How much will Tasmania pay for shorting the carbon price?

The carbon price is finally set to go this week (14th July) with both the Coalition and PUP committed to deliver on their election promises. After all, a promise is a promise. And you can't go back on a promise unless, that is, if it happens to be about the R-word. Any Coalition promise to do with those "utterly offensive" (to quote from Treasurer Joe Hockey) Renewables, seems to be somehow exempt from the promise that a promise is a promise …

The Coalition government has already introduced a bill to repeal ARENA (Australian Renewable Energy Agency) and everyone in the game suspects it is doing all it can to can the RET (Renewable Energy Target). Both would break election promises, making one wonder about the third "R" to be sacrificed.

In the current discourse, it seems easy to forget that the carbon price is an environmental measure motivated by the need to reduce growth in atmospheric CO2 levels, not specifically to wreck the economy. Contrary to the Coalition's protestations, there has been a strong decline in electricity emissions over the period of the carbon price, by about 18 million tonnes per year. While the details of cause and effect can be debated, we are about to see a dramatic demonstration of just how effective carbon pricing has been on electricity emissions, and that could have consequences for Tasmanian wholesale electricity prices in the medium term if rainfall declines to below average [1].

With repeal of the carbon price, the emission intensity of electricity system is set to rise by 1.5-3.5%. And that makes it a reasonable bet that emissions on the National Electricity Market will increase this financial year for only the second time in six years, even if absolute demand for electricity continues to decline.

Why so?

In the words of respected analyst Hugh Saddler it seems likely "that emissions reductions over the past year may have been "borrowed" from the future". The suggestion is that by selling down power reserves, hydro operators may have been shorting the emissions market.

And why wouldn't they? As pointed out in a previous post, hydro benefits from carbon pricing. With the uncertainty in carbon pricing hydro operators have had every incentive to sell as much power as soon as possible.

Two sets of figures tell the story.

The first compares of electricity sent out from Tasmanian hydro generators with the local demand for electricity in Tasmania.

The second shows the level of Tasmanian reservoir storage supporting hydro generation.

The figures show that Tasmanian hydro generators have been selling electricity into the mainland market at unprecedented rates, drawing down storage levels dramatically since the carbon price was implemented in July 2012.

Levels in the Gordon, which has almost 1/3 the total storage capacity, are down to near 20% - levels not seen since the Millennium drought despite significantly above average catchment rainfalls over the last year.

A bit of technical detail is needed to provide the context.

Less the local distribution losses, any imbalance in supply (or sent out energy) and demand in Tasmania is accounted for by exchange with the mainland via the Basslink interconnect. In the last years of the Millennium drought up until late 2009, hydro supply in Tasmania was so limited that it could not supply Tasmanian demand, so Basslink flowed mainly south with the extra import of mostly Latrobe valley supplied electricity. Then reservoir levels were at less than 30% capacity.

According to data from the market operator AEMO, in financial year 2008-09, Basslink flow was 90% of the time southwards supplying Tasmania with an additional 2570 gigawatt hours of electricity at an average rate of 280 megawatts.

Basslink has to make a buck, and so there is a price signal attached to such a concerted asymmetric flow. In that year, Tasmanian wholesale prices were around 25% higher than Victoria.

With the breaking of the drought, Tasmanian hydro generation levels increased sufficiently to supply the local demand. With wholesale prices in Victoria at record lows, partly due an unexpected downturn in demand, there was no driver for persistent flow one way or the other across Basslink. Rather, by using the inherent flexibility of hydro generation, Basslink provided Tasmanian generators with the opportunity to send power northwards when prices rose in Victoria, and buy back as prices lowered, making money on the arbitrage. With the two way flows in balance, wholesale prices averaged out at about $30 per megawatt hour in both states. With good rains, reservoir storage levels improved almost 30% between 2009 and 2012, despite the greater generation.

The situation changed with the start of carbon pricing. With storage averaging above 50%, and a doubling of Victorian prices to almost $60 per megawatt hour to accommodate the carbon price (Victorian brown coal electricity produces up to 1.3 tonnes CO2 per megawatt hour incurring a carbon price of $30 per megawatt hour) hydro power was sent northwards across Basslink at unprecedented rates. According to AEMO, in 2012-13 the flow direction was 90% of the time northwards sending a net 2041 gigawatt hours into Victoria. July storage levels have fallen around 25%.

Since the price differential of around $10 per megawatt hour is needed to sustain the flow, and the extra demand for Tasmanian hydro power pushed prices to around $48 per megawatt hour. With no significant extra cost on the generation side, Hydro Tasmania's before tax profit doubled to $238 million in 20012-13 on the back of a revenue rise from $1 billion to $1.57 billion. Of course, with the majority of that hydro generation still being served into Tasmania, the large part of that profit will have been borne by Tasmanian consumers.

What does it mean for future emissions and prices.

It is inevitable that hydro generation will be scaled back significantly. Firstly, Victorian wholesale prices will drop back to pre-carbon prices of around $30 megawatt hour so there will be no price signal for net export. The more than 2000 gigawatt hours supplied into Victoria by hydro in each of the last 2 years will be picked up by brown coal generation adding an extra 2.5 million tonnes CO2 emissions to the NEM.

Secondly, the drawdown in Tasmanian storage capacity means current rates of generation are unsustainable. With good rains expected to continue in the near term, Hydro Tasmania would appear to have sufficient capacity to meet Tasmanian demand. If so Tasmanian wholesale prices should drop, maintaining parity with Victoria at around $30 per megawatt hour [2].

But the worry is that the draw down of storage to capitalise on the demise of carbon pricing has risked future supply in the event of a return to below average rainfall conditions.

If reserves prove insufficient, and Tasmania again needs to import, Tasmanian wholesale prices will hold above $40+ per megawatt hour. Further, a return to 2008-09 conditions, when the net flow into Tasmania was some 2600 gigawatt hours, would add a further 3.5 million tonnes to NEM CO2 emissions.

If such a scenario were to eventuate, it would be a consequence of policy uncertainty. The uncertainty around carbon pricing has narrowed the window of opportunity for hydro generators and they have used it to effect. Had there been bipartisan support for the carbon price, hydro generators would likely have scaled back output to more sustainable levels, benefiting Tasmania for the long-term.

That all makes the politics of Tasmanian electricity once again front and centre especially with Tasmanian PUP senator Jacqui Lambie and her "kennel mates" quite unashamed in imposing their interests on the national agenda.

With how it pans out in the hands of Hughie, the Coalition must be praying it rains cats and dogs, not just PUPS.

Notes added July 18th

[1] Wholesale (or pool) prices in Tasmania have had no direct relation to the way regulated electricity tariffs are set for residential customers and small business customers on standing offer prices, the energy supply component of which in recent years has been set "as the average of the long-run marginal cost of electricity generation by a notional electricity generator to supply electricity to non-contestable customers on mainland Tasmania and the price Aurora Energy would pay to purchase electricity in Victoria and transport the electricity to mainland Tasmania for supply to non contestable customers on mainland Tasmania", as outlined in footnote 3 here.

[2] For the short term, in its media release of the June 19, the Office of the Tasmanian Economic Regulator has already approved "a 7.80 per cent decrease compared to the prices applying for the period 1 January 2014 to 30 June 2014" for residential customers and small business customers who are on standing offer prices for 12 months from July 1, 2014, reflecting "the change in market conditions" presumably on the expectation of lowered Victorian wholesale prices.

Mike Sandiford, Professor of Geology and Director of Melbourne Energy Institute, University of Melbourne

This article is republished from The Conversation under a Creative Commons license. Read the original article.