Saturday, February 20, 2016

Innovative idea would fix brown coal problem

Tony Abbott's decision to put short-term popularity ahead of the nation's longer-term economic interests by abolishing the carbon tax has left Malcolm Turnbull with more than a few problems. Just one is the likelihood that less-polluting power stations will close while more-polluting ones keep pumping out greenhouse gases.

At the Paris summit late last year, our government was shamed into promising to step up our reduction of carbon dioxide emissions, even though, without the carbon tax, we lack an economic instrument strong enough to bring the promised reduction about.

But we could make some progress if we could find an acceptable way of taking out of production the worst of Victoria's brown coal (lignite) power plants. The emissions per unit from these plants are about 50 per cent higher than for black coal plants.

The problem is explained in a paper by Associate Professor Frank Jotzo, of the Crawford School of Public Policy at the Australian National University, and Salim Mazouz, of EcoPerspectives.

Thanks to our less wasteful use of electricity and the growth in sources of renewable energy, we now have excess capacity to produce coal-fired power. Sooner or later, some power stations will have to close.

Trouble is, the absence of a price on carbon means there's no guarantee it will be the more-polluting brown-coal plants that bite the dust.

That's because brown coal-fired electricity is significantly cheaper to produce than black coal-fired power.

Why? Because the brown coal power stations are right next to the brown coal mines, thus minimising the cost of shipping the coal to the station.

And the brown coal itself is cheaper because there's nothing else to do with the stuff, whereas black coal could be exported to foreign power plants, which would pay well for it. (Black has a higher "opportunity cost".)

The lower cost of brown coal-fired power (lower "short-run marginal cost", in the jargon) means the brown coal stations do well in the continuous auction to sell power into the national electricity grid.

This means that, though the decline in demand for power from the grid has caused the level of production capacity use to fall for all types of power plants, the brown coal plants are still operating at about 70 per cent of capacity, compared with black coal plants at about 50 per cent.

That's more reason to fear that, if the question is left to be resolved by the market, the plants that close won't be the high emitters.

If we had a decent carbon tax – or emissions trading scheme, they're much the same thing – it would add more to the cost of brown power than it would to black power, so to speak, because its impost varies according the emissions-intensity of the product being taxed.

So, provided the tax was sufficiently high, it would push the firms in the market in the direction that was most desirable from the perspective of tackling climate change. Which, of course, is the reason you have a carbon tax.

But although various power stations aren't making adequate profits, there's little sign that any of them is close to throwing in the towel.

Why not? Because each of the potential quitters is telling themselves that, if they can only hang in there longer than a couple of the others, they'll get their cut of the departing firms' market share, meaning they'll then be in better shape.

Such a Mexican standoff is known to economists as a "collective action problem". The firms in a market have got themselves into a situation where they realise that something they're each doing is damaging to themselves and everyone else, but no particular firm is willing to be the first to stop doing the crazy thing because they fear their rivals would take advantage of them.

Many economists give you the impression competition is an unalloyed benefit. Collective action problems are an example of the downside of competition.

Which means they're an instance of "market failure" – circumstances where problems can't be solved simply by leaving it to the market. (Another instance of market failure is, of course, the damage to the climate caused by greenhouse gas emissions.)

The existence of market failure establishes the case for government intervention in the market – provided you can be confident the intervention will make things better rather than worse.

Intervention by the government is pretty much the only solution to collective action problems. The government comes in over the top and imposes a solution equally on all the firms in the market, which go away pleased they no longer feel obliged to do the crazy thing.

Here's the point: Jotzo – an environmental economist of international stature – and his colleague have proposed an ingenious, innovative, agile solution to the brown coal problem, one that would cost the government and the taxpayers nothing.

You invite the four brown coal power producers to enter an auction by nominating the minimum amount they'd need to receive to be willing to close down. You'd pick the winner or winners according to the ones that offered the cheapest cost per unit of emissions reduced.

You'd be hoping the winners were Hazelwood, owned by GDF Suez, the oldest and most emissions-intensive generator, and Yallourn, owned by Energy Australia, the second oldest and second most emissions-intensive generator.

But the government wouldn't just hand over a cheque. Rather, it would recover the cost by imposing a levy on all the remaining black and brown power plants – those that would benefit from the closures – in proportion to their emissions.

It's true the remaining power stations would want to pass that extra cost on to their customers. But because distribution costs (poles and wires) are so great, the (higher) wholesale price is only a small part of the retail price, meaning the effect on households is likely to be small.

Not a bad idea.