Renewable energy: regulation, commercialisation and investment
Dr Steven Kennedy
Deputy Secretary, Department of Climate Change and Energy Efficiency
Committee for Economic Development of Australia
22 August 2011
Thank you to CEDA for the invitation to speak to you today.
It has been a busy time for those of us involved in climate change policy these past few months and I welcome the opportunity to talk to you about the future of renewable energy in Australia and the Government's plan for a Clean Energy Future.
Prospects for renewable energy in Australia are intimately linked to climate change policy.
In fact, I would go as far as to argue that the future of the renewable industry in Australia is dependent on a credible climate change policy.
If we are not talking about lowering and stabilising global emissions in response to the risks posed by climate change there is much less reason to be talking about renewable energy in Australia. Arguments based on energy security, unlike in other countries, would have little resonance in Australia.
But it's not just any climate change policy, it's a credible climate change policy designed to deliver a sustained signal to investors.
One could argue that all policy is about credibility but it is especially the case for climate change policy. Something I will return to in my concluding comments.
A consideration of climate change policy always sensibly starts with the science.
I'll take as given for today's talk that advice from Australia's top scientific institutions and the world's academies of science that climate change is real and presents a significant risk to future prosperity. It warrants a policy response and that policy response is to reduce global emissions. Such an approach is consistent with the bipartisan unconditional commitment to lower Australia's emissions by 5% by 2020 on 2000 levels.
A reduction in global emissions will require a contribution from all countries—for developed countries a reduction in emissions and from developing countries a lowering in the rate of increase of emissions.
A credible global response will require countries to test other countries efforts to lower emissions and deliver on their pledged reductions. And that is the nature of the global agreement struck at Copenhagen and reinforced at Cancun and the nature of the agreement that the world continues work toward.
There are many dimensions to evaluating other countries' efforts to reduce emissions. One interesting dimension is the ability of policies to deliver emissions reductions at least cost.
The reason we care about whether the reduction in emissions is at least cost is because a least cost reduction in emissions is the policy most likely to be maintained and enjoy continued support from domestic populations.
The Productivity Commission recently evaluated over a 1000 policies from a number of countries to reduce emissions.
The key conclusion from their work is that an economy wide price on carbon is the most effective policy for reducing emissions.
There are four features of a carbon price for the policy to work most effectively.
First, the price should be applied to most emissions.
Second, the policy should support the transition from no carbon pricing to carbon pricing to minimise structural dislocation and support behavioural change.
Third, it should link to other schemes around the world to most effectively contribute to the global reduction in emissions.
And fourth, the policy should be supported by institutions that encourage good governance, provide policy certainty and promote the endurance of the policy.
The Government's carbon price mechanism announced as part of the plan for a clean energy future has broad coverage of emissions (around 60% for the scheme and a further 6% when including the application of a carbon price through fuel tax arrangements). It provides a large proportion of scheme revenue to households to support the transition to carbon pricing, in fact more than any of the other schemes implemented or planned. It will also link internationally with other schemes in a predictable way in three years, and it will be buttressed by three independent institutions to support its operation.
The independent climate change authority will regularly review the scheme and recommend to government future scheme caps. The authority will also review the operations of the Renewable Energy Target and Carbon Farming Initiative on a 2 and 3 yearly basis respectively.
The Productivity Commission will review assistance to industry and other features of the scheme to ensure that support is both efficient and environmentally effective.
And an independent regulator will enforce and maintain the emissions trading apparatus.
With a credible emissions reduction scheme putting a price on carbon, the transition to renewable energy can take hold in a sustained way by improving the profitability of low emission power generation relative to high emission power generation.
Other policies can also support the transition to renewable energy, though one might ask the question why not just put a price on carbon, and leave it at that.
There are two set of reasons for complementary policies.
The first set of reasons goes to the well-known failures of markets to deliver optimal investment in new techniques and capital – investment in innovation.
While the arguments for support for innovation are well accepted and best delivered through a broad based technologically neutral mechanism, there is a strong case for further support for innovation when an intervention quickly and permanently alters relative prices and ultimately the structure of the economy.
This is case with the introduction of a carbon price through an emission trading scheme.
In the Government's Clean Energy Plan, support for innovation in low emission technologies and renewable energy is primarily delivered through the establishment of the $3.2 billion Australian Renewable Energy Agency (ARENA) and new independent $10 billion Clean Energy Finance Corporation.
The Government's support for renewable energy is aimed across the full development chain from R&D and commercialisation to deployment.
ARENA will independently administer $3.2 billion in existing Government support for R&D, demonstration and commercialisation of renewable energy technologies.
The $10 billion Clean Energy Finance Corporation will invest in businesses seeking funds to get innovative clean energy proposals and technologies off the ground. It will invest in the commercialisation and deployment of renewable energy, energy efficiency and low-pollution technologies.
The second set of reasons for introducing policies to complement a carbon price go to arguments for building among the community and businesses the credibility of Government policies and their intent in lowering emissions.
Policies such as the Renewable Energy Target are in this camp. These policies pull forward investment in low emission power generation and anchor business expectations around the Government's ongoing response to climate change.
The Renewable Energy Target (RET) is a legislated scheme designed to deliver on the Government's commitment that the equivalent of at least 20 per cent of Australia's electricity comes from renewable sources by 2020. The RET is expected to drive $20 billion of investment in large-scale renewable energy by 2020.
Policies such as the RET add to the credibility of climate change policy by demonstrating intent and of the suite of policies beyond putting a price on carbon, are among the next most efficient, a conclusion supported by the recent PC study.
Why then have I been so interested in discussing the credibility of the policies to lower emissions in a talk about the future of renewable energy in Australia?
It's because the long-lived investments that will be needed to lower emissions in Australia will only be made if there is an enduring suite of policies against which business can evaluate future profitability.
While credibility will flow from Governments' sustained commitment to these policies and the institutions that support their implementation and operation, it will also flow from the evidence that these policies deliver change. The RET is one example where we can examine the evidence and see the change.
For the carbon price, compelling evidence that it will transform the economy comes from Treasury modelling. These modelling exercises, undertaken over the past three years, represent some of most sophisticated and extensive modelling undertaken in policy development in Australia's history.
I will focus on what the Treasury modelling says about the electricity sector given our focus on renewable energy.
The Treasury modelling suggests that instead of emissions in the sector growing by 60 per cent by 2050 without carbon pricing, emissions decline by around 60 per cent with carbon pricing.
Emissions reductions are a result of slower growth in electricity demand but mostly because of substitution towards low emission technologies.
The modelling shows that the carbon price changes the composition of electricity generation in Australia driving significant change in the mix of technologies and fuels used.
The Treasury modelling (the core policy scenario) shows that over time, the electricity sector will move away from coal-fired generation toward renewable energy, with renewable energy growing from 10 to 40 per cent of the generation mix by 2050, and conventional coal-fired generation falling from 70 to below 10 per cent of the generation mix by 2050.
This represents around $100 billion in investment in the renewable energy sector over the period to 2050. Output from the renewable energy sector, excluding hydroelectric, grows by over 1700 per cent to 2050.
The pace of transition to a low carbon economy in this modelling reflects Australia's existing economic structure and the dominance of coal-fired electricity generation.
The modelling shows that as these assets reach the end of their economic life, emissions step down as capacity is replaced with lower emissions technologies.
This enables Australia to reduce a greater proportion of emissions domestically and reduce our reliance on imports of international permits.
As with all modelling exercises, assumptions are made about the future. However, the modelling results are generally robust to a range of assumptions.
The modelling also only includes known technologies. It is almost certain that new technology that we don't know about yet will also play a role in making our world cleaner. If this occurs, the costs of climate action could be significantly lower than currently modelled.
Under Treasury's core policy scenario the early increase in renewable energy is largely driven by increased wind generation. However, over time, other renewable energy sources become increasingly competitive.
By 2050, geothermal is a major source of renewable generation, accounting for between 13 per cent (ROAM) and 23 per cent (SKM MMA) of total generation in 2050 (average 18 per cent calculated from the aforementioned numbers) .
Of course, the exact mix of generation will depend heavily on a range of uncertain factors, including the cost of new technology and the price of energy commodities like gas.
I can bravely predict that the actual mix of technologies will be different to that predicted by Treasury.
One of the interesting lessons from the original MRET, is that trying to predict accurately the future technology mix is inherently difficult.
The best available modelling at the time projected the MRET target would be achieved largely through growth in the biomass (of which bagasse was the large majority, estimated atover 60% of total renewables) renewable energy industry, with very little wind generation by this point in time.
We now know that wind generation has been the dominant technology representing around half of the 2010 target under the RET, whereas biomass generation represents only around 15% (8% bagasse and 6% other biomass). This has been attributed to larger than anticipated cost reductions and technology improvements for wind, coupled with drought that restricted the output of hydro generation over that period.
That the modelling failed to predict the precise mix of technologies should not concern us.
What we can be certain of is that well designed policy that uses market mechanisms will achieve policy objectives at the lowest cost to the economy. All modelling supports this conclusion.
The future of renewable energy in Australia is clearly a positive one.
While we don't know what the exact mix of renewable energy technologies will be in the future, we do know that if Australia is part of an effective global response to climate change, renewable energy will be part of that future.
How efficiently Australia transforms to that future, how effectively we transform the economy while maximising the prosperity of all Australians, will depend on the effectiveness of policies.
A key feature of that effectiveness will be policy credibility, their known ability to lower emissions at least cost, and the quality of the institutions that surround the implementation of these policies.
Because the response to climate change requires a Government intervention to create property rights that don't currently exist to correct a market failure – the Government's role in this response is crucial.
Many reforms of the past have required the Government to resist the temptation to help out an industry or sector in the economy. Resisting or removing the Government intervention in these cases has improved the welfare of citizens.
The policy response to climate change will never be like that. It will always require a Government intervention to correct the market failure to improve prosperity. This only provides more impetus to get the intervention right.
And the future of renewable energy in Australia will directly depend on the quality of this intervention.
 The views expressed are those of the author and not necessarily those of the Australian Government. I would like to thank Julie Gilfelt and John Jende for discussions and input to this paper.