The Latrobe Valley and the carbon tax.


There appears to be lots of ‘doom and gloom’ around brown coal generation in Victoria’s Latrobe Valley under the carbon tax. It is far from obvious that this is justified – at least in the next few years. Indeed, while there may be a switch to gas-fired plant under the $23 per tonne (CO2 equivalent or CO2-e) tax in the longer term, not much is likely to happen in the short term – except the price of electricity will rise – unless the government throws money at Hazelwood to convince International Power to close it down. 

Why? Using figures from John Freebairn’s paper (here), brown coal produces about 1.26 tonne CO2-e per MWh and gas fired plant at least 0.4 tonne CO2-e per MWh. So a $23 tax adds about $29 per MWh to brown coal’s cost and about $9 per MWh to gas. So the tax gives gas a $20 per MWh ‘cost advantage’ relative to coal.

Now in the short term (i.e. with existing plant rather than new plant), viability in the National Electricity Market depends on a generator’s short-run marginal cost (SRMC). If the price is above a generator’s SRMC then the generator is getting a return on its capital. Otherwise, it is not. So in the short-term, gas will only be able to underbid base-load brown-coal generation if its SRMC (without the tax) is no more than $20 above brown coal.

Hmmm. I don’t think that is the case. John doesn’t have much data in his paper, and SRMC depends on the price of the input fuel. But I think the gap is usually estimated at approximately $25 per MWh or more for SRMC. This is broadly in line with two reports cited by John although the lower figure says that gas can profitably underbid coal with a $17.50 per tonne tax (the other estimate is $40 per tonne for gas to profitably underbid coal).

So the most likely result is that the tax will push up the cost of brown-coal generation by more than gas-fired generation, but not by enough to create profitable switching with existing plant. So all that will happen is that the higher SRMC will be reflected in the spot electricity price (in other words – passed through to retailers who will either be allowed to pass it through to consumers or they will go bankrupt very fast).

Of course, as John notes, even if there is switching, current gas capacity is so low that the brown coal plant will still be dispatched most of the time. And, even with the tax, the SRMC of brown coal is less than the long run marginal cost of new gas-fired plant – so there is unlikely to be rapid development of new gas fired plant to displace more brown coal generation.

So in the short term there is unlikely to be a problem for the Latrobe Valley unless we think that a price rise for electricity will lead to large demand reductions. The owners of current brown coal plants will make a lower return on capital but they are unlikely to find it profit maximising to shut down.

The longer term is more interesting. Switching will depend on the cost of building new plant versus maintaining old coal-fired plant. And the tax (or ETS) may alter this decision so new gas fired plant will replace brown coal plant as the latter is retired over the next few decades.

So, for the Latrobe Valley, the carbon tax itself should not be creating too much consternation in the short term. Of course, the federal government may throw some money into the mix to hasten the closure of Hazelwood. That may stop International Power from complaining but the future of the Valley will depend on where any new gas-fired plant is built. Given that the transmission infrastructure already runs to the Latrobe Valley and it is relatively close to gas supplies, even this prospect should not concern the Valley residents too much.


5 Responses to "The Latrobe Valley and the carbon tax."
  1. That all depends on the elasticity of demand as to whether the power companies can pass it all on. My guess is they can’t, my power bill shows I consume at 1.19 tonnes per quarter, or 4.76 per year. If the full price is passed on that’s an increase of $109.00 and which will incentivise me to decrease my consumption. If demand goes down the producer will have to bear some of tax through reduced profitablity do to demand being elastic. This leads to reduced profit with will reduce the equity in these businesses. If A= D + E and the Asset depreciates in value due to reduced profit, it’s not like they can reduce their debt, so the equity stake will decrease remarkably, which reduces the companies ability to move onto other things

  2. Spot on re maintenance costs. Either the current generators will switch to gas, or new gas players will enter. As prices increase (as they have done since privatisation) and users find ways to consume less, profits will trend down. So, if current (lignite) generators try to keep profits up, there’s risk they will skimp on overheads and the risk of failure will increase.
    So, assuming governments are aware of these risks, do they have external audits of (these aging) plants, and are the records of inspections available?
    On the other hand, a brown-out would be handy.  

  3. Stephen, that average emissions figure hides considerable variation.  The number for Hazelwood is more like 1.55 tonnes per MWh, which gives a cost increase of $35.65 per MWh for Hazelwood.
    That would give gas a cost advantage of $25-odd per MWh, perilously close to the magic number, and that’s in the first year of pricing.

  4. Stehpen,

    The issue for the Vic brown coalers is not just the change in SRMC.  They have massive fixed costs.  Hazelwood needs over $150M a year ($100/kw at least) to cover maintenance + mine.

    SRMC cost is well under $10/MWh.

    LRMC cost assuming 80-90% capacity factor are closer to $40/MWh.  Even ignoring the debt the LRMC cost is close to $30/MWh.

    Now add 1.5 * $23 to that and its very close to the price of gas new entry.  But also well under the price (about $40/MWh) that NSW black coal will generate more and export south. 

    The most marginal brown coal Hazelwood will be in trouble from day 1.  Currently the rolling 12 month pool price in Vic is under $30/MWh so they are in the red as it is.

    There is no hope of the situation improving for Hazelwood so there is no point them hanging on. It will either close or be bought out and due to the fixed costs issue (mine) it will be a full station closure over 2-3 years. Doing that will help the situation for everyone else in the La Trobe valley because that will raise prices by shifting the supply/demand balance.

  5. Folks

    Some really good comments – thank you. I think the role of the interconnectors and NSW generation is really interesting. It is hard to get a ‘capacity’ for the NSW-Vic interconnectors because there are various flow constraints on the system. Also, because the snowy lies on one of the interconnectors, I am not sure how much capacity is currently used or available for use in normal periods. But it does look like a reasonable proposition that increased flows from NSW black coal power stations could underbid Hazelwood.
    Of course, this creates an interesting conundrum if Hazelwood ceases operation. The NSW-Vic interconnectors are congested in peak periods and so the full effect of pulling Hazelwood out will be felt in those periods. This could lead to significantly more price spikes in Victoria and potential supply issues until new gas peaking plant can be built. 

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