Energy and Climate Policy in Australia: Out of Touch and Out of Time?
by Enrico Colombo
Just before the leadership spill two weeks ago, Australia’s former prime minister Malcolm Turnbull discarded the carbon emissions reduction target contained in the National Energy Guarantee (NEG). The proposed legislation was aimed at reforming the country’s electricity market and addressing the “energy trilemma” of ensuring emissions reduction, grid reliability and power price affordability. Now, the new prime minister Scott Morrison has declared the NEG “dead” and will move to completely dismantle it.
It has concerned many that such an important piece of legislation became stranded amid political quarrels. Climate change is one the most pressing global issues and poses enormous threats to humanity overall, and to Australia in particular, which has experienced droughts during the hottest winter on record.
In this article, we discuss the main issues facing the country’s energy market as well as Australia’s international commitments to the Paris Agreement. Leveraging analytical insights from our Carbon Risk Rating, we also look at the way forward for Australian utilities.
The Energy Trilemma Explained
Australia’s carbon footprint problem. Australia accounts for approximately 1% of global GHG emissions, but the country has one of the highest per-capita emission levels, as well as one of the world’s most carbon intensive power grids. Australia is highly dependent on fossil fuels: electricity generation accounts for over one-third of emissions and roughly 80% of electricity comes from fossil fuels, with coal being the dominant source. The use of renewables has been rising; they are expected to make up approximately 23% of national grid by 2020. Overall, however, Australia’s emissions continue to increase, hitting a record high in 2017.
The Affordability Problem. Energy prices across the country have soared in recent years. Inquiries by the Australian Competition and Consumer Commission (ACCC) – which we flagged through our Controversy Research – have found that energy bills increased by 44% in real terms between 2007 and 2017.
In a nutshell, the three main causes for the rising costs are:
- Increasing network costs (40% of the increase): Australia has one of the largest and longest geographically interconnected power systems in the world, spanning over 5,000 km through 40,000 km of transmission lines.  Considerable capital spending to reinforce the ageing infrastructure occurred in the last decade, and regulated network businesses were guaranteed returns on such investments.
- Wholesale generation (+17%): old coal power plants were closed and only partly replaced with gas-fired generation during a time of high gas prices. Incentive schemes for renewables further increased costs by 17%.
- Market oligopoly (+26%): the “big three” vertically integrated generators and retailers (AGL, Origin and EnergyAustralia) hold large shares of the retail market and control 60% of generation capacity. The ACCC noted that electricity retailers have at times used complex, confusing and misleading behaviour, and issued 56 recommendations to bring down prices. 
The Reliability Problem. Australia’s electricity grid routinely experiences peak demand issues, power outages and blackouts. Extreme weather events, old coal power plants not operating at full capacity or being phased out, and increasing renewables entering the grid are all contributing to the volatility.
Committed to the Paris Agreement?
The new government has affirmed that its priority is not to cut emissions but to bring power prices down, and in doing so is also pressing utilities by threatening to impose price caps and launch further inquiries. Following recent reports of ongoing pressure from some of the more conservative and climate-skeptical politicians to exit the Paris Agreement, a withdrawal has now been ruled out and the government is unlikely to introduce any meaningful initiatives to start reducing emissions.   This is despite, according to Climate Action Tracker, Australia’s policies being insufficient and the country not being on track to meet the 2030 commitments.
In a June 2018 poll by the Lowy Institute, 59% of Australians said global warming is a serious threat which should be addressed, and 84% supported investments in more renewables. With federal elections due in the next 12 months, can a government afford to go against voters who have expressed such unequivocal concerns about environmental challenges?
Investors and businesses have also shown support for climate policies. For example, the Investor Group on Climate Change, representing more than USD 2 trillion in assets under management, has consistently called for greater action and policy certainty, which are necessary for more investments in the energy sector. Furthermore, the appointment of Scott Morrison as the new PM and of Angus Taylor as minister of energy, both supporters of fossil fuels, has prompted calls for investors to think more seriously about sovereign bond exclusions over climate change.
Carbon Risk for Australian Utilities
Utilities seem to have recognized their high exposure to carbon risks and the need to adapt to a carbon-constrained world. They have formulated strategies to address their material carbon risks and have set ambitious targets for reducing emissions from their operations.
The graph below shows our Carbon Risk Rating assessment for the two major Australian utility companies, Origin Energy and AGL Energy.
Carbon Risk Rating - AGL vs. Origin Energy
The Unmanaged Risk score is Sustainalytics’ assessment of the part of carbon-related risks that a company is not currently managing. It is the result of subtracting the Managed Risk (the risks we assess as being addressed by a company’s policies, targets and strategies, current performance) from the Exposure score (quantitative measure of the total carbon-related risks a company faces).
Notably, the scores in our model have not changed following the latest political developments, given that both companies already had more ambitious climate strategies than the proposed NEG.
AGL is Australia’s largest emitter. Its electricity output in 2017 consisted of 86% coal, 6% gas and 8% renewables. Meanwhile, its actual nameplate generation capacity (not yet fully operational) was 18% renewables, and AGL is Australia’s largest non-government operator of renewable energy generation. The company withstood enormous pressure from the government to revise closure plans for its coal-fired Liddell power station, and AGL has committed to gradually phase out coal generation by 2050 while investing in new renewable and near-zero emission technologies.
Origin is Australia’s fourth-largest GHG emitter, with coal and gas accounting for 68% and 31% respectively of its generation portfolio. Origin was the first Australian company to commit in December 2017 to a science-based GHG emissions reduction target of 50% by 2032. The company expects renewables to account for 25% of its generation mix by 2020, although in 2017 renewable sources were virtually absent in its energy portfolio. Furthermore, Origin faces higher exposure to fugitive methane emissions risks from its unconventional coal seam gas operations.
In our view, regulation can bring certainty to policy frameworks which can stimulate investments, particularly in the energy sector. The government’s short-term focus on immediate power price reductions, coupled with political uncertainty and opposition to climate action are likely to delay much needed investments for the low-carbon transition. Unfortunately, such delays come after decades of scarce and ambiguous climate policies, and at a time when we can no longer afford discussions but rather need concrete actions. As one commentator summarized it, climate change “is real, it is happening, it is getting worse and we need to act.”
Our analysis aims to remove the “noise” and focus on the key drivers of exposure and management of carbon-related risk. In this sense, our model reveals that the lack of such legislation does not materially change the carbon risk exposure of major utilities. Therefore, we suggest that investment decisions or portfolio allocation of a climate-focused investor should not be significantly affected by the absence of a long-term vision and policy to guide Australia into a low-carbon future.
Increasing global investments, growth in scaled production and technology improvements continue to reduce the cost of renewable energy and storage technologies. The world is already moving towards more renewables and energy storage, and Australia is indeed the country with the highest solar rooftop penetration in the world and it is leading in terms of battery storage. A growing number of people are choosing to go off the grid, marking what may well be an exodus from utilities. 
We expect utilities to continue to shift their energy mix towards less coal and more renewables, driven by simple economic cost-curves and long-term survival. A report co-authored by researchers from the Australian National University flagged the dwindling commercial prospects for coal against the backdrop of falling costs in renewables and storage. In fact, recent data from the Australian Renewable Energy Agency and RenewEconomy.com.au showed that solar is already the cheapest form of electricity generation in Australia.
The government seems to be missing the reality that cutting power prices and curbing emissions can go hand in hand. For investors, questions remain about whether utilities will adapt fast enough, the cost of adaptation, and whether the government will eventually be part of the solution.
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