"The end goal is exactly the same. But how we get there can be either a smooth transition or it can be a very difficult process for business."

Tony Concannon, Executive Director, International Power (Australia)

When Australians flick the switch to turn on the lights, the TV, the computer or airconditioning, they have traditionally done so on two safe working assumptions. Living in a resource-rich country, they have come to expect that, first, they will be guaranteed certainty of supply and, second, that they will get power at a significant discount to what consumers pay elsewhere in the world. Is that about to change?

In the search for the right policy responses to the challenge of global climate change, the dilemma confronting governments here is how to reduce Australia’s greenhouse gas emissions while still being able to exploit the nation’s wealth of energy resources, keep prices competitive and affordable, maintain investment and growth in the energy and resources sector, and not compromise the security of power supplies. It is not an easy or straightforward equation.

In June, as part of its State of the Nation series, CEDA brought together the federal Minister for Energy and Resources, Martin Ferguson, and three prominent experts on the electricity generation sector to explore these issues. The debate came in the aftermath of the interim Garnaut Report on emissions trading, which recommended creating an all-encompassing carbon market in Australia, with the full auctioning of carbon permits and no exemptions.

International Power (Australia) executive director, Tony Concannon, warned the CEDA event that this blueprint would have put at risk $12 billion worth of investment in coal-fired power generation in Australia, and led to the doubling of energy prices for industry and households.

The Rudd Government’s release of its Green Paper on climate change in July signalled significant modifications to the Garnaut proposal. In response to industry warnings of large-scale dislocation of investment, production and jobs, it held to its timetable to introduce emissions trading by 2010 but announced "preferred positions" which included free permits for parts of the energy sector most exposed to international competition, a pledge of transitional assistance for the coal industry, and a proposal to compensate motorists with a reduction in fuel excise. The full scope and detail of the government's plans will be unveiled in a White Paper scheduled for release later this year.

CEDA's State of the Nation debate underlined how complex and challenging it will be to get this policy right.
      
State of the Nation heard from three experts with unique insights into the economics of electricity generation in Australia. They were: Les Hosking, managing director and CEO of NEMMCO, the body with oversight of the national electricity market; Paul Hyslop, the development director of ACIL Tasman, which provides government and industry with economic advice and modelling on energy and climate change; and Tony Concannon, whose global energy business includes owning and operating some of the largest power plants in south-eastern Australia.

Questions raised in the discussions included:

• Is there a future for coal-fired electricity generation in Australia?
• Does Australia have sufficient power generation capacity in the pipeline to meet demand, and what will be the impact on investor confidence if one effect of emissions trading in Australia is to render coal no longer viable?
• Can carbon capture and sequestration come to the rescue of the coal industry - and, if so, when?
• What would be the impact on gas prices if, under emissions trading, it was to become the preferred energy source for electricity generation?
• Is it realistic to expect renewable energy alternatives such as wind, solar and geothermal to do the heavy lifting to provide baseload power?
• More controversially, is there a future role for nuclear power?
• And how would the restructuring of the cost base of power generation in Australia affect industry competitiveness more broadly? What would be the implications for Australia’s longer-term economic prospects?

The view from Canberra

In his presentation, Mr Ferguson acknowledged the importance of reliable and secure energy supplies in underpinning Australia’s prosperity. The task was not only to continue to ensure the efficient supply of power to homes and business but also to maintain Australia's strong position as a leading energy exporter to the Asia-Pacific. But these aims had to be reconciled with Australia's responsibility to play a constructive role in countering the impact of climate change.

"Over the past few years much has changed in the energy industry," Mr Ferguson said. "The global supply-demand balance for energy has tightened, sending energy prices up across the board. Concerns about energy security have risen along with prices, but so has awareness of the impact of climate change and the need to take action to reduce emissions. Responding meaningfully and effectively to climate change while maintaining adequate, reliable and affordable energy remains a key challenge for the Government and the energy sector generally."

While Australia was well endowed in gas and coal reserves, it was becoming increasingly dependent on imported oil. "The need for policy settings that promote exploration is most apparent in the oil sector where our future depends on finding Australia's next Bass Strait," he said. "My department is currently developing policy options to intensify mineral and petroleum exploration. In the latter part of 2008. I will be bringing forward for government consideration a package of proposals to significantly enhance Australia's exploration efforts."

Without new oil discoveries, he said, Australia could face a trade deficit in petroleum products of more than $25 billion by 2015. By then, domestic oil production could be as little as 20 per cent of our needs, and there would be increasing pressure on Australia to diversify. "Not only do we have to find the next Bass Strait, we have to do more with our vast reserves of natural gas and coal seam methane. Despite the many projects under consideration on both the west and east coasts, Australia still has only two LNG export projects two decades after the birth of the industry. The outlook for LNG exports is rosy with exports already totalling $5 billion a year, but we must not underestimate the challenges of getting major gas projects off the ground."

"We also have to be more innovative in the ways we use our natural gas and coal," he said. Government was investigating policies to encourage conversion of gas and coal to liquid transport fuels like ultra clean diesel.

Uranium would also be critical. "We will need to continue the safe development of our uranium resources which are so important to those countries less fortunate than Australia when it comes to energy options and who rely on nuclear power for clean development."

But the most significant policy challenge facing the energy sector was climate change. "The Australian government is serious about acting responsibly on climate change…the government is also serious about being economically responsible and we are committed to reducing emissions at least economic cost, while maintaining adequate, reliable and affordable energy supplies and the international competitiveness of Australia's industries."

How a carbon price will change the electricity market

Les Hosking briefed CEDA on the potential implications of "cap and trade" emission constraints for pricing signals and investment decisions within the power generation industry. He said carbon trading was likely to prompt a major shakeup of the "order of merit" of the various competing energy sources in Australia’s national electricity grid.

It is a decade since five state-based power generation systems in southern and eastern Australia were interconnected to create a single national electricity market (NEM). The objective was to share energy sources, and rationalise investment across a highly capital-intensive industry. Today, about $11 billion is traded annually on the world’s longest electricity grid.

Currently, coal represents by far the largest provider of energy to the system, contributing just over 80 per cent of total electricity supply.

But Mr Hosking said that when you imposed carbon permits on the industry, introducing an additional cost to the short-run marginal costs of power generators, "the merit order would invert so that gas would be used more as a baseload provider of electricity than now…brown and black coal will go further out of the merit order. That, of course, is a considerable risk to the brown coal industry, and to Victoria, if that happens too suddenly."

He said the debate over the energy mix to meet Australia's future power needs would be especially critical approaching 2011-12, when the industry faces major investment decisions on building new capacity to satisfy projected demand.

"There’s a little bit of a perfect storm arising here," he said. "We do have a situation in 2011-12 when more generation has to be built. We also have a carbon permit scheme being introduced…and, of course, we have other issues, such as nuclear, which won't go away."

Although Australia had done well in meeting additional generation needs on a "just in time" basis over recent years, Mr Hosking said the current uncertainty had raised some doubts about whether the large-scale investment necessary would happen as and when required after 2010.

There would also be question marks over which energy sources investors would be prepared to back. "Will it continue to be in brown coal? The gut reaction to that is, well, no, unless it's carbon capture. Will it be in gas? Depends on the price of gas. Will it be in renewables? Depends on where they are and so on."

Mr Hosking issued a general caution on possible unintended consequences. "Policymakers have to consider the long-run impact of tinkering, and imposing prices into the industry…looking at reliability and security, we don't want to see too many brown coal and black coal power stations going into mothballs or winding up completely before we're absolutely sure we've got enough gas to replace it. Then we don't want to see too much gas come in until we're absolutely sure we've got enough carbon capture or other sources to replace that. And, certainly, the whole of Australia doesn't want to see government backflip in nuclear energy in 2015 or beyond…because they got it wrong. That would be a terrible investment signal to the rest of the world."

Carbon trading must be efficient

Paul Hyslop told CEDA that emissions trading, if properly implemented, would prove an effective instrument to bring about dramatic changes in the electricity sector in a relatively short period of time. If the target was set at 20 per cent carbon reductions by 2020, ACIL Tasman’s modelling indicated the effects would include the shutdown of all brown coal-fired generators in Victoria and South Australia, a rise by a third in electricity prices, and significant upward pressure on the price of gas in eastern Australia. Moreover, the writing-off of investment in existing generating plant, and the volume of investment required for new generating plant, would be unprecedented.

"An emissions trading scheme will work," he said. "It will bring about carbon reductions and it will do it in the lowest cost and most efficient manner…in short, in combating anthropogenic-induced global warming, it's good policy."

However, Mr Hyslop said much would depend on the overall integrity of the scheme. He said government should resist "special interest arrangements", the scheme clearly should have as broad a coverage as possible, and once established, it should not be subject to political interference.

"Energy prices are going to go up…stepping in after the scheme is operating to limit the rises will simply slow or even stop carbon abatement."

Mr Hyslop went on to brief the audience on ACIL Tasman's modelling of carbon reductions over what he called the 'transition period' through to 2020, looking at scenarios for carbon abatement of around 20 per cent. He explained that the target, as measured against the base year of 2000, was a steeper climb than it appeared at face value.

"Emissions have been growing since 2000 and, particularly if you look at the electricity sector, to get even a 10 per cent reduction by 2020, you'd actually have to get a 23 per cent reduction over current levels. If we go to 20 per cent, it's a 32 per cent reduction over current levels. So our focus has been to model these reductions in order to assess their feasibility, and to analyse the effect of carbon permit, the likely electricity plant mix, and the effects on the gas market, which is very relevant to the electricity market."

Mr Hyslop said the impact of the scheme would be greatest on Victoria's brown coal. "For an emission reduction target of 20 per cent over 2000 levels, our modelling indicates that most of the Victorian brown coal plant will be shut down, as well a all the coal-fired plant in South Australia, and some coal-fired plant in NSW and Queensland…we expect that this plant would be replaced by high efficiency gas turbines."

While some of the replacement plant would also involve renewables - wind, solar, geothermal and biomass - Mr Hyslop said most of these energy sources were not "cheap" and he warned that renewable energy targets set by governments threatened to distort emissions trading from the outset.

Is clean coal part of the answer?

Mr Ferguson told CEDA that when it came to electricity generation, there was no task more urgent than to develop 'clean coal' technologies to lower the emission intensity of coal-fired power. Mr Ferguson was confident carbon capture and storage could, and would, be deployed, and predicted coal would continue to make a major contribution to Australia's energy needs "well into the future".

"A nationally coordinated effort is needed to bring forward the commercial availability of these technologies," he said. "Through the National Clean Coal Initiative (NCCI), I will be working with industry, state governments, researchers and stakeholders to develop a national framework that supports the accelerated development and demonstration of clean coal technologies. This includes the $500 million National Clean Coal Fund.  Carbon dioxide capture and geological storage is one of a range of options that will help Australia achieve a significant reduction in greenhouse gas emissions. Australia has significant geological storage potential, particularly in our offshore sedimentary basins. The Government committed as part of the National Clean Coal Initiative to implement a regulatory regime to provide access and tenure to offshore Australia for geological storage."

Les Hosking said although there was a commitment by industry and government to preserving coal in the energy mix, this was not as straightforward as it seemed, even if clean coal technology proved viable. "Where do they put (the C02) coming out of Queensland and NSW? The oil fields are a hell of a long way away….it might look simple, but it's not so simple. It will need some very careful thought. Is carbon capture possible? What is the potential? It looks as though the government's going hell for leather on getting it up as early as possible…so cross the fingers.”

Tony Concannon was unconvinced that the technology would come on-stream quickly enough to change the calculations for coal-fired power generation.

"Looking at it from a coal use perspective, there is no known technology today, on a large scale basis, to either reduce significantly emissions from both those fuels or to capture that CO2 and then store it," he said.

"Within the industry the view is that it’s going to take 20 years in order for that to actually develop, not 20 months when the emissions trading scheme is currently proposed to be put into effect."

Mr Concannon said unless there was a steady and patient timetable to make the shift towards a low-carbon economy, government research and development incentives for clean coal technology might prove to be of little or no consequence. "There are a number of clean coal developments around Australia but I just reaffirm the point…the Minister has mentioned $500 million here and $100 million there (but) if the industry has lost $12 billion it just dwarfs these incentives. So I actually see a knee-jerk reaction. Business would retreat from clean coal and would just go the easy option of gas and then you'll see a significant rise in energy prices…you're probably looking at a 100 per cent increase in energy prices."

Hard decisions ahead

Tony Concannon said a careful design of the emissions trading scheme would be "absolutely imperative" if Australia was to continue to prosper from relatively low-cost power and maintain its stature as a leading global player in energy and resources. He said business was looking for a steady transition through to 2030, and warned that miscalculations could cost existing players in coal-fired power generation up to $12 billion in lost investment, and create fears of sovereign risk.   

International Power is one of the giants of power generation worldwide. It produces 31,000 megawatts of electricity across 20 countries. It is the world's fourth largest owner and operator of wind turbines, and is prominent in carbon trading in Europe. Since becoming a major player in the Victorian power industry in 1996, it has become the largest privately owned energy producer in Australia, producing 12 percent of the national electricity market, with a retail business of just under 400,000 power and gas accounts. It runs diverse fuel and technology, including gas and renewables, but two of its biggest assets in Australia are the Victorian brown coal generation plants of Hazelwood and Loy Yang B.

Mr Concannon told CEDA that, currently, almost 85 percent of Australia's electricity was supplied by coal-fired generation, and the price for baseload power in Australia was 40 per cent lower than in Britain, and 60 per cent lower than in the US. Attempting to move too quickly to a different mix of lower-emissions technology could be costly and difficult, with significant implications for long-term investment.

"Some models suggest a very smooth transition from one fuel to the other," he said. "We actually believe the reality would be far more disjointed. The directors of those multiple businesses will have to make some very difficult decisions over the next year, as to whether or not their businesses are actually going concerns."

Mr Concannon said business was running hard to achieve transition to low- emissions technology but existing alternatives to coal for large-scale power generation were limited. "One is, you could fill in nuclear power," he said. "Despite its large reserves of uranium, Australia to date has effectively turned its back on nuclear power….the other is you could clearly burn more gas." But greater reliance on gas would see prices "go north significantly" and gas reserves were relatively finite, compared to as much as 600 years' worth of brown and black coal.

Mr Concannon said private industry had invested in power plants in Australia in good faith, on the basis of the existing legislative framework. Changing the rules of the game, with new legislation undercutting the value of those assets, would arouse serious concerns. "It's very difficult to raise $12 billion. International investors will be looking very closely to see whether or not Australia is going to make a change in law which they would view as being severe sovereign risk."

The IP Australia chief urged policymakers to exercise great care in their approach to emissions trading. "The end goal is exactly the same. But how we get there can be either a smooth transition or it can be a very difficult process for business."