In today’s Australian, Brent Gunther from the Queensland electricity industry argues that not compensating electricity generators for a carbon tax would be disastrous. The article is here. Let’s look at his arguments.
Argument 1: The National Electricity Market (NEM) has been a great reform success and not compensating electricity companies will damage the NEM.
I agree that the NEM has been a fantastic reform that has allowed for competition and innovation in parts of the electricity production chain – particularly generation and retailing. And a carbon tax will hurt the coal-fired generators in the NEM. And most power in the NEM is currently produced using coal-fired base-load generators. So a carbon tax or emissions trading scheme (ETS) will hurt the coal-fired generators in the NEM. But that is not the same as damaging the NEM itself.
The NEM is a market. Markets are really good at dealing with structural changes in tastes, technology or taxes. Indeed, markets deal with these ruthlessly. Ask the blacksmiths that went out of business when internal combustion automobiles wiped out horse-drawn transport. Or more recently, ask the music companies and newspapers who are trying to survive the market storm surrounding the internet.
The NEM will not be damaged by a carbon tax. It will come under pressure. Because it is a market created with strict regulatory rules, the regulators who monitor this market will come under a lot of pressure. Electricity prices will rise. If the transition is not handled carefully, there could be large price spikes in peak periods. The owners of coal-fired generators will lose a lot of the value of their investments. Significant investment in new efficient gas-fired generation will probably occur.
So gas-fired generators will win. Coal generators will lose. The price of electricity to consumer will rise. There will be increased research into alternative fuels as the monetary incentive for this research rises. But the NEM will survive. Indeed, the NEM is exactly the flexible market structure that we need for a radical change in relative prices created by a carbon tax.
Argument 2: The loss of value due to regulatory risk associated with a carbon tax will undermine new investment in generation.
Two responses to this. First, it appears that there is currently a lack of investment in electricity generation in the NEM because of regulatory uncertainty. Who would want to invest in a new power station today when the future rules relating to pollution are so uncertain? Once the rules are set then investment can occur with less risk. So a clear carbon tax should offset current uncertainty, not increase it. Of course, the new investment is unlikely to be in coal-fired generators.
Second, while the current risk relates to unclear government policy, the underlying force here is improved knowledge. We need a carbon tax because our scientists have found out that carbon emissions are a lot more problematic than previously thought. In economic terms there is an externality that has been ‘underpriced’ and the government needs to deal with the problem. These changes have occurred throughout history. Sewerage used to be channeled down the middle of the street (and still is in some developing countries). As we understood the risks involved with this, governments acted. In the north sea, over-fishing and a lack of property rights meant that cod numbers rapidly declined. In that case, a failure of government to act means that a significant fishing industry has effectively been wiped out. Think of the debate on smoking and cancer in the 1960s and 1970s. Think of the current debate on gambling following improved understanding of the psychology of addiction.
As knowledge changes, so too must the rules of our markets. The debate on climate change and carbon taxes is simply one recent example. To call it regulatory risk is “an undergraduate rhetorical device”.
Argument 3: The owners of coal-fired generation should receive higher compensation to aid future investment.
It appears from the article that the compensation for coal-fired plants is to aid future investment in non-coal-fired power plants. It is far from obvious that this is a valid argument. The government, through a carbon tax, is simply correcting the price. Should cigarette companies be compensated when it is found out that cigarettes are linked to cancer and the government raises the tax on cigarettes?
A carbon tax (with certainty that relevant policies will not be subject to political whims), will aid investment in those technologies that produce less carbon-dioxide-equivalent emissions. It will aid research into technologies that will make coal-based fuels economically viable (after all, here in Australia, we have a lot of coal). But it will hurt the profits of coal-based generators. Why compensating the owners of coal-based generators will help this new investment in other technologies is far from clear.
Of course, the real risk is that the carbon tax will continue to be a political football. With uncertainty over the future of a carbon tax or an ETS or some other government climate policies, investment in electricity generation will be low. This is not an argument to compensate the owners of coal-fired generators. Rather it is an argument for the government (and the opposition) to get their act into gear and set a clear forward-looking policy framework for carbon emissions. This – not compensating the polluters – will aid investment.