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The nature of uncertainty

As the debate continues in Australia with regards the implementation of a carbon price, the issue of investor uncertainty has risen up the agenda. A recent interview conducted by ABC (Australian Broadcasting Corporation) illustrates the point:

One of Australia’s largest home and business electricity suppliers has warned that household power bills will double in six years after a carbon price is introduced and uncertainty over its implementation might lead to power shortages.

The gas and electricity giant’s chief executive said uncertainty over what the long-term carbon price might be has stalled capital investment in the industry and halted construction of new power stations. “Capital is not being invested so we haven’t seen new power stations built,” the CEO told ABC TV today.

Electricity regulator Australian Energy Market Operator (AEMO) had forecast shortages of baseload power for Queensland in 2013 and 2014, with Victoria and NSW experiencing shortages in 2015 and 2016, he said. “Given the timeframe for building new power stations, we’re concerned that we need that certainty today so we can build power stations to meet that coming gap in the market,” the CEO said.

He said that gap had resulted in electricity prices rising by 40 per cent in the past three years as a result of network investment. Rising fuel and gas prices would cause them to increase by another 30 per cent over the next three years, the CEO said. The mooted carbon tax of between $20 and $25 a tonne of emissions would not change industry behaviour but would double electricity bills for households over six years given the 30 per cent rise, he said.

Without wanting to comment on any of the figures in the interview, it is nevertheless clear that uncertainty surrounding the implementation of policy is a problem for some, but should it be?

When it comes to power generation on a national scale, arguably the uncertainty question is about the exact nature of the policy rather than the existence of carbon policy at all. Although some will still choose to disagree, there really is very little uncertainty around the need to reduce CO2 emissions, so it is much more about how and when rather than if.

The “when” question is perhaps less uncertain than we might imagine. In the context of major power projects with planning, approval and construction periods of up to ten years, exposure to a carbon price during the operational lifetime of the facility (i.e. the 2020s and 2030s) becomes a near certainty. Although there is concern as to the lack of policy development in key regions today, it is also true that in the last ten years there has been a spectacular shift in the policy agenda. Carbon markets are a reality, global carbon trade exists, carbon targets are the stated goal of dozens of economies and most financial institutions now operate carbon business units of one sort or another (from trading to analysis). By 2020 and beyond, as the environmental picture becomes clearer, policy implementation will likely accelerate, even if it still isn’t sufficient to address the issue head on. So the working assumption should be that a carbon policy framework will be in place during the operational life of a project just starting out today.

So the real issue is “how” (in actual fact “how much”) – i.e. what will the policy look like and what sort of price signal will it send? This was probably at the root of the decision by a number of coal fired generators to actively engage in the formulation of US cap-and-trade policy in 2009 and 2010 – it wasn’t a burst of environmental enthusiasm that brought them to the table, but the sobering reality of a regulatory future that might be created without their input. Many companies now address this aspect of uncertainty with assumed carbon prices, as is the case in Shell today. From a planning perspective looking out 10-20 years, the actual shape of the policy isn’t that important, the key issue is the carbon price it might deliver. Even this can be picked apart based on signals from legislators today and arguments put forward by academia. For example, it is clear from signals in the EU and the UK that in the EU-ETS covered sector the desired outcome is a noticeable shift in the type of generating capacity, so we therefore shouldn’t imagine that a price of €5-10 will somehow suffice. Equally, there are enough technology options in play at the moment to offer significant emission reduction opportunites below €100 per tonne of CO2.

Although it all looks messy today, there is reason to believe that this issue is far more certain than it appears. Even in Australia, both parties now have carbon price policies of some sort whereas neither really did ten years ago. In Canada, there is the proposed moratorium on unabated coal which certainly injects a carbon price into the power sector and in the USA the progressive implementation of rules under the Clean Air Act may well persuade legislators to look again at a more comprehensive approach. Even if they don’t the CAA alone delivers a pretty powerful signal.

Of course, once governments start to collect significant revenue from carbon pricing policies, certainty abounds.

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