NEG might be the answer but Turnbull needs to explain why

Minister for the Environment and Energy Josh Frydenberg.

Experts agree that a steady diet of fudge, cream pies and french fries is far healthier than consuming grains and vegetables. Or at least they do in 2173, according to Woody Allen’s movie Sleeper (1973).

And experts also agree that you can place additional reliability and emissions-reduction constraints on our electricity network and ­prices, instead of soaring, will fall.

Or so the Energy Security Board contends in its final detailed design report on the national energy guarantee, released last week.

Explainer: What exactly is the NEG and how it would work?

Backing the ESB’s claim is modelling that shows, compared with a “business as usual” scenario, renewables would account for a greater share of capacity under the NEG, emissions would be lower and consumer bills would be lower too, with prices in the wholesale electricity market 20 per cent below the levels they would otherwise reach.

Faced with those results, one’s immediate inclination is to utter the only double positive in English that yields a negative: sure, sure.

After all, the results come from the same model, which predicted, in the 2015 review of the renewable energy target, that prices in the National Electricity Market would be 50 per cent lower today than they are.

The fact that the ESB report makes no attempt to test the model’s forecasting ability, or explain the difference between its results and earlier studies, is therefore hardly reassuring.

But those are far from being the only concerns. While the report’s discussion is cursory, closer inspection suggests the fall in prices is largely due to two ­assumptions.

The first is that the NEG will dramatically reduce the required rate of return on investment in generation, cutting the cost of capital by more than a third over the period to 2030.

Inexplicably, the report provides no sensitivity testing around that assumption; but it could account for half the projected difference in prices between the scenarios with and without the NEG.

The second assumption is that the NEG will induce dispatchable generators to offer a greater share of their capacity in the contract market, altering prices in that market and reducing generators’ bids in the electricity pool.

Here, too, the report provides no sensitivity testing; but this assumption likely explains the bulk of the remaining price effect.

While not impossible, those ­two assumptions are highly ­questionable.

Yes, greater policy certainty would lower risk premiums and so reduce required returns. But the NEG does nothing to resolve the fundamental uncertainty about future emissions targets and introduces substantial new risks, notably about the impacts of the reliability requirements. As a result, the dramatic drop the report projects in the cost of capital is difficult to accept.

The contention that contract cover will rise, boosting competi­tion in the contract market and in the electricity pool, is no less ­dubious.

The intent and effect of the reliability requirement is to increase the demand for dispatchable capacity, as retailers must, under the requirement, be able to back a high share of their load with that capacity.

At the same time, according to the report itself, the supply of dispatchable capacity will scarcely grow. With greater demand, and practically constant supply, prices for dispatchable capacity should rise, not fall, compared with business as usual.

Indeed, there are good reasons to believe they would have to rise substantially for a higher share of dispatchable capacity to be made available in the contract market. In particular, the NEG increases the value to vertically integrated operators of holding on to dis­patchable capacity, as that ensures they have it available should the reliability obligations be ­triggered.

Rather than reducing the opportunity cost of entering into contracts, as the report assumes, the NEG therefore appears likely to increase it. And here too, the fact that the report does nothing to test its assumption — for instance, by examining whether, at the assumed higher average levels of contract cover, an individual generator would be any better off marginally changing the capacity it had under contract — compounds the doubts.

All that is bad enough. But the fundamental defect in this model is that it assumes prices can fall over the longer term even if costs don’t. Subsidised competi­tion from renewables consequently leads to sustained reductions in charges, regardless of what happens to aggregate ­system costs.

That assumption is completely contrary to the experience of the past decade. Moreover, it shifts the focus in a manner that is inconsistent with serious policy analysis. Yes, the welfare of politicians depends on what happens to consumer prices, as every populist knows; but the welfare of communities ultimately depends on what happens to costs.

This report takes the error to rarely equalled extremes. Entire categories of costs — such as the increased retail, transmission and distribution costs arising from the NEG obligations — are essentially assumed away. And in a significant departure from earlier practice, it simply does not present data on overall system costs.

Then again, why would it? In the world it paints, the best things in life — greater reliability, fewer emissions — are better than free: the more of them we have, the cheaper electricity will be.

It is consequently unsurprising that Labor and the Greens would ask: “Why stop there?” If it only makes consumers better off, why not double the emissions reductions target? And it is also unsurprising that the government, confronted by those demands, is on the back foot.

That we face a reliability crisis is undeniable. That the NEG may be the right response should not be ruled out, given the political constraints.

But if the Coalition does not justify its own policies properly, how will it be placed when a Labor government does the same?

We won’t have to wait forever to find out. In the meantime, enjoy having that cake and eating it too. As for me, I’ll have fudge, with added lashings of cream. It is, I’m told, good for your health.