Policy Options Commonwealth and State Governments have adopted a range of policy tools in an effort to encourage GHG abatement in Australia. The most significant policy in dollar terms is the Commonwealth s Greenhouse Gas Abatement Program (GGAP). In addition to GGAP, the two most notable policies introduced to date are the Commonwealth s Mandatory Renewable Energy Target (MRET), and the system of greenhouse benchmarks for electricity retailers in NSW, due to be implemented as a mandatory policy in 2003 both of these measures require industry to go beyond no regrets. Major individual policies implemented to date vary in the extent to which they are likely to generate effective and efficient GHG abatement. There is currently some inconsistency and overlap in the mix of policies operating across jurisdictions and nationally. The implications of inconsistencies and overlap in greenhouse policies across Australia are likely to be exacerbated by the existence of the National Electricity Market (NEM). One way of addressing any duplication or inconsistency in the way that Australia s greenhouse policy is currently targeted would be to replace current policies aimed at the stationary energy sector with a single national policy instrument. There are two main options in this regard a national emissions intensity requirement or a national emissions trading system for the sector. 1 For the purposes of this report, the stationary energy sector refers to the electricity industry. 2

8 Both emissions trading and emissions intensity requirements can be designed to encompass least cost abatement if they incorporate a wide range of sectors and abatement opportunities. However an emissions intensity requirement has the advantage of allowing the Government to place a cap on the cost of abatement. Under either emissions trading or a regulatory emissions intensity arrangement, major issues arise in relation to the coverage of the policy measures, and the extent to which a broad range of sectors of the economy can be included in abatement efforts. Economic Impact of Policy Alternatives Two separate economic modelling approaches were adopted to examine the policy options bottom up electricity sector modelling (MMA) and general equilibrium modelling (CoPS). Four cases were modelled a base case in which most stationary energy abatement policies were assumed to be removed; a current policy mix case which incorporated MRET and the NSW benchmark system; an emission intensity requirement case which replaced existing policies with a national intensity requirement; and an emissions trading case which replaced existing policies with a cap and trade emissions trading system. The latter three cases were all designed to achieve the same level of GHG abatement, which was around 21Mt of CO 2 e. The key conclusion of the MMA modelling was that the delivered cost of electricity is likely to fall under either the current policy mix or the replacement of that mix by a national emissions intensity requirement. While this result is somewhat counter intuitive, it can be explained by the existence of demand management opportunities and excess capacity in the NEM the subsidy provided to these sources by the emissions intensity policy reduces overall pool prices, at least in the short term. This result has potentially significant implications for the application of an emissions intensity requirement in the NEM. The cost of the policy would be absorbed largely by the coal fired generation sector rather than consumers more generally, with the gas fired generation sector reaping the gains. This outcome implies transfers of wealth between sectors that may not have been envisaged in the original policy design. The MMA modelling also concluded that delivered costs to customers are lower for a national emissions intensity requirement than for the current policy mix. This is not surprising since the current policy mix includes MRET, a measure that focuses on renewables rather than facilitating a greater level of abatement at the lowest cost. Any measure that fails t o allow the market to choose between all fuels used in generation, including gas, is bound to be a sub-optimal approach to abatement. Observed differences between the MMA and CoPS results are relatively small and may be readily explained. The MMA model of the NEM is a detailed, bottom up model that mimics the way the market works in practice. It allows for less than perfect competition, for example, and the existence of excess capacity. In comparison, MMRF GREEN is a dynamic, general equilibrium model that assumes perfect competition and no excess capacity and it does not replicate the detailed workings of the NEM. 3

9 While it does not claim to embody an engineering-based replica of the electricity market, however, the CoPS model is a powerful tool for assessing the relative impact on the Australian economy of stationary energy sector abatement policies. The results are complex, however, and show that the various measures would have impacts on electricity prices on the one hand and GDP and economic welfare on the other that, at first glance, may be difficult to reconcile with each other. Comparing Case 3 (national stationary energy intensity requirement) with Case 4 (emissions trading) it is clear that the latter has a significantly greater impact on electricity prices than the former. This is because, under a cap and trade permit system, every emission of CO 2 -e (in the electricity sector in this case) is effectively taxed. While the revenue is assumed to be recycled to the community in some way, it is not used to subsidise electricity prices since that would be contrary to the objective of the measure. Emissions trading, therefore, unambiguously leads to a rise in electricity prices, with the extent of the increase being dependant on the restrictiveness of the cap. This finding remains true irrespective of whether permits are sold t o emitters or allocated to them in some way under a grandfathering system. With the emissions intensity requirement the market mechanism works differently. The effective tax on the more emissions-intense generators (brown and black coal) is returned as an effective subsidy to the less CO 2 -eintense businesses (gas and renewables). This by itself means that, in a market where the more greenhouse-friendly generators are already able t o compete, the price effect will be less than under emissions trading. This is clearly demonstrated by the CoPS modelling. When the analysis takes in the detailed market operations modelled by MMA, however which encompasses spare capacity it becomes apparent that the coal generators cannot pass on to consumers the full extent of the tax. In effect, the subsidy dominates, at least in the short to medium term, and the average price of electricity in the market declines slightly. The coal generators, or more precisely their government and private owners, underwrite this price reduction via a decline in profitability. In terms of the relative impact on GDP, however, CoPS shows that emissions trading with the sale of permits provides a better outcome than the emissions intensity benchmark. This finding is largely a reflection of the technical way in which the model works. Under the benchmark scheme, the electricity sector is forced into a less technologically efficient fuel mix more gas and renewables and less coal which reduces returns to capital overall. Despite the significant price effect, emissions trading creates a better technological solution since less gas and renewables are used relative to the benchmarks case. In addition, the return of all the revenue to Australian residents means there is no net tax effect on the economy. Under the emissions trading with grandfathering scenario, however, the impact on GDP is much the same as under the benchmarks case. This is because the better technological solution is more than offset by the fact that leakage of some of the recycled revenue to overseas shareholders means that there is effectively a new net tax levied on Australian economic entities. It also needs to be understood that the main reason why an emissions trading system appears to be more efficient than an emissions intensity requirement 4

10 is that adjustment costs are not accounted for in the modelling. The price impact of emissions trading because the equivalent of a tax is imposed on every unit of emissions is much more significant than that of an equivalent benchmarks scheme, where the impact is at the margin rather than across the board. Once adjustment costs are accounted for, an emissions trading regime may well be less efficient than an emissions intensity requirement. The main results of the modelling are summarised in Table ES1 below. Table ES1 SUMMARY OF KEY MODELLING RESULTS (CHANGE RELATIVE TO CASE 1: NO POLICY CASE) Case 2: Current policy mix Case 3: Emissions intensity requirement Case 4a: Emissions trading system (auctioned permits) GDP (Avge. % change ) Consumption (Avge. % change ) Electricity Price (% change in 2010) Cost of abatement (Marginal $ per tonne CO 2 e in 2010) n/a $ $6.40 GDP, consumption and electricity price results are derived in all cases from CoPS MMRF GREEN model. The cost of abatement for Scenario 3 is derived from MMA modelling; and the cost of abatement for Scenario 4 is from CoPS. Source: MMA and CoPS modelling Implementation Issues Consideration of any broadening of an emissions intensity benchmark beyond stationary energy should focus on providing appropriate incentives for reducing transport and agriculture emissions, and encouraging emissions offsets through carbon sequestration. Protocols and the practical methodology for estimating carbon sequestration are already very well advanced, and the extension of an emissions intensity requirement should be relatively straightforward. It would be much more difficult, however, to extend an emissions intensity requirement to the transport sector. Provision of credits for emissions reductions in the transport sector are more difficult to estimate than for carbon sequestration, as they rely crucially on the counterfactual, which is difficult to establish. In the agriculture sector, significant measurement problems exist. This implies a need for a coordinated approach to greenhouse policy, whereby an emissions intensity requirement for the stationary energy sector (including sinks) would be complemented by a separate set of policy measures in the transport sector and, ideally, agriculture. This would not preclude allowing credits for transport related emissions reductions on an ad hoc basis, using the basic mechanism established for carbon sequestration credits. Such transport credits would need to be accredited individually by an appropriate body. 5

11 A national emissions intensity requirement for the stationary energy sector would be an effective policy tool for achieving GHG abatement in the short to medium term, particularly as such a policy tool allows the government to cap the overall cost of abatement. In the longer term, when significant mandatory emissions reductions are required from a range of sectors, an across-the-board emissions trading system would be a more cost effective policy option. However the replacement of the current policy mix by a national emissions intensity requirement for the stationary energy sector raises a number of implementation issues. For example, legislated policies such as MRET would need to be unwound, and investors should be compensated for good faith investments made on the basis the existing policy settings. The same transitional problems would need to be addressed when moving from an emissions intensity requirement to an emissions trading scheme. Further, the establishment of an emission intensity requirement would entail implementation costs, and potentially have capital value implications for coal fired plant owners. In principle, companies subject to international competition should be quarantined from a greenhouse policy measure that would negatively affect their competitive position. In practice this would be a complex process and would need to be limited to those players that meet certain criteria of trade exposure and energy intensity. It would be less necessary, and more easily achieved, under an emissions intensity requirement which has lesser price impacts than emissions trading. Conclusions Current greenhouse policy in Australia is characterised by a variety of policy measures, many of them directed towards bringing about GHG abatement in the stationary energy sector. The variety is to be found not only in the policy instruments operating at the national level but also in the fact that some operate only in individual States. The range of overlapping and sometimes contradictory measures has the potential to bring about: an inefficient allocation of productive resources between industries; an inefficient allocation of productive resources between Australian States; an inefficient allocation of productive resources between countries, since efficient Australian production is disadvantaged relative to overseas competitors; and a higher marginal cost of abatement in some sectors than that required to meet Australia s overall emissions targets. The MRET scheme in particular, by focussing exclusively on renewables rather than relatively greenhouse-friendly fossil fuels such as gas, is an inefficient means of encouraging abatement. The NSW energy intensity requirement scheme is clearly more efficient. Yet the NSW scheme may produce outcomes that are unforseen and presumably undesirable from the perspective of policy makers in that State. Our modelling suggests that it would bring about a significant transfer of wealth from NSW to electricity consumers in other States. 6

12 The results from the general equilibrium modelling undertaken by CoPS, show clearly that in terms of the negative impact of policy alternatives on GDP economic welfare and jobs, the current policy mix is clearly suboptimal. A similar level of abatement in the stationary energy sector could be obtained more efficiently by means of either a national emissions intensity benchmark scheme or emissions trading in the electricity sector. The choice between emissions trading and an emissions intensity benchmark scheme is a difficult one. Emissions trading has some advantages, and in the CoPS modelling, where permits are auctioned, it leads to a better macroeconomic outcome (although much of this differential is driven by the impacts of revenue recycling and therefore is not the case to any significant degree where permits are grandfathered). On this basis, in the longer term, once Australia commits to achieving substantial binding emission reduction targets that will require economy wide action to be achieved, a system of emissions trading would be likely to represent the most efficient and effective policy tool with which to meet these commitments. However emissions trading effectively imposes a tax on each and every emission of CO 2 e, and as a result unambiguously gives rise to a greater impact on electricity prices than does an emissions intensity requirement, which only taxes emissions at the margin. The latter, modelled as Case 3, has a modest positive impact on prices under the CoPS modelling but a slight negative or neutral impact in the medium term under the more detailed electricity sector modelling undertaken by MMA. The consequent adjustment costs of the price impacts of emissions trading are not accounted for in the modelling and they could be significant. The Government would be faced with a substantially greater potential carbon leakage problem under this scenario than emissions intensity benchmarks and may well need to take action to protect energy-intensive, trade-exposed businesses, with all the arbitrary judgements that such a policy would necessarily involve. Another major disadvantage with emissions trading is the practical difficulty of revenue recycling (which groups in the community should benefit?) or grandfathering (who should receive the free permits?) and the arbitrary judgements and administrative costs that would necessarily be involved. In a situation where we still do not know the details of Australia s long term approach to greenhouse gas abatement, in a global context, there may be little benefit in establishing a complex emissions trading regime with its associated adjustment costs. A national energy intensity requirement would be substantially more efficient than the current policy mix. If properly designed, it is not clear that a national emissions intensity requirement for stationary energy would be inferior to emissions trading in terms of its likely impact on the economy and in practical terms, particularly as a transitional measure, it offers significant advantages over that alternative. A benchmarks regime would not lead to any significant price effects in the years leading up to the first commitment period and therefore would not create any perceptible pressures for adjustment. It would put Australia in a stronger position in terms of meeting emission targets under the Kyoto Protocol and it would send appropriate market signals to asset owners in the stationary energy sector. 7

13 While the electricity sector is the most significant source of emissions, an exclusive focus on that sector would be inimical to efficient resource allocation in the economy. Although an emissions intensity requirement would not be readily applicable to other sectors, its introduction should be accompanied by separate measures designed to bring about comparable abatement in sectors such as transport and agriculture. Finally, any policies that go beyond no regrets should be designed to have a minimal impact on industries operating in the traded goods and services sectors. Carbon leakage, whereby production and employment moves overseas in response to measures introduced unilaterally by Australia, provides no global greenhouse benefit and is thoroughly undesirable. Negotiated agreements between companies or industries and the Government provide a possible vehicle for effectively quarantining industries in the tradeables sector from the effects of measures that go beyond no regrets. If our projections are correct, however, the introduction of a national emissions benchmark in the stationary energy sector, directed towards providing the levels of abatement produced by current policies, would have a modest price impact and would be unlikely to require such compensatory measures. The introduction of an emissions trading regime, however, as a consequence of its associated price effects would result in a strong argument to protect energy-intensive industries in the tradeables sector. If the Government were to do this, however, it would not only result in practical problems and arbitrary judgements. Where relatively inexpensive abatement prospects exist in the tradeables sector, it would also cause these lower cost abatement opportunities to be excluded. This could compromise one of the major advantages of emissions trading, namely its efficiency in causing the cheapest abatement opportunities to be taken up. 8

14 Chapter 1 Introduction Box 1.1 TERMS OF REFERENCE 1.1 Terms of Reference The Allen Consulting Group was commissioned by the CoAG Energy Market Review Secretariat ( the Review ) to assess the relative efficiency and cost effectiveness of a stationary energy emissions intensity requirement. The objective of the task was to contribute information and insight to assist in exploring the implications for the energy sector and the domestic economy as a whole of introducing a national emissions intensity requirement. These implications are assessed relative to the major policy alternatives, namely the current greenhouse policy mix and a system of national emissions trading. The Terms of Reference for the project are outlined in Box 1.1 below. 1. Provide a qualitative and quantitative assessment of the benefits and costs of abating the same level of emissions that existing Commonwealth stationary energy measures (the Mandatory Renewable Energy Target, Generator Efficiency Standards, and stationary energy Greenhouse Gas Abatement Projects) and State based stationary energy measures (the NSW Electricity Retailer Benchmark Scheme and the 13 percent Queensland Gas Target) are aiming to achieve with a stationary energy emissions intensity requirement; 2. Provide analysis as to how an emissions intensity requirement could immediately be extended in order to draw in other sectors and allow the widest possible response to the measure; 3. Comment on any likely impediments, from the implementation of an emissions intensity requirement, in transitioning to an emissions trading regime should Australia decide to implement such a regime; 4. Provide an analysis and assessment of the benefits and costs of introducing an emissions intensity requirement instead of directly implementing a national emissions trading regime; and 5. Provide analysis as to the best option to protect the traded sector of the economy in the event of Australia introducing measures domestically prior to the introduction of abatement measures internationally that impose equivalent obligations on Australia s trading competitors. 1.2 Project Context The fifth term of reference for the CoAG Energy Market Review requires that the Review Panel assess the relative efficiency and cost effectiveness of options within the energy market to reduce GHG emissions from the electricity and gas sectors, including the feasibility of a phased introduction of a national system of greenhouse emissions reduction benchmarks. To this end, this project is charged with examining the potential impact of replacing the current mix of greenhouse policy instruments targeting the 9

15 stationary energy sector at both a Commonwealth and State/Territory level with a single consistent national greenhouse policy. The major policy options in this regard are discussed in further detail in Chapter Two, however the two options under examination are: a national system of GHG emissions trading for the stationary energy sector; and a single, national emissions intensity requirement for the stationary energy sector. The relative merits of the three policy options (the current policy mix and the two alternatives listed above) are the focus of the project, in particular in relation to the criteria of effectiveness, efficiency and equity. 1.3 Outline of Report The remainder of this report addresses the Terms of Reference as outlined in Box 1.1 above. Chapter Two provides an analysis of the major policy options open to governments seeking to reduce GHG emissions. Chapter Three outlines the modelling undertaken for the project, and provides the major modelling results. Chapter Four concludes the project by considering implementation issues associated with each of the policy options. 10

16 Chapter 2 Greenhouse Policy Options Key Points Commonwealth and State Governments have adopted a range of policy tools in an effort to encourage GHG abatement in Australia. The most significant policy in dollar terms is the Commonwealth s Greenhouse Gas Abatement Program (GGAP). In addition to GGAP, the two most notable policies introduced to date are the Commonwealth s Mandatory Renewable Energy Target (MRET), and the system of greenhouse benchmarks for electricity retailers in NSW, due to be implemented as a mandatory policy in 2003 both of these measures require industry to go beyond no regrets. Major individual policies implemented up until now vary in the extent to which they are likely to generate effective and efficient GHG abatement. There is currently some inconsistency and overlap in the mix of policies operating across jurisdictions and nationally. The implications of inconsistencies and overlap in greenhouse policies across Australia are likely to be exacerbated by the existence of the National Electricity Market (NEM). One way of addressing any duplication or inconsistency in the way that Australia s greenhouse policy is currently targeted would be to replace current policies aimed at the stationary energy sector with a single national policy instrument. There are two main options in this regard a national emissions intensity requirement; and a national system of emissions trading for the stationary energy sector. Both emissions trading and emissions intensity requirements can be designed to encompass least cost abatement if they incorporate a wide range of sectors and abatement opportunities. An emissions intensity requirement has the advantage of allowing the Government to place a cap on the cost of abatement. Under either emissions trading or a regulatory emissions intensity arrangement, major issues arise in relation to the coverage of the policy measures, and the extent to which a broad range of sectors of the economy can be included in abatement efforts. 2.1 Existing Policy Framework The potential to achieve Australia s abatement target at least cost is a central challenge to policy makers, the satisfaction of which requires a thorough review of the alternatives. There are a number of policy mechanisms available to governments to reduce greenhouse gas emissions and assist in the achievement of abatement targets for Australia. These include: the use of voluntary schemes (e.g. the Australian Greenhouse Office s (AGO s) Greenhouse Challenge Program); regulatory measures (e.g. the imposition of legally binding standards, backed up with fines and penalties for exceeding allowable emission levels, such as the NSW greenhouse benchmark policy); 11

17 a variety of economic instruments (such as emission trading arrangements of different forms and taxation measures); and some combination of the above. To date, Australia s domestic policy response to the greenhouse issue has been characterised by a combination of different types of policies and programs implemented by both the Commonwealth and State/Territory governments. The Commonwealth has so far committed around $1billion to greenhouse policies and programs. The most significant actions implemented to date by the Commonwealth are: the Mandatory Renewable Energy Target (MRET) this policy places a legal liability on wholesale purchasers of electricity to proportionately contribute towards the generation of an additional 9,500GWh of renewable energy per year by 2010; the $400 million Greenhouse Gas Abatement Program (GGAP) GGAP targets opportunities for large scale, cost effective and sustained abatement from a range of sectors; the Generator Efficiency Standards Measure (GES) this measures aims to encourage businesses to achieve movement towards best practice generation performance and, as a result, reduce GHG emissions; $460 million in grants related programs provided to encourage the commercialisation and deployment of renewable energy and alternative fuels; the Greenhouse Challenge Program a voluntary industry/government partnership Program which aims to generate GHG abatement from members and increase knowledge in the area of GHG awareness and accounting procedures; and mandatory labelling and minimum energy performance standards to drive energy efficiency improvement in appliances and equipment. Simultaneously, States and Territories have also been introducing their own policies to reduce GHG emissions. The two most notable policies in this regard are: the proposed NSW benchmark scheme for electricity retailers this scheme will require wholesale purchasers of electricity to reduce per capita GHG emissions to a level 5 per cent below levels, or 7.27 tonnes of CO 2 e per capita by 2008; and the Queensland 13 per cent Gas Scheme this scheme will require electricity retailers and other liable parties to source at least 13 per cent of their electricity sold in Queensland from gas fired generation from 1 January There is also a range of voluntary programs at the State/Territory level, such as NSW s Energy Smart Business Program, which aim to encourage member organisations to undertake agreed GHG abatement actions. In line with the stationary energy sector s role in contributing to Australia s GHG emissions, the majority of policies in all jurisdictions are targeted towards reducing GHG emissions from energy use. 12

18 The extent to which the current Australia wide greenhouse policy response can be deemed appropriate will be determined largely by the effectiveness and the efficiency of the measures that make up the current mix. In broad terms: effective policies are those that result in the required levels of GHG abatement; and efficient policies are those that achieve this abatement in a least cost manner. Mandatory Renewable Energy Target The Commonwealth s MRET policy or indeed any mandatory quota for renewable energy is likely to be an effective way of stimulating the development of the renewable energy industry. Setting a target for the amount of all energy that has to come from renewable sources will effectively provide a subsidy to renewable energy sources that will make them relatively more cost competitive in comparison to fossil fuel based energy alternatives. The subsidy will bring on renewable energy capacity at a greater rate than that which would have occurred in the absence of government policy. In this way, a mandatory renewable quota provides a stimulus to the renewable energy industry and promotes its development. However, an MRET type policy is very unlikely to be an efficient means of achieving GHG abatement, at least in the short term. A policy which has as its primary aim a reduction in GHG emissions should, according to economic principles, aim to achieve this abatement at the lowest possible marginal cost. A switch from coal to renewable generation such as that intended by MRET does result in GHG abatement, but there are significant cheaper abatement options including, predominantly, gas fired generation that would also abate emissions, but at a much lower cost. A policy such as MRET which solely targets one means of abating GHGs effectively locks out relatively cheaper abatement opportunities and in doing so increases substantially the overall costs of achieving a set level of GHG abatement. Despite these obvious shortcomings of using mandatory renewable targets to achieve least cost GHG abatement, there are however a number of practical reasons why a government may want to encourage the development of renewable energy and to direct its policy towards achieving this. Some arguments in favour of a renewables target are: stationary energy is the greatest source of GHGs policy initiatives to stimulate technological change can be justified so as to increase the availability of reasonably priced renewable energy in the future; investment in the new technology and plant needed to generate substantial levels of reasonably priced renewable energy will be a long term process. In that context, a quota for renewables may well be a reasonably efficient instrument if the goal is to increase their market share so as to contribute to GHG abatement; and if Australian industry were induced to invest in renewables R&D and plant, it may reap a first mover advantage and receive much wider benefits in the future by developing products that will have a substantial value in a world where carbon emissions come at a significant cost. 13

19 On the other hand, if the development of renewable energy were the Government s objective, MRET may not be the most efficient or the most equitable means of achieving it. The increased costs are passed on to energy users, with the highest costs being borne by those industries which happen to be energy intensive. If they operate in the traded goods and services sectors and compete with firms overseas that are not subject to these measures, they may well lose business to these overseas competitors without giving rise t o any net global GHG abatement benefits. The two issues of abatement and renewable energy industry development should be kept separate. In terms of the abatement objective, fuel source neutral measures should be applied so as to give rise to the cheapest abatement available using known technology. If the Government wishes t o encourage the development of a renewables industry, then it should subsidise that directly from taxation revenue, on the basis that the whole community would then be responsible for funding it. NSW Greenhouse Benchmarks for Electricity Retailers In May 2002 the NSW Government announced that it would implement an enforceable greenhouse benchmark scheme from 1 January 2003, with the benchmark phasing down to 7.27 tonnes CO 2 e per capita by In essence the benchmark scheme will set an emissions intensity benchmark per unit in this case members of the NSW population. The emissions intensity benchmark multiplied by the number of units (i.e. the population) will result in an emissions baseline for the State. Key features of the revised scheme include: mechanisms for assigning electricity and emissions from particular generators to retailers; recognition of electricity sales forgone (largely generated by demand side management) as a means of reducing per capita emissions; provision for emissions offsets through carbon sequestration; and trading of abatement credits (related to retailer s compliance obligations), along with provisions to bank and draw down credits across years. The scheme also has a number of provisions dealing with recognition of emissions and emissions abatement associated with interstate electricity generation, and the relationship between the scheme and the measures associated with the Commonwealth s MRET policy. The extent to which such a scheme is likely to be an effective and efficient response to GHG abatement is discussed further in Section 2.2 below, where the application of this broad type of policy at a national level is discussed. Briefly, by expanding the range of abatement opportunities beyond just renewable energy generation for example by incorporating gas fired generation, sinks and demand side management an emissions intensity benchmark such as that proposed in NSW is likely to be considerably more effective and efficient in achieving abatement than a policy such as MRET which focuses solely on abatement from one source. 14

20 Other Policies and Measures GGAP The Commonwealth s GGAP provides funding to activities that are likely to result in substantial emission reductions or substantial sink enhancement. GGAP only supports projects that will result in quantifiable and additional abatement not expected to occur in the absence of GGAP funding if this aim is achieved, GGAP is likely to be an effective means of reducing levels of GHG emissions. In theory, GGAP will also represent a least cost means of abating GHGs because it aims to seek out abatement projects from a wide range of sources with a low cost for each tonne of emissions that is reduced or avoided. GGAP employs a competitive selection process, with two key cost effectiveness indicators informing project selection: GGAP funds (dollars) per metric tonne of reasonably assured and additional CO 2 e estimated to be abated in ; and net national cost (dollars) per metric tonne of reasonably assured and additional CO 2 e estimated to be abated in If the GGAP project selection mechanisms are operating effectively, the marginal cost of abatement achieved under the GGAP should be broadly equivalent to that which would be achieved using a market instrument to generate GHG reductions. Projects funded under GGAP are also expected to provide complementary benefits, for example opportunities for rural and regional Australia, ecologically sustainable development, employment growth, the use of new technologies and innovative processes, and non government investment. Others The vast range of other greenhouse polices and programs in place at both the Commonwealth and State/Territory level are likely to have varying degrees of effectiveness and efficiency in achieving GHG abatement. Many policies, such as the Greenhouse Challenge Program, have objectives that go beyond just GHG abatement per se, and extend into other areas such as the generation of awareness about the importance of GHG abatement and the building of knowledge around measuring, monitoring and verifying GHG abatement. Implications of Current Policy Mix To date, the development of greenhouse policy at a Commonwealth and State/Territory level has been guided largely by the National Greenhouse Strategy (NGS), which aimed to provide the overarching framework for the introduction of abatement policies. As noted above, the major individual policies implemented up until now appear to vary in the extent to which they are likely to generate effective and efficient GHG abatement. Moreover, the NGS is necessarily very broad in providing direction for policy makers. As a result, there is currently some inconsistency and overlap in the mix of policies operating across jurisdictions and nationally. 15

21 The inconsistency in greenhouse policies relates largely to the extent to which different jurisdictions are opting for voluntary or mandatory policies, and the consequent extent to which organisations operating in one or more jurisdictions are being expected to go beyond no regrets in addressing GHG emissions. For example, the Victorian Environment Protection Authority s (EPA s) recent State Environment Protection Policy (Air Quality Management) requires EPA licence holders to meet GHG emission standards in order to retain their licences. For companies that are affected by this State regulation, it is likely that participation in voluntary abatement programs (such as the Commonwealth s Greenhouse Challenge Program) where abatement reductions and GHG management is voluntary may become redundant. Further, companies that operate in jurisdictions other than Victoria may be forced to adapt operational procedures Australia wide to meet requirements in that one State. Policies at the Commonwealth and State/Territory level may also overlap in their intention and in the compliance requirements they place on companies. A clear example of such overlap between polices in different jurisdictions is the Commonwealth s MRET measure and the proposed mandatory benchmark system for electricity retailers in NSW. Both measures have as their aim to some degree the reduction of GHG emissions via an increase in the use of renewable generation. However the means by which companies must comply with the measures is widely different. The imposition of two or more mandatory requirements on retailers by separate jurisdictions often with the same or similar aims unnecessarily duplicates compliance costs for business, with no additional gain to the overall level of GHG abatement achieved. Such costs represent deadweight losses for the Australian economy and their existence clearly does not represent achievement of least cost abatement. The implications of inconsistencies and overlap in greenhouse policies across Australia are likely to be exacerbated by the existence of the National Electricity Market (NEM). The NEM provides a central point through which market players trade electricity both across and within States. The operation of disparate greenhouse policies in various jurisdictions within the NEM may complicate pricing and trading behaviour in the market, and potentially reduce the efficacy of any policies that attempt to work through it. Moreover, stationary energy is by far Australia s largest source of GHG emissions this in itself suggests that a consistent and central approach to managing these emissions is likely to be optimal. 2.2 Alternatives to the Current Policy Mix One way of addressing any duplication or inconsistency in the way that Australia s greenhouse policy is currently targeted would be to replace current policies aimed at the stationary energy sector with a single national policy. This project will examine two major alternatives in this regard: a single, national emissions intensity requirement; and a national emissions trading scheme. 16

22 National Emissions Intensity Requirement An emissions intensity requirement is a regulatory abatement policy that aims to reduce GHG emissions by placing a limit on the amount of emissions that can be generated by the production of output in one or more industry sectors. In the case of an emissions intensity requirement applied to the stationary energy sector, the regulation takes the form of a limit on the greenhouse gas intensity of electricity production. An emissions intensity requirement in the stationary energy sector works by imposing a regulatory standard that increases the demand for electricity generated from relatively less greenhouse intense energy sources. Demand for less intensive generation is created because electricity retailers (and in effect, end consumers) are required by the policy to manage their purchase of electricity from generators in a way that achieves the required level of emission intensity. By creating demand for less emissions intensive forms of electricity generation, the emissions intensity requirement indirectly provides a subsidy to generation from gas and renewables, and in turn, indirectly imposes a tax on generation that is more greenhouse intense, such as that which uses black or brown coal (Figure 2.1). The indirect subsidy arises from the fact that the cleaner forms of generation can command a higher price in the market than would have been the case in the absence of the emissions intensity requirement. The indirect tax arises because demand for electricity generated from coal falls, and hence coal generators receive a lower price for their supply of electricity. Overall, the policy induces a shift away from coal and towards less emissions intense forms of generation such as gas and renewables. In turn, this shift reduces the emissions intensity of electricity generation in line with the regulatory benchmark. Essentially, an emissions intensity requirement is a regulatory policy that is similar in its effects to a market based emissions trading system, and it can be designed to incorporate many of the efficient characteristics of a market based abatement policy. For example, the system proposed in NSW will allow retailers to reduce the emissions intensity of their purchases from generators by sourcing abatement opportunities not only from relatively less emissions intensive generation, but also from demand side management measures and from carbon sinks. This will promote the sourcing of least cost abatement opportunities and is in stark contrast to the MRET policy that limits abatement to that which can be sourced from renewable generation. Moreover, if trading of credits is incorporated under an emissions intensity requirement, the ability of the policy to capture least cost abatement opportunities will be further enhanced. The emissions intensity requirement under examination in this project incorporates all three of these efficiency enhancing characteristics namely demand management, sinks and the trading of abatement credits. 17

23 Figure 2.1 IMPACT OF AN EMISSIONS INTENSITY REQUIREMENT ON THE MARKETS FOR COAL AND GAS P G S 0 G subsidy P 1 G P 0 G GAS D 1 G Q 0 G Q 1 G D 0 G Q G P C S 0 C COAL P 0 C tax P 1 C D 0 C Q 1 C Q 0 C D 1 C Q C The imposition of the emissions intensity requirement shifts demand for gas from D 0 G to D 1 G and the demand for coal from D 0 C to D 1 C. This provides an indirect subsidy to gas equal to P 1 G P 0 G, and imposes an indirect tax on coal equal to P 0 C P 1 C. Source: The Allen Consulting Group Setting an Abatement Target An abatement target under an emissions intensity requirement can be defined in relative or absolute terms. A relative emissions intensity requirement such as that proposed for NSW generally reflects some criteria of emission performance over time, such as emissions per unit of output, population etc. This design has the advantage of allowing output levels to grow without the abatement target associated with the policy necessarily being breached. The absolute level of GHG abatement achieved 18

24 under an emissions intensity requirement is determined post hoc according t o a pre determined emissions intensity target, and an unknown future output level. The level of abatement achieved by such a scheme is therefore variable and ultimately determined by levels of electricity demand (or more specifically in the case of the NSW system, by population). While this feature of the policy potentially reduces the costs of the policy in economic terms, it also clearly involves a trade off in relation to the certainty with which a target level of abatement can be achieved. An absolute emissions intensity requirement on the other hand, typically establishes an ex ante finite cap on emissions such as an emission target measured in tonnes of greenhouse gas, or a percentage annual reduction in emission levels. While an absolute emissions intensity requirement target is less flexible under conditions where output is growing, the use of an absolute abatement target clearly has the advantage of improving the certainty with which an emissions target will be reached. The terms of reference for this consultancy require that we examine the impact of replacing a suite of current greenhouse policy measures with an absolute emissions intensity requirement. Specifically, the emissions intensity requirement in this analysis is designed to abate the same level of emissions as the combination of the following measures: MRET; GGAP; the GES measure; the NSW Electricity Retailer Greenhouse Benchmarks; and the Queensland 13 per cent Gas Scheme. The determination of the actual level of abatement that will be achieved using these measures requires the use of economic modelling to project growth in emissions and the impact that the relevant measures will have on those emissions. Modelling of this type was undertaken for this project and is the subject of Chapter 3. As is shown in that chapter, the suite of measures listed above is projected to abate around 21Mt of CO 2 e emissions in 2010 this is the abatement target for the emissions intensity requirement we will examine. Point of Application An emissions intensity requirement could theoretically be applied at a number of different points in the electricity supply chain e.g. electricity generators, electricity retailers or, with more difficulty, consumers. The most efficient point is likely to be the customer interface in the wholesale market. In practice these interfaces are also the meters for large end-users connected directly to the transmission system. For retailers, these will be also at the points (substations) where the transmission system connects with the distribution system. Application of an emissions intensity requirement at these points would be preferable because: this is the basis for the current MRET Scheme and the proposed GEC scheme in Queensland and so would minimise the cost to retailers to comply with the scheme; and 19