Bhavnagri: What the world can learn from Australia’s low-carbon agonies

By Kobad Bhavnagri
Head of Australia
Bloomberg New Energy Finance

To download the full VIP Comment in PDF format, click here.

Australia is home to a whole host of weird and wonderful animals. Enormous, flightless birds. Mammals that lay eggs. Trees that only germinate saplings after fires and stocky birds that love to swim. Its flora and fauna are full of contradictions.

Its energy sector can seem equally bizarre. Electricity demand is shrinking even as the economy grows. Domestic gas users are screaming “shortage” while liquefied natural gas exports are booming. Fuel resources are abundant but consumer prices are surging. Renewables are cheaper than new fossil capacity, yet coal remains king. And the public is deeply worried about a future with a warming planet, yet climate policies are being dismantled.

So is the country another case study of inevitable backlash against clean energy? Or is it a demonstration that in the end there is now no alternative to decarbonisation? I will inch towards an answer below, but in the meantime two things are clear from the Australian experience – first, old rules are being broken in the energy system without anyone really knowing what the new ones are; and second, as so often, politicians are just making things worse.

Demand is changing, but not as you know it

There are some rules we thought would never be broken. One was the relationship between GDP growth and electricity demand. Australia began breaking this rule in 2007, when demand growth in the National Electricity Market started to fall behind continued, robust economic growth. In 2011, demand for grid-supplied energy actually began falling and it has continued to drop to this day. Since 2010, electricity demand on the NEM has fallen by 8% while national GDP has grown by 9% in real terms.

Like in the US and Japan, the energy sector has been caught completely unawares by the changes. In 2007, the Australian Energy Market Operator forecast that demand in the NEM – which supplies nearly 90% of Australia’s electricity – would rise by 29TWh to 227TWh in 2013. Instead, demand over that time period fell by 13TWh, meaning the forecast was out by a whopping 25%. Unlike many other countries, Australia largely escaped the turmoil of the global financial crisis, with its economy never technically falling into recession and only one quarter of negative economic growth being registered in 2008 and one in 2011. So the rule of GDP growth and energy demand really has been smashed.

There are several reasons for the fall in Australian consumption of grid-supplied electricity. The principal one has been energy efficiency. According to research conducted for the Australia Institute, building codes, appliance standards and solar hot water were responsible for around 37% of the reduction in 2013. The next most significant factor was distributed energy, which accounted for 18% of the fall. This includes small-scale PV, which in 2013 had been installed on 17% of Australian household roofs, as well as other small generators such as cogeneration plants, landfill gas and run-of-river hydro. Consumers have also been responding to surges in electricity prices (which we will come to later) and consciously reducing their consumption, accounting for 14% of the fall.

A shrill and deeply politicised debate over carbon pricing, with much fear-mongering over the impact it would have on prices, seems to have played a perverse role in spurring behaviour change. And then there has been de-industrialisation. Australia’s manufacturing sector (particularly aluminium smelting) has been reeling from an uncomfortably high exchange rate and from costs higher than those of international competitors. The closure of major industrial facilities has resulted in the shedding of some 5TWh of load per year, or around 10% of the total reduction. Interestingly, however, this was only the fifth most important factor. The remaining 21% of the reduction was due to reduced growth in energy-intensive industries and slightly slower economic growth than was originally forecast.

The outlook for electricity demand is now highly uncertain. Only this month, the market operator downgraded the 2020 forecast it made just seven months ago by another 2%. Generators, retailers and distributors alike are reeling from the impact of reduced volumes, and most are now pushing hard for a pull-back in the climate policies they once supported, to stem losses and buy time. But none have yet announced new strategies adapting to the fracture of the system’s old law. Most appear to be fighting the tide, rather than swimming with it.

Plenty of energy, but at a high cost

The Australian continent is blessed with enormous local energy supplies, both in the form of fossil fuel deposits and renewable energy resources. But the cost of electricity for Australians has risen dramatically in recent times. Since 2007, retail electricity prices have risen by 66% on the nation’s east coast at the same time demand for power first flat-lined and then declined. During this time the cost of generating electricity hardly changed, and the introduction of a carbon price added only around 10% to the average consumer’s bill. What really changed were transmission and distribution charges. Bullish demand forecasts and a weak regulatory regime led to a slew of network investments that have saddled the country with high electricity costs for the foreseeable future. Network charges now account for 40-50% of the retail energy tariffs. The unceasing increase in consumers’ bills – even as they saved energy – has entrenched a deep suspicion of utilities, who are now ranked as even less trustworthy than banks. Households have embraced photovoltaic (PV) as a means to regain some control of their bills.

This leaves transmission and distribution businesses wondering whether their costs will ever be fully recovered in an environment where volume is in long-term decline. The widely expected response is an increase in fixed charges, which of course only helps build the incentive for consumers to get completely off-grid, as soon as technology to do so is available at a reasonable cost. The distributed PV industry awaits that moment with bated breath.

The resource curse, part II

“Dutch disease’,” where a country’s resource endowment leads to a hollowing-out of other valuable sectors, is a well-documented phenomenon. Australia’s decade-long mining boom has driven up the value of the currency and inflated skilled labour costs. Now the country’s resource wealth is buffeting the manufacturing sector from another angle – soaring gas costs.

The development of coal seam gas on Australia’s east coast has revolutionised the country’s previously dull onshore gas industry. In 2017, the nation is set to overtake Qatar as the world’s largest supplier of liquefied natural gas (LNG), reaping billions of Aussie dollars for domestic producers.

But the export gas boom is not playing out so well for local users. According to a survey conducted by the Australian Industry Group, contract gas prices have already more than doubled as they converged with the export price, and what is worse, long-term supply agreements are nearly impossible to obtain for major users. Producers, it seems, are keeping their stocks uncommitted in order preferentially to supply valuable international markets and protect against the risk that the new fields do not deliver the expected volumes. The situation has exposed the inadequacy of Australia’s opaque and illiquid domestic gas market: it is dominated by three suppliers with virtual monopolies in their respective regions; there are only around 100 major users supplied almost entirely via confidential bilateral contracts; and newly created spot markets have negligible volumes and even less relevant prices.

The cure for the domestic energy woes is not clear; indeed there may not be one. The Australian government has so far – to its credit – firmly stated that it will not go down the protectionist “domestic reservations” path, as this tends to lead to perverse outcomes. But the alternative approach of leaving the market to rebalance itself only works if the market is evenly balanced between suppliers and buyers, and if it is liquid, neither of which are the case in Australian gas.

The nation’s energy wealth has so far led to riches for producers, but pain for local users. It has also meant gas generation for electricity is being priced out of the market. This is a scenario the US is clearly trying to avoid via the control the Department of Energy (DOE) is exercising over LNG export licences. But will the DOE be able to bake it just right so that the US can have the cake, and eat it too?

Clean energy beats new fossil fuels, but coal will remain king

Thanks to Australia’s excellent wind and PV resources, renewables are now among the most economic and certainly the lowest-risk new electricity generation sources in the country. At $76/MWh with no fuel price risk, wind would be considered by many as a better proposition than new gas at $61/MWh in a market where long-term gas supply contracts are so hard to procure. At $89/MWh, new coal is far out of the money, saddled with carbon policy and reputation risk for investors. If additional power was needed tomorrow, utilities would by-and-large turn to wind to meet their requirements.

While competitive for new generating capacity, however, renewables are still far from being able to compete with existing generators, which produce electricity at prices of around $28/MWh (excluding current carbon costs). These generators supplied 73% of Australia’s electricity in 2013, and almost all have a technical life that allows them to operate until at least 2030. Incumbent coal’s low cost means that the nation’s coal fleet will be long-lived. Our latest projections indicate that coal generation will hardly change to 2030, meaning renewables will only be built (in the absence of other policy support) to meet incremental demand – which, as we have seen is expected to be limited. Power sector emissions are thus expected to remain stubbornly high for the next decade and beyond.

This is a problem many developed countries face, and many more are going to come across in the future. In order to de-carbonise, Australia would have to drive through an orderly exit from coal. But facing that reality has been a very difficult task for the country, which is still bitterly divided 15 years after the debate started on how to do it.

Turning back the clock on climate policy

As all this has played out, Australia has become a poster child for how not to stage a political debate about climate change. Rising energy costs, incumbent businesses losing money, and a leader with a strong ideological view have proved to be a perfect storm for Australia’s climate policy, running it aground with surprising speed.

Since taking office in September 2013, the Abbott government has closed or diminished the importance of almost every climate-change-related function it has had the executive power to alter: the Department of Climate Change was shut down; the Climate Commission, set up to provide scientific advice, was shut; for the first time in 17 years no minister showed up to represent Australia at climate negotiations, when these were held in Warsaw in December 2013; almost all foreign aid for climate change adaptation was cut; and the country’s 20% Renewable Energy Target was put under review by a panel headed by a self-styled climate change “sceptic.”

Further changes have been put on the legislative agenda as top priorities: closure of the AUD 10bn Clean Energy Finance Corporation, Australia’s green investment bank; axing of the independent policy advisor, the Climate Change Authority; defunding of the AUD 3.2bn Australian Renewable Energy Agency and of course the repeal of the Carbon Pricing Mechanism, subject of a “blood oath” by the Prime Minister himself. Most recently, Tony Abbott announced his intention to establish a coalition of nations opposed to carbon pricing and trading programmes, in a thinly veiled effort to disrupt global momentum towards stronger emission reduction targets.

The long-list of actions is unmistakable – the Australian government has signalled nothing short of contempt for efforts to cut carbon dioxide emissions.

The driving force behind all this is ostensibly the ideology of Prime Minister Abbott, who once described the science of climate change as “absolute crap.” He has since retracted his statement, but there is a lack of evidence that his conviction has changed in a material way.

The government has promised still to meet Australia’s CO2 pledges, via an AUD 2.6bn Emissions Reduction Fund aimed at running reverse tenders for abatement projects. However no modelling has been produced to suggest the policy might be effective, and it has failed to attract any credible endorsements apart from that of its designer. It is, in short, a “do nothing serious on emissions” policy.

Paradoxically, the Australian public have long desired action on climate change, with polls taken by the Lowy Institute since 2006 showing that 80-90% of people consistently think the problem should be addressed. But after 15 years of bitter partisan debate, capped by the implementation of an emissions trading programme with a hugely unpopular fixed price, the nation is deeply confused and divided on what form action should take, and whether they are willing to pay for it. Most crucially, the public has become apathetic and fatigued, giving the government room to make sweeping changes.

Turning back the clock is good for some incumbent businesses in the short term, but it will mean paralysis for new investment. Neither renewable nor fossil-fuel industries can invest much under a policy framework with little long-term credibility. International and domestic protest against the government’s agenda is beginning to build, and another change in emissions policy seems inevitable at some point in the medium term. The contradictions are too uncomfortable to play out forever.

Meanwhile, Australians keep putting PV on their roofs, improving their energy efficiency, and building the occasional larger renewable energy project. Welcome to the menagerie!

To download the full VIP Comment in PDF format, click here.

About BloombergNEF

BloombergNEF (BNEF) is a strategic research provider covering global commodity markets and the disruptive technologies driving the transition to a low-carbon economy. Our expert coverage assesses pathways for the power, transport, industry, buildings and agriculture sectors to adapt to the energy transition. We help commodity trading, corporate strategy, finance and policy professionals navigate change and generate opportunities.
Sign up for our free monthly newsletter →

Want to learn how we help our clients put it all together? Contact us