Careless plan sure to spark an energy disaster

The government’s price cap on coal and gas will save the average Australian household $230 per year.

In one sense, last week’s delayed energy policy announcements by the federal government were underwhelming. The key ministers have known for months about the problems in the electricity and gas markets, yet it has taken until now to devise a faulty set of measures that will create even more problems down the track.

The expectation is, by the government’s imposition of domestic price caps on gas and coal, average household electricity bills will be $230 a year lower than they would be otherwise. That’s not an absolute reduction but a reduction from the enormous increase that was otherwise expected. Instead of electricity prices rising by 36 per cent next year, they will rise by 23 per cent. The trouble for the government is that most households (or businesses) will not be judging their bills on the basis of some sort of counterfactual.

The second part of the package is funding of $1.5bn for targeted rebates to customers who are in receipt of government transfer payments, to be matched by the states and territories. But rather than simply pay cash subsidies to these customers, the plan is that the money will be used by the retailers to lower the prices charged, but just for this group.

Prime Minister Anthony Albanese confirmed last week the government would impose domestic price caps on gas and coal.

Now if that sounds complicated, you wouldn’t be wrong. The retailers don’t have that information about customers. It will be a complicated exercise to crossmatch the records of the federal government with those of the retailers to identify customers who will be charged the lower rate. Small variations in the name of the welfare recipient and that recorded by the retailer – A. Smith versus Tony Smith – can create havoc. The alternative is for eligible customers to apply for the concession, but there will be some customers, often vulnerable ones, who fail to do so.

As for businesses, the intention is for the lower prices to apply only to small ones. This raises the definition of what a small business is – an issue that was part of the recent industrial relations amendments.

One problem is that the energy intensity of a business – and hence the pressure from higher energy costs – is not closely related to how many workers they employ. Some larger businesses with more than 20 workers, for instance, are struggling because of the nature of their activity – small-scale manufacturing is an example.

You may ask why the government opted to offer up this targeted assistance in such a clumsy way. First, it wants to prevent any potentially inflationary spending that could occur if cash subsidies were made available. Second, the policy must have a dampening effect on observed inflation – that is, the consumer price index. There were other options, but this outcome could not be guaranteed.

The exercise becomes more complicated when you realise the electricity market is not the same in every state, with wholesale prices varying between them. In addition, some states already offer targeted electricity rebates; it’s not clear what will become of them. There is a possibility that electricity customers in some states will do better than those in other states – an unpalatable outcome for a federal intervention.

So what should we make of the price caps? As every sensible economist knows, price caps are a highway to unintended consequences while generally failing to produce the intended outcome. In this case, new regulations facing the gas industry will doubtless have the impact of reducing investment and crimping supply.

Anthony Albanese made much of the government avoiding sovereign risk by not interfering with contracts that gas and coal producers have entered into with overseas customers. But these domestic price caps are also an example of sovereign risk by interfering in well-established markets in which investors had legitimate expectations of governments refraining from such interventions. Many investors in Australian gas and coal assets are overseas companies that can easily reroute investments elsewhere.

While Climate Change and Energy Minister Chris Bowen maintains the price caps are for 12 months only, the legislation involves an arrangement wherein the ongoing domestic gas price will be regulated according to an externally determined “reasonable pricing provision” with producers made to supply the domestic market. This also potentially sets up a damaging arbitrage between gas and coal in which it becomes cheaper to generate electricity from gas than coal. This would increase demand for gas in the context of restricted supply.

The consequences of this ill-considered “reasonable price provision” for gas are disastrous. As the Bass Strait reserves quickly run down, there will be less gas coming from the south. (Note the pipelines are designed for south-north transmission.) The operators won’t be inclined to make further investments in those fields. In the meantime, Queensland producers will have little reason to supply any more to the southern domestic market.

Regulated prices make some sense for declared constructed assets such as transmission lines because they are natural mono­polies. Investors are guaranteed a rate of return based on the cost of capital. But when it comes to gas, there are virtually no parallels, with high risks and uncertainties.

There is the requirement to secure acreage; the cost and risk of exploration; uncertainty of reserve estimation and well flow; the cost of processing and transport; and volatility of the ultimate financial reward. There is no way any “reasonable pricing provision” can provide the necessary incentives for gas producers in Australia to continue other than milk their existing assets and find other places to invest their capital.

It’s hard to avoid the conclusion that the Albanese government is happy to see the effective demise of the gas industry. As one analyst has observed: “It is beyond me why any major player in the east coast market would put fresh capital into the ground, given the huge uncertainty on the regulatory regime and what the government might, in any given year, determine is a reasonable price.”

Of course, the costs of such an eventuality would be substantial, including the loss of export earnings, well-paid jobs and truly reliable electricity. It also will doom gas-intensive manufacturing users. The tragedy is, had the government genuinely consulted with the industry, a compromise could have been reached in relation to assured domestic supply at reasonable prices.

The obvious advice is to hang on to your hat. Even if the war in Ukraine comes to an end, global energy markets won’t be returning to pre-war arrangements, with sanctions against Russian gas and oil likely to continue. The Albanese government will have to dream up another excuse for Australia having extremely high energy prices notwithstanding our abundance of resources, and the Labor Party Left, the Greens and the teals will be celebrating the demise of the gas industry.