The Australian
By: Matthew Warren
Modelling the economic effects of an emissions trading regime is no simple matter
Predicting the effects of a policy reform as big and complex as a national emissions trading scheme is like trying to work out who the murderer is in an Agatha Christie mystery, except the crime hasn't been committed yet.
Climate Minister Penny Wong is now getting down to the grisly business of trying to frame a scheme that will cut emissions without igniting inflation, public outcry or an exodus of heavy industry.
Tense exchanges in recent meetings with major emitters reflect the high stakes and suggests the industry is not only worried about the potentially lethal nature of getting this wrong, but how many victims there may be.
One of the key underlying tensions is who and what to believe. Much of the detailed technical and commercial knowledge of Australia's energy markets rests inside the power companies that face annihilation if the Government gets this wrong.
These are the same companies and experts that are lobbying for compensation for multi-billion-dollar asset losses and coming up with warnings of unintended consequences that would completely undermine the scheme.
To inform its decision-making, Treasury has enlisted the aid of the three major computable general equilibrium (CGE) models available to assess the effects of different emissions cuts and prices on the national economy.
The CGE models from Monash, ABARE and Reserve Bank Board member Warwick McKibbin are vast banks of algorithms honed and refined over years to try to reflect how the economy would respond at a macro level to the introduction of different shocks.
These models are complex and have evolved to respond to energy price shocks from a price on greenhouse gases.
They assume predictable market conditions in which the demise of one power generator is seamlessly and swiftly replaced by a more expensive player with lower emissions.
Modelling is being done for Treasury on the impact of more modest emission cuts, and for Professor Garnaut, who is understood to be considering what the Australian economy must look like to reach his posited 90 per cent emissions cuts by 2050.
So great is the shock in this instance that the assumptions and inputs overwhelm the models, rendering them almost useless as predictive tools.
The modelling process is already delayed until August, reflecting the difficulty of the job at hand, in particular the impacts on Australia's substantial energy-intense trade-exposed sector.
About 1 million Australians are employed in industries that either make or use a lot of energy. Most of Australia's big energy users are either major exporters or compete directly with imports.
Submissions to the Garnaut climate change review revealed that most Australian industries supported the principle of exempting energy-intense, trade-exposed industries, provided it included them.
Staring into the commercial abyss of a runaway carbon price, the major generators have also been busy recruiting the national electricity market models owned by CRA International and Acil Tasman to interpret emissions trading at a more detailed level.
Draft results are grim, with even a modest 10 per cent cut in emissions by 2020 understood to drive a $45 a tonne carbon price, which would shut three out of the four brown coal power stations in Victoria's La Trobe Valley along with other power stations across the country, and spike wholesale electricity prices by nearly 100 per cent.
Even this modelling can't predict the unintended consequences arising from commercial decisions taken by generators such as Babcock & Brown Power, TruEnergy, AGL and International Power, faced with this multi-billion-dollar game of Russian roulette every time the emissions permit price rises.
These big power stations operate at about full capacity, or they don't operate at all. Once a power station's profitability is overrun by the cost of buying carbon permits, every day it generates it loses the owner money.
The estimated 80 per cent loss in asset value, coupled with growing operating losses, will put these businesses under serious pressure.
They, or their liquidators, have limited options. They can recover the remaining value of the loss-making power station by selling it off, or they can switch it off, suddenly cutting 25 per cent of the electricity supply in the state and easing pressure on their rivals by sending prices skyrocketing.
A sell-off will be a fraction of the value of the plant. The new owner will have much lower capital overheads to service, and will therefore turn the least profitable power station into the most profitable.
Rather than cut emissions, a rising carbon price could just transfer wealth from old power companies to new entrants able to run their secondhand brown coal power stations flat out, relatively immunised from a rising price on carbon.
These reinvigorated brown coal plants would discourage investment in new gas and renewable generators. It's a long way from the intended outcome.
The Chinese say you discover a fence needs mending when your sheep have run away. These outcomes will be tricky for any future government to round up should they get away.