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Focus: The Warburton Report

8 September 2014

In brief: The Expert Panel appointed by the Federal Government to review the Renewable Energy Target scheme has recommended changes to it that would severely curtail its operation. Partner Grant Anderson reports.

 
 

How does it affect you?

  • The Expert Panel has recommended either closing the large-scale renewable energy target scheme to new entrants or significantly restricting the annual targets under the scheme on the basis that the scheme is both an expensive emissions abatement tool and provides an economically inefficient subsidy which prejudices fossil fuel-fired electricity generation.
  • If adopted, these recommendations are likely to significantly reduce the price of large-scale generation certificates and therefore undermine the viability of existing renewable energy generation projects that are exposed to the certificate price.
  • Financiers of renewable energy generation projects may have the right to resize debt or otherwise renegotiate existing financing arrangements through 'review event' mechanisms, and are likely to be more conservative in the amount, pricing and conditions of the debt that they are willing to provide for new projects.
  • Both the Government's likely response to the Warburton Report, and the amenability of the Senate to any changes that the Government might propose to the large-scale renewable energy target scheme, are uncertain.
  • In the absence of clear bipartisan support for the renewable energy target scheme, continued uncertainty about the future of the scheme is likely to chill future substantial investment in renewable energy for some time.

Background

The Renewable Energy Target scheme (RET) is designed to encourage investment in renewable energy technologies, thereby reducing greenhouse gas emissions from the electricity sector. It does this by providing for the creation of renewable energy certificates (RECs) in respect of electricity that is generated from eligible renewable energy sources such as wind, solar, hydro, wave and geothermal. The RECs, once registered, can be traded and sold. In order to create a market for RECs (to enable renewable energy generators to earn revenue by selling them), electricity retailers and other wholesale purchasers of electricity are required to surrender a certain number of RECs for each calendar year as their contribution to meeting that year's renewable energy target (this contribution is proportional to their share of the national wholesale electricity market). A failure to surrender the requisite number of RECs attracts a $65/MWh shortfall charge. The RET is to expire in 2030 and has a target of achieving 45,000GWh of renewable electricity generation by 2020. The RET is divided into two components:

  • the 'large-scale renewable energy target' (LRET), which is intended to support large-scale renewable energy generation – the LRET is capped at 41,000GWh from 2020 and the price for RECs under the LRET is determined by market forces (but effectively capped by reference to the shortfall charge); and
  • the small-scale renewable energy scheme (SRES), which is intended to support small renewable generation units (such as rooftop solar PV and solar water heaters) – the amount of renewable energy generation that is supported by the SRES is uncapped but the price payable for RECs under the SRES is capped at $40 plus GST (by virtue of the application of a multiplier, more than one REC can actually be created for each MWh that is generated by a small generation unit).

Wholesale electricity purchasers are required to surrender both RECs created under the LRET (large-scale generation certificates or LGCs) and RECs created under the SRES (small-scale technology certificates or STCs).

On 17 April 2014, a panel chaired by Mr Dick Warburton AO LVO was established by the Federal Government to examine the operation and costs and benefits of the RET. In its report (the Warburton Report) the panel has recommended changes to the RET that, if accepted, will severely curtail its operation.

Assessment of the RET

The Warburton Report finds that the RET has encouraged significant new renewable electricity generation; large-scale renewable generation capacity has increased by around 5,100MW since the RET was established in 2001 (with 3,800MW being attributable to wind generation). As a result, large-scale renewable energy generation in 2013 accounted for approximately 11 per cent of electricity generation.1 This leads the report to conclude that 'the renewables industry [is] now established in Australia'.2

The issue for the report, then, is whether the continued existence of the RET can be justified on grounds other than the original need to facilitate the establishment of an Australian renewables industry. According to the Warburton Report, the remaining rationale for the RET 'hinges on its capacity to contribute towards the Government's emissions reduction target in a cost effective manner'.3 To date the RET has been responsible for the abatement of around 20MtCO2-e of greenhouse gas emissions in total (Australia's electricity sector emissions over this period were around 2,500MtCO2-e).4 Conversely, if left in place, the RET is forecast to abate an average of 20MtCO2-e per year from 2015 to 2030 (compared to electricity sector emissions of around 195MtCO2-epa),5 ie just under 10 per cent of annual electricity sector emissions. This is not an insignificant amount, particularly given that electricity generation accounts for just over one-third of Australia's greenhouse gas emissions and that Australia needs to reduce its accumulative emissions by 421MtCO2-e by 2020 to realise the Government's commitment of emissions in 2020 being 5 per cent less than Australia's emissions in 2000.6 However, according to the Warburton Report, the RET is not a cost effective emissions abatement tool; the cost of this future emissions abatement is estimated as between $32 to $62/tCO2-e and 'there are many measures offering abatement at lower cost compared with the RET, such as energy efficiency improvements and pasture and grassland management measures.'7

The perceived vice of the RET is therefore that it promotes renewable energy generation as an emissions abatement mechanism ahead of other lower cost abatement opportunities in other areas of the economy.8

The difficulty with this approach is that it ignores the reason for the introduction of the RET in the first place. In the absence of an effective carbon price, which internalises the cost of emissions caused by fossil fuel-fired electricity generation, renewable energy generation is not able to compete on a level playing field with fossil fuel-fired electricity generation and so requires some other form of support. The Warburton Report points to the Government's Emissions Reduction Fund as the primary mechanism for meeting Australia's 2020 emissions reduction target, and it is the case that there would be little reason for the RET if there were an effective carbon price in place (See our Focus: Expanded renewable energy target scheme). Indeed, it was previously considered that, by 2030 when the RET is due to terminate, renewable energy generation would not need to be subsidised by the RET because by that time there was expected to be a sufficiently high carbon price to drive renewable energy generation (See our Client Update: COAG agrees changes to Renewable Energy Target scheme and Focus: Expanded renewable energy target scheme legislation passed). However, a potentially hostile Senate means that there is no certainty that the Government's proposed Emissions Reduction Fund will come to fruition. Moreover, the absence of an overall cap on emissions means that there is no guarantee that emissions reductions purchased by the Fund will not be cancelled out by emissions increases elsewhere in the economy. In these circumstances, the use of renewable energy generation can play an important role in restraining emissions from the electricity generation sector, which are a significant contributor to Australia's greenhouse gas emissions.9

For so long as there is no effective carbon price, renewable energy generation cannot compete with fossil fuel electricity generation and, until that time and contrary to the Warburton Report, it will not be possible to establish a sustainable renewables industry in Australia.10

The Warburton Report particularly focuses on the subsidy represented by the RET, and its case for major reform to the RET rests squarely on the perceived need to 'avoid, or materially reduce, the cost' of this subsidy.11 The report estimates the amount of this subsidy to date to have been $5.2 billion, being the value of the LGCs have so far been created. 12 While the report refers to this subsidy as being one from the 'community' to renewable energy generators, at least most of the immediate cost of the subsidy appears to be borne by the incumbent fossil fuel electricity generators (in this regard the RET has not been, and is not predicted to be, a very significant component of either residential or commercial/industrial retail electricity prices).13 The report criticises this subsidy on the basis that it has underwritten the displacement of fossil fuel generation by higher cost renewable energy generation, and has resulted in a consequent transfer of wealth from fossil fuel generators to renewable energy generators (through lower wholesale electricity prices and displaced fossil fuel electricity generation). Yet this is precisely what the RET was designed to do. The real issue seems to be that, in the current environment where electricity demand is declining,14 the existence of this subsidy is more clearly visible, with renewable energy generation capacity supplanting fossil fuel generation in the merit order and incumbent fossil fuel generators (primarily black coal) being mothballed or curtailed and delayed in their return to service. Conversely, the abolition of the RET would result in additional fossil fuel-fired electricity generation at the expense of renewable energy generation.15

Warburton Report proposals for RET reform

Given the rationale advanced by the Warburton Report for the reform of the RET, it is not surprising that the report does not support either extending the timeframe for the RET to achieve the current target of 41,000GWh of renewable energy or reducing the 2020 target to a 'true' 20 per cent of electricity generation.16 Instead the report proposes two options under which the LRET would continue to 2030 but would be substantially curtailed.

The first option is the 'grandfathering' option under which the LRET is closed to new entrants, so that the only participants in the LRET would be existing and committed renewable energy power stations. A power station is considered to be 'committed' for this purpose if it is under construction or is fully financially and contractually committed (ie has been the subject of a final investment decision and has engineering and procurement contracts in place). Given that most (if not all) proposed renewable energy projects were put on hold some time ago in light of the uncertain future of the RET, there may well be no 'committed' projects. This option would be implemented by setting annual targets under the LRET that correspond to the generation of these power stations.17 Under this option the proportion of renewable energy generation would settle at around 16 per cent, which is below a 'true' 20 per cent target.18

The second option is the 'additional demand' option, under which the annual LRET target for a year is set in the previous year and is equal to the previous year's target plus 50 per cent of the expected growth in electricity demand in the relevant year.19 The report is not in favour of fixed targets (based on longer term electricity demand forecasts) partly because this exposes incumbent fossil fuel electricity generators to the risk of electricity demand being lower than forecast, with the result that the additional renewable energy generation will reduce wholesale electricity prices and displace existing fossil fuel electricity generation.20 However, a problem with such 'floating' targets is that the resultant uncertainty about the level of those targets may make it more difficult for renewable energy generators to raise debt finance and to enter into the long term LGC offtake agreements that underwrite many existing renewable energy generation investments. In any event, the relatively subdued electricity demand outlook may mean that there is only a minimal increase in the annual LRET targets under this option.

Both of these options contemplate reduced annual LRET targets, which is likely to result in significant downward pressure on LGC prices and some LGC price volatility, especially given the current LGC surplus and the fact that reduced LGC supply will result in a less liquid LGC market.21 In recognition of this, the Warburton Report suggests that the Government should explore price stabilisation options such as increasing the short term annual LRET targets to absorb the excess LGCs, fixing the LGC price or setting a price floor (and cap) for LGCs.22 None of these suggestions is entirely satisfactory and such interference in the market may well result in quite perverse incentives and outcomes.

Both of these options will also result in increased retail and wholesale electricity prices towards the end of the decade, as well as higher greenhouse gas emissions due to the increase in fossil fuel electricity generation.23

EITE exemption

The original renewable energy target for 2010 was 9,500GWh. When the target was increased to 45,000GWh for 2020, emissions-intensive trade-exposed (EITE) electricity customers were granted a partial exemption for that part of the RET liability referable to their electricity load as was above that which would have applied had the target remained at 9,500GWh. This was a recognition of the fact that exposing EITE activities to electricity prices that incorporated the full RET liability would prejudice their international competitiveness. For highly emissions-intensive activities the exemption is for 90 per cent of this additional liability (or around 75 per cent of the total liability), and for moderately emissions-intensive activities the exemption is for 60 per cent of this additional liability (or around 50 per cent of the total liability). The exemption is delivered to each EITE electricity customer by issuing the customer with an annual partial exemption certificate (PEC), which records the volume of electricity for which the customer is entitled to an exemption. Electricity retailers are able to surrender PECs to reduce the number of RECs that are necessary to cover their RET liability, and so EITE electricity customers will typically provide their PEC to their electricity retailer in exchange for a lower electricity price.

Despite a number of submissions advocating for at least highly emissions-intensive EITE activities to have a complete exemption from RET liability, the Warburton Report has recommended against any changes to the partial exemption arrangements. This is because it considers the resultant cost savings to EITE electricity customers to be relatively small and because these exemption arrangements do not reduce the volume of liable electricity under the LRET, so that an expansion of the exemption arrangements would simply increase the cost of the RET that is borne by other electricity consumers.24 An alternative would be to exclude the load of EITE electricity customers from the calculation of the LRET, in which case the exemption of that load from LRET liability would not impose additional costs on other electricity consumers.25 This alternative would also move the LRET target closer to 20 per cent of expected 2020 electricity generation.

Implications of the Warburton Report recommendations

As explained above, the LRET is to some degree a victim of both its own success and prevailing circumstances. From the outset, the LRET was conceived as a scheme to subsidise renewable energy generation. In part this was (and remains) necessary because renewable energy generation cannot compete with fossil fuel electricity generation in the absence of an effective carbon price. As such, an intended objective of the scheme was to re-engineer the mix of electricity generation in Australia to include 20 per cent of renewable energy by 2020. Where electricity demand is falling, as is currently the case, this inevitably means that new renewable energy generation will displace existing fossil fuel electricity generation (whereas, in times of increasing electricity demand, the impact on fossil fuel electricity generation would be less obvious as new renewable energy generation would simply take up a greater proportion of this increased demand).

Most large-scale renewable energy projects that are project-financed have power purchase agreements in place under which they have long-term offtake arrangements for both their electricity and LGCs, typically at a bundled price. These projects might therefore not be affected by any change to the LRET, unless that bundled price is subject to renegotiation for a change in law and any change to the LRET comes within the contractual 'change in law' definition under their power purchase agreements. However, a change to the LRET may well trigger a review event under their financing arrangements, in which case the financiers might have the right to 'resize' the project debt by way of a mandatory prepayment of debt, most typically by way of a sweep of additional cash from the project in priority to equity. Obviously, renewable energy projects that rely on LGC revenue or have, in the past, been forecast to rely on such revenue following expiry of their power purchase agreements will be adversely affected by any changes to the LRET that significantly reduce the LGC price.

Apart from this, the main impact of any changes to the LRET is likely to be felt by new renewable energy projects. Uncertainty as to targets and volatile LGC prices will mean that new projects may find it more difficult to secure long-term offtake arrangements for their power and LGCs, and that financers may be more conservative in the amount, pricing and conditions of the debt that they are willing to provide for new projects. This in turn will require equity to provide more funding or to look for alternative capital providers to bridge funding gaps.

Other recommendations of the Warburton Report

The Warburton Report has recommended reforming the exemption from self-generation under the LRET by:

  • relaxing the 'dedicated line' requirement,26 but only so as to permit the supply of incidental amounts of electricity for community services (such as hospitals, water/sewerage, fire, emergency, police and community radio/telecommunications services) and to not-for-profit organisations;27 and
  • extending the 'one kilometre limit' requirement28 to cover the immediate footprint of the self-generation project.29

In addition, the report has recommended that projects which are supported by the LRET should not be eligible to participate in the Emissions Reduction Fund,30 and should not be able to obtain funding from either the Clean Energy Finance Corporation or the Australian Renewable Energy Agency31 (a number of projects which generate LGCs are, in fact, currently funded by these two bodies).

Finally, the Warburton Report recommends either the immediate abolition of the SRES or its accelerated phase-out by 2020 (with the threshold capacity for eligible rooftop solar PV systems being reduced from 100kW to 10kW).32 This is on the basis that the SRES has already over-achieved its share of the RET target, that the SRES entails a very high abatement cost ($100-200/tCO2-e), and that the rooftop solar PV industry is commercially viable without the SRES subsidy.33

Next steps

The Warburton Report has, not unexpectedly, been the subject of a serious backlash from the renewable energy industry. Indeed, even within the Government, the report has been met with divided views and so there is no guarantee that its recommendations will be adopted or that the Government will not propose more or less radical changes to the LRET. However, even the Government's response to the report will not be determinative as it will still need to negotiate any proposed changes to the RET with a Senate in which Labor, the Australian Greens and at least three cross-benchers are opposed to any significant changes. While this may ultimately mean that the RET survives relatively intact, a continuing absence of bipartisan support for the RET is simply likely to prolong the uncertainty which has dogged the industry to date, with the result that there may be no further substantial investment in renewable energy for some time.
If you would like any further information on the RET, please contact any of the people below.

Footnotes
  1. Warburton Report, pp.7-8.
  2. Warburton Report, p.i.
  3. Warburton Report, p.i.
  4. Warburton Report, p.11.
  5. Warburton Report, pp.40-41. The reason for the higher abatement from 2015, compared to the previous period, is the higher annual LRET targets that apply from 2010.
  6. Warburton Report, p.43.
  7. Warburton Report, p.42.
  8. Warburton Report, pp.26, 44.
  9. Electricity sector emissions are forecast to increase steadily from 2020 to 2030: Warburton Report, p.41.
  10. An LCC price of $40-$50 is required to support wind generation in the absence of a carbon price.
  11. Warburton Report, p.44.
  12. Warburton Report, p.9.
  13. Warburton Report, p.18, 36, 37. Indeed, repealing the RET is expected to lead to a small increase in retail electricity prices.
  14. Electricity demand has declined on average around 1.7 per cent per annum from 2009/10 to 2013/14 and, while it is forecast to increase with LNG projects in Queensland coming on steam, 2023/24 electricity demand is expected to remain below 2009/10 levels: Warburton Report , p.15.
  15. Warburton Report, pp.17, 18, 29-31, 58.
  16. Warburton Report, p.51. The existing 41,000GWh target for the LRET corresponds to 26 per cent of the electricity generation that is forecast for 2020, which the Warburton Report asserts would require an additional 9,000MW of new large-scale renewable generation capacity (or 26,000GWh), an amount that is technically achievable: Warburton Report, pp.29, 32-33, 43. The achievement of a 'true' 20 per cent target would require a further 3,200MW of large-scale renewable energy generation.
  17. Warburton Report, pp.61, 64.
  18. Warburton Report, pp.58, 63.
  19. Warburton Report, pp.53, 56, 64.
  20. Warburton Report, p.50.
  21. Banking institutions reportedly hold around 20 per cent of the LGCs currently on issue, which is the same amount that Origin reportedly holds: The Australian, 'Banks exposed to big RET risks', 14 July 2014.
  22. Warburton Report p.112.
  23. Warburton Report, pp.54, 55, 62.
  24. Warburton Report, pp.80, 82.
  25. Warburton Report, p.v.
  26. Renewable Energy (Electricity) Act 2000 (Cth), s.31(2)(b)(ii).
  27. Warburton Report, pp.84, 114.
  28. Renewable Energy (Electricity) Act, s.31(2)(b)(i).
  29. Warburton Report, pp.84, 113.
  30. Under current proposals it is not at all clear that large-scale renewable energy generation would qualify for participation in the Fund in any event.
  31. Warburton Report, pp.92-93, 103.
  32. Warburton Report, pp.76-78, 113.
  33. Warburton Report, p 76.

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