Productivity, Affordability and the Energy Transition: A PC scorecard

The perennial policy question of how to transition quickly and affordably is never far from a headline. Recent analysis from the Productivity Commission (PC) suggests it is “not as bad as it appears” when it comes to balancing these twin goals but also suggests some ways to achieve least-cost investment in the energy system.

In line with the AEC’s Energy2050 vision, these suggestions revolve around capitalising on market-based policy and jurisdictions working together through the National Electricity Market (NEM). Let’s take a closer look.  

Energy Productivity Decline Not Unexpected

The PC’s recently released Quarterly Productivity Bulletin reported labour productivity is going from bad to worse.  The Bulletin also included a feature article on productivity in the electricity industry, given its central role in supporting a productive economy. It has pointed to some critical factors that could improve sector productivity. The report highlights that there has been significant investment to replace coal assets reaching end of life, which is necessary.  However, it notes there has been measured productivity decline, as there is a lag between the building of energy assets and when they are up and running at full capacity, while some of the benefits that come from that investment, such as system quality improvements, grid reliability and lower carbon emissions are not captured in conventional measures of productivity.  The Bulletin highlights that despite a 126 per cent increase in capital stock in the energy sector since 2001-2002 to date output has only increased 14 per cent in the same period, but that the outcome should not come as a surprise and the long-term investments being made can be expected to deliver over time.

The Bulletin notes that the decline in electricity sector productivity is not unexpected as the system is transformed.  One key driver is the timing of the investment required relative to the assets being fully utilised:

“In the electricity sector, the decline in measured productivity is happening because investment in the sector tends to be lumpy, large and take many years to complete. Significant investment is being made now, which will provide energy services for years into the future. But new assets – new generators and an upgraded transmission and distribution network – are not yet fully utilised. Partly, this is because they are still under construction, and partly because they need to be built before existing facilities can be retired or closed. The upshot is that a decline in productivity, as traditionally measured, is not unexpected.”

The other is the shift from a thermal dominated system to a renewable based system has different capital intensity:

“A system based on renewable energy is fundamentally different from one based on coal. Renewable energy is even more capital intensive than the assets being replaced, but with subsequent output requiring zero fuel costs and lower labour input. On the other hand, output from VRE sources fluctuates with weather conditions, and those fluctuations tend to be correlated geographically. This means VRE sources have lower capacity factors (actual generation relative to their maximum possible generation). For example, in CSIRO’s latest GenCost modelling, it is assumed that large-scale solar PV has a capacity factor of 19% under its low-cost scenario, whereas new black coal is assumed to have a capacity factor of 89%…. In contrast with traditional generation technologies, VRE sources also tend to be more spread out geographically.”

Disciplined Policy Focus

The Bulletin points to more that governments can do to ensure the most productive transition which amplifies some of the findings and recommendations of its earlier report – Investing in cheaper, cleaner energy and the net zero transformation. The Bulletin flags that unless governments drive least-cost investments and have coordinated policy settings, productivity will be unnecessarily depressed with costs higher than they need to be.

In particular, the PC argues a disciplined policy focus will help see investment flow to the least-cost energy systems and most efficient way to bring down emissions. The overarching message is that Australia “needs an integrated suite of policies, working in concert, to improve productivity in the electricity sector and minimise costs to consumers”.

Overall, it argues there should be a move to more market-based signals for supply and for assets to providing firming and reliability services.

Market-based solutions are key to achieving a least-cost transition  

The Australian Energy Council’s Energy2050 report spelled out a clear vision for how investment in the electricity grid should occur: “It is crucial that a credible, NEM-wide, market-facing policy is implemented to support the required rate of investment in new generation and storage and to deliver the mix of technologies that will support reliability, security and emissions targets”.

This aspect of “NEM-wide” policy is particularly important in the current political context where state jurisdictional policies have proliferated. While these policies might have political capital, their efficiency is suboptimal compared to states working together under a harmonised framework. The PC’s analysis backs this up.

The PC says that procurement based on state-level renewables targets “are also likely to raise costs and should be phased out”. This is because different jurisdictions have different degrees of comparative advantage in renewables and policy settings should ensure investment flows to the most cost-effective locations.

In a similar vein, state governments should avoid picking winners where possible. The PC says a shift to technology-neutral renewable incentives could reduce the costs of meeting current state renewable targets in the National Electricity Market by an estimated 4 per cent from now until 2040. The reduction is because targets for specific technologies can push costs up.

Linking technology-neutral renewable energy incentives with federal rather than state-based targets “could achieve rates of renewable penetration consistent with current state targets at 8% less total cost over the period 2026 to 2040.

These findings are particularly instructive in light of reports on Tuesday that the Commonwealth Government is seeking expanded energy market monitoring powers to better manage electricity bill impacts. While it might seem hopeful, these new powers if implemented should consider the PC’s insights about how to lower electricity bill costs.

Other measures to boost productivity include:

·         Market and regulatory arrangements should optimise grid investment and usage, including encouraging non-network solutions, such as shifting demand.

·         Ensuring timely investment. The PC notes development of energy infrastructure is taking too long and estimates that a one-year acceleration for developing new wind farms and key transmission could cut power bills by 7 per cent over a decade. The bulletin notes that recent Federal changes to the Environment Protection and Biodiversity Conservation Act 1999, including national standards, facilitating regional planning are essential to speeding up approvals. But it also argues more administrative changes could build on this and see regulatory and facilitation resources focused on projects that are most important to the transition. Other steps suggested are:

o   Form an adequately resourced “strike team” to assess priority clean energy projects.

o   An independent Australian Government Coordinator-General should be appointed with strategic oversight to work across governments and with industry to keep approvals moving and to break through roadblocks.

To find an efficient emissions reductions approach governments should calibrate policy settings to broadly align all emission reduction policy costs with national target-consistent carbon values[i].

The following table highlights the current policy position and compares it to what the PC recommends.

The PC’s work reinforces the central findings of the AEC’s Energy 2050 report, specifically:

• A least-cost system transition should be the overarching objective
• Market-based investment signals are critical to efficient outcomes
• Technology neutrality avoids unnecessary cost escalation
• System integration (generation, networks, firming, demand) is essential
• Faster delivery of infrastructure is key to lowering consumer costs.

Energy2050 and the PC analysis highlight the energy transition is not just about building more capacity it is also important to ensure we are building the right system, at the right cost, at the right time.