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Inefficient though fairly effective carbon pricing

IT is now widely understood (i) that current carbon pricing has fairly marginal impacts on electricity prices and that (ii) current electricity prices are high because of excessive investment in network costs which stems from the way electricity prices are regulated: Ross Gittins provides a simple explanation of this second issue.  Australian  electricity prices are very high and this electricity is largely generated in coal-fired power stations.  Thus the inefficiency in transmission creates the high prices which reduces the quantity demanded of electricity. Indeed this quantity – along with associated carbon emissions – have fallen over recent years.  Are we getting an effective carbon price as a consequence of the distribution network inefficiency?  Not really since there is real inefficiency here because there is a waste of resources, particularly capital, in the electricity sector. In terms of resource allocation it would be preferable to provide households and firms with much cheaper electricity and then to tax the carbon emissions severely enough so that demand was significantly curtailed.  In addition, high electricity costs in themselves do not provide the correct market signal to switch away from coal to less polluting sources of electricity such as gas although this switch has been occurring since 2008 well before carbon pricing came in operation.  They do however provide incentives to switch towards solar energy by households and firms trying to insulate themselves from higher electricity prices.  The interesting feature of the latter switch is that it increases the excess capacity of the electricity sector and makes more electricity price increases likely. This virtuous “downward spiral” accentuates the decline in demand for carbon-based electricity supplies and does have positive although imperfect effects in addressing climate change.

For these reasons I strongly favour retaining incentives for solar and wind energy because of the effects this will have on the conventional power sector.  On the other hand, as Ross Garnaut has pointed out to us, the effects of growing excess capacity in the electricity sector are likely to undermine the effects of the Emissions Reduction Scheme subsidies proposed by the Coalition Government.  Power stations with excess capacity are likely to draw on carbon reduction subsidies by closing down plants with uneconomic excess capacity and then by operating remaining plants at closer to full capacity. This might mean that the carbon reduction subsidies might have very limited effect in reducing emissions – they will simply provide subsidies to the uneconomic (and often privately foreign-owned)  power firms.

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