Will the National Energy Guarantee hit pause on renewables?

The federal government’s new National Energy Guarantee (NEG) proposal looks likely to put the brakes on renewable energy investment in Australia. And based on the sparse detail so far available, there are serious questions about whether the plan really can deliver on its aims of reliability, emissions reductions and lower prices.

The broad mechanism design could be made to work, but to be effective in driving the transition of the energy sector it would need adequate ambition on carbon emissions and very careful thought about the reliability requirements of the future electricity grid.

Read more: Infographic: the National Energy Guarantee at a glance

The policy may well be used to force investment into the fossil fuel power fleet through regulatory intervention, and perhaps for the power sector to buy emissions offsets. This would risk locking in a carbon-intensive power system.

The NEG: top or flop?

Having rejected several options – including an emissions intensity scheme, the Clean Energy Target put forward by the Finkel Review, and any continuation of the Renewable Energy Target – the government has finally managed to get a policy proposal through the party room, formulated in advice by its newly established Energy Security Board.

Analysts’ initial reactions have ranged from unbridled enthusiasm to derisive rejection. It depends on political judgments, expectations about how the scheme might operate in practice, and how high one’s expectations are for efficiency and environmental effectiveness.

The politics of this are complicated, but there are hopes that the Labor opposition will agree to the scheme in principle. But the decision is ultimately with the Australian states, which would need to pass legislation to implement it.

Reliability guarantee: supporting fossil fuels?

The first element of the NEG is the “reliability guarantee”. This would require electricity retailers to buy some share of their electricity from “dispatchable” sources that can be readily switched on. The NEG list includes coal and gas, as well as hydro and energy storage – essentially, anything except wind and solar.

The NEG proposal might be informed by a political imperative to support coal. As John Quiggin has pointed out, defining coal-fired plants as dispatchable is questionable at best: they have long ramp-up times and are sometimes unavailable.

The Australian Energy Market Operator (AEMO) would prescribe the share of the “dispatchable” power sources and perhaps also the mix of technologies in retailers’ portfolios, separately in each state. This would be a remarkably interventionist approach.

Demand from retailers for the power sources they are told to use could trigger investment in new gas generators, refurbishment of existing coal plants, and some investment in energy storage. It is difficult to see how it would force the building of new coal plants, given their very large upfront cost and long-term emissions liabilities.

Would electricity prices be lower, as the Energy Security Board’s advice claims? Investment in new power generation will tend to reduce prices, cutting into profit margins. But the resulting investments will come at higher economic cost than market solutions, because they are determined by regulators’ orders made with a view to the short-term energy mix, not long-term cost-effectiveness. And there would be risk premiums on project finance, reflecting uncertainty about future policy settings.

Emissions guarantee: flexible but weak?

The NEG’s second pillar is the “emissions guarantee”. This would require retailers to keep their portfolio below some level of emissions intensity (carbon dioxide per unit of electricity).

This increases the demand for electricity from lower-emissions technologies, allowing them to command higher market prices and therefore encouraging investment in them. This price signal would benefit renewables and also favour gas over coal, as well as discriminating against the most polluting coal plants.

The Energy Security Board’s advice suggests that retailers would have flexibility in complying with that obligation, by buying and selling emissions components of their contracts, and potentially also using emissions offsets from outside the scheme to make up for any exceeding of emissions limits.

The reliability and emissions elements of the NEG interact with each other, and the net effect depends on the detailed implementation as well as the relative importance of the two components.

Given the politics within government, the weight could be on support for coal and gas generation. The reliability guarantee could therefore end up putting a tight lid on the amount of new wind and solar that can enter the system.

Renewables, gas or credits?

The Energy Security Board makes explicit reference to Australia’s Paris target of a 26-28% reduction in emissions, relative to 2005 levels, by 2030. Prime Minister Malcolm Turnbull has said the NEG will be expected to cut electricity emissions by a similar percentage, as a “pro rata” contribution to this goal.

But to meet the economy-wide target, the electricity sector would need to make deeper cuts, because emissions reductions are cheaper and easier here than elsewhere.

The Energy Security Board says it expects renewables to reach 28-36% by 2030. This is rather low, considering that the Finkel Review projected 42% under its proposed clean energy target, and 35% under business as usual. Other analyses have shown that much higher levels of renewables are achievable.

So if the NEG is not geared to support renewables, how could significant emissions reductions be achieved?

One way would be to replace coal with gas-fired power, and brown coal with black coal. But the government has flagged that it is opposed to closing old coal plants. And a large-scale shift to gas would raise electricity prices further, unless gas prices were to tumble.

Read more: The government’s energy policy hinges on some tricky wordplay about coal’s role

That leaves another option, mentioned in the Energy Security Board’s report: power retailers could buy emissions offset credits from elsewhere to make up for not meeting the emissions standard, specifically from projects under the government’s Emissions Reduction Fund (ERF).

This might be attractive for the government, as electricity retailers would then pay for ERF credits, rather than government as has been the case until now. It may also be attractive to the power industry, as it would reduce the cost of complying with the new obligations. Retailers would pass on the costs to their customers, so electricity consumers would end up paying for ERF projects.

Even assuming that all of the ERF’s emissions reductions are real (and some of them may not be), all this does is shift the adjustment burden from electricity to other sectors such as agriculture.

The NEG has the potential to reduce emissions effectively if the parameters are adjusted accordingly. But what seems more likely is that it will put the brakes on investment in renewables, solidify the status quo and delay the energy transition.