The two big flaws driving our power crisis

Only if we understand the true causes of the current energy crisis can we effectively fix it, writes Rod Sims. Pictured: Pluto LNG Plant, Karratha. Picture: Woodside

Understandably, there has been a lot written about the causes of Australia’s electricity crisis. The focus is often on failing coal-fired generators, the war in Ukraine and the transition into renewable energy. However, such a focus misses the bigger picture.

In my view there are two fundamental errors underpinning the crisis: first, the lack of a price on carbon; second, building three rather than two liquefied natural gas projects on the east coast about 10 years ago. The implications of these errors are profound.

Most economists agree that if you want to reduce carbon emissions because of their contribution to climate change then putting a price on carbon is the most efficient way to do this.

Some people argue that putting a price on carbon creates an artificial market, but this does not recognise the adverse effects from carbon emissions, which are now, whatever some believe, irrevocably widely accepted. Once you do recognise this, then putting a price on carbon is basic economics as demonstrated by AC Pigou more than 100 years ago in The Economics of Welfare.

Of course, there are many issues with doing this. At the crude end are arguments that pricing carbon is a tax, a term likely to put most people off, or the argument that you should not “commodify the atmosphere”. At the more sophisticated end you have the difficulty of calculating the correct price; this can be overcome by setting an emission reduction trajectory and letting the market set the price. And other measures will be needed, such as support for core research and development to drive the necessary technological breakthroughs.

But the central issue is: do we rely on markets or do we not? Unfortunately, Australia has not. We have had many attempts, starting with the Rudd government’s first attempt in 2008 that was defeated by the Coalition and the Greens, albeit for different reasons. Indeed, the ALP government introduced an emissions trading scheme in 2012, only for a Coalition government to repeal it in 2014. The result is, rather than a market solution, we have relied on government interventions, particularly the renewable energy target. The problems with a dominant reliance on the RET are many. For one, it deals only with the third of Australian emissions due to electricity generation and ignores the rest.

The more relevant problem given the electricity crisis is that solar and wind generation receive revenue from the RET outside of the electricity market, so they bid in to the market operator for dispatch whenever they are available and irrespective of system need. There is thus no priority on reliable or secure energy that the energy market provides, so there is a reduced benefit to closed-cycle gas or coal-fired generation operating. While some will applaud this, it has led to a reduced incentive to maintain plants – a key factor underpinning recent plant breakdowns.

A market solution would have seen closed-cycle gas and coal-fired generation reduced, so achieving our environmental goals, but would have seen the system cope with this without the fear of blackouts. Coal-fired plants would first have found ways to reduce their emissions, given the incentive provided by the carbon price, which does not exist for them under the RET, and then, importantly with fast-start gas-fired plants, would have had an incentive to meet system reliability and security needs.

I stress that there need be no lessening of environmental goals; simply set the emission reduction goal at the desired level. The market is then forced to find the least-cost way of meeting this. And this is not an argument against renewable energy. Indeed, studies suggest renewable energy backed by a small amount of gas provides the cheapest electricity.

And as Ross Garnaut has argued in his book Superpower, Australia is well placed to be the source of the cheapest energy in a low-carbon world. The problem is the transition path; do we allow the market to keep a focus on reliability and security or do we not?

Mention of gas segues nicely into the second error. This is that about 10 years ago Australia committed to three $20bn gas plants, not two. We did not have enough gas for three plants and, despite the gas industry saying otherwise, having three plants saw the LNG export industry absorb gas that historically had been used to meet domestic demand. This saw domestic gas prices increase substantially and now sees Australia’s gas market operator needing to cap gas prices at 10 times the level of gas prices a decade ago.

To be fair, some state governments have not helped, with NSW having an effective moratorium on gas development and Victoria banning even onshore exploration of conventional gas, despite having available sources. But just as we need gas-fired generation it is difficult to get gas and the prices can make generation uneconomic. This has contributed significantly to the energy crisis.

Australia is one of the top gas exporters in the world. All other significant gas exporters have low-priced domestic gas. On Australia’s west coast, approving gas exports was accompanied by a West Australian government mandating a domestic gas reservation scheme that sees domestic supply exceed demand and so prices at about $5 to $6 a gigajoule. On the east coast Australia stands alone in letting the market set the price at about six times the WA price, reflecting that we are short of gas due to gas exports.

The issue is complicated. The industry argues that without LNG exports many fields currently producing would not have been developed and that local gas would have risen in price anyway to cover needing gas from increasingly expensive fields. Whatever the merits of these arguments, Australia has less available domestic gas and much higher-priced gas than if only two gas export projects had been built.

So what to do now? The errors are in the past. First, I would still urge a price on carbon. It is far less regressive than having high solar feed-in tariffs or electric vehicle incentives that favour higher-income groups. And future investment and innovation need a price signal in our low-carbon journey that has a long way to go.

Second, the federal government needs to pressure the LNG exporters to supply the domestic market at a price close to the WA price, with the threat of legislation. Some will say the market should not be interfered with; I once argued this but was wrong. We now have an immediate crisis that is costing the economy dearly, and we have already lost manufacturing capacity that will not come back, and we will lose more.

Only if we understand the true causes of the current crisis can we effectively fix it.

Rod Sims is a professor with the Crawford School of Public Policy at Australian National University and in March completed nearly 11 years as chairman of the Australian Competition & Consumer Commission.