Elsevier

Economic Analysis and Policy

Volume 48, December 2015, Pages 71-81
Economic Analysis and Policy

Full length article
Brown coal exit: A market mechanism for regulated closure of highly emissions intensive power stations

https://doi.org/10.1016/j.eap.2015.11.003Get rights and content

Abstract

In this paper we propose a market mechanism for regulated exit of highly emissions intensive power stations from the electricity grid. The starting point is that there is surplus capacity in coal fired power generation in Australia. In the absence of a carbon price signal, black coal generation capacity may leave the market instead of high emitting brown coal power stations. We lay out options for a mechanism of regulated power station closure using a market mechanism. Plants bid competitively over the payment they require for closure, the regulator chooses the most cost effective bid, and payment for closure is made by the remaining power stations in proportion to their carbon dioxide emissions. This could overcome adverse incentive effects for plants to stay in operation in anticipation of payment for closure and solve the political difficulties and problems of information asymmetry that plague government payments for closure and direct regulation for exit. We explore the issues theoretically and provide empirical illustrations. These suggest that closure of a brown coal fired power station in Australia could yield emissions savings at costs that are lower than the social benefits. The analysis in this paper is applicable to other countries.

Introduction

Many of the world’s electricity grids have ageing and highly carbon dioxide emissions intensive coal-fired power plants. The short run marginal costs of the highly emissions intensive brown coal (lignite) power plants are low compared to black coal, gas and liquid fuel power plant (but higher than renewables). This is the case since there often is no alternative use for the brown coal mined in proximity to the power stations. Consequently brown coal plants operate for significant periods, increasing the emissions intensity of electricity supply. This is the case for Australia’s fleet of brown coal fired power stations (Elliston et al., 2013, Byrnes et al., 2013), and similar examples exist in other countries (for example Germany, see IEA, 2011; Traber and Kemfert, 2011).

Where there is sufficient available capacity in lower-emissions plants, these plants could be closed down with benefits in terms of lower carbon dioxide emissions, and lessened local air pollution and other benefits for local amenity, including from ceasing associated open-cut mining activity. However such closure may not necessarily happen without policy intervention even in the face of overcapacity. Firstly, brown coal fired plants typically have lower short-run marginal costs of operation than the lower-emissions alternative of black coal and gas plants. These marginal costs dominate production decisions because investments were made in the past and are now sunk—in other words, once plants and mines are established, the operating costs of coal plants are mainly a function of fuel costs.

Secondly, there is a general impediment to exit: if one plant exits the market, the remaining ones will receive higher revenues. This acts as a disincentive to closure as every operator has an incentive to defer closure in the hope that another plant will close. Even if the gains to plants remaining on the grid were to outweigh the foregone gains to the exiting plant, the owners of power plants will typically not be able to achieve such an outcome without regulation, either because they cannot effectively co-ordinate or because competition law precludes them from such coordinated action.

The Australian National Electricity Market (NEM, the grid spanning the country’s Eastern and Southern states) has overcapacity, as established by AEMO (2015). In recent years, overall electricity demand has reduced while renewable electricity generation–in particular wind power–has been added to the system (Fig. 1). From 2007 to 2014, average capacity utilization factors for black coal plants fell from 63% to 53%, for brown coal from 79% to 70%, and for gas fired generation from 31% to 26% (data from AEMO via NEMSight).

In this context, the Council of Australian Governments Energy Council considered the merits of reviving a ‘payment for closure’ policy pursued by the previous government (COAG, 2014). This policy aimed at providing funds to a (brown coal) generator to retire their generation capacity with a view to easing the excess capacity in the NEM as well as reducing emissions.1 A variant of payment for closure of brown coal power plants is expected to be implemented in Germany, with payments of 230 million euros per year over a seven year period from electricity consumers to plant operators in return for taking 2.7GW of plant capacity out of production and placing the stations in reserve (Deutsche Welle, 2015).

In their communiqué dated 11 December 2014, the COAG Energy Council stated their lack of support for a contract-for-closure policy:

“…Nor does [the council] support assistance to generators to exit the market. The Council considers it is for the market to provide signals for investment and de-investment for generation, and opposes the transferral of the costs of retiring assets onto consumers or taxpayers”.

The Australian Energy Market Commission (AEMC, 2015) also argued against intervention to facilitate plant exit:

“The evidence suggests that any barriers to exit have not deterred generators from commencing various stages of exit or the full retirement of plant. This would support leaving it to the market to determine which plant should exit”.

These statements not withstanding, the issue of overcapacity and the possibility of government intervention to achieve ‘orderly’ exit remains on the agenda. For example, Nelson et al. (2015) assess barriers to exit and suggest various possible policy interventions to ameliorate outcomes compared with leaving market participants to make exit decisions. They argue that some operators mothball their plants rather than shutting them down permanently, and that this detracts from investment in renewable generating capacity. Nelson et al. (2015) see significant barriers to exit and a role for measures to facilitate closure of power plants to improve market stability and investment conditions in the electricity sector.

Such considerations are primarily concerned with market stability and investment conditions, and generally do not take account of climate change, or indeed of any other externalities. A case for government intervention could be made on grounds of greenhouse gas emissions. For instance, black coal in Australia has an average emissions factor of just over 0.9 tCO2 per MWh generated, whereas brown coal based generation in Australia ranges from 1.2 to 1.5 tCO2 per MWh, with an average of 1.3 tCO2 per MWh. These emissions factors have stayed largely unchanged through time for each technology, however the total emissions intensity in the NEM fell due to the changes in composition especially the increase in renewables generation (Fig. 2). Capacity factors–the share of actual power output compared to what it would be if the plants ran every hour of the year at full capacity–has declined, for brown coal fired plants from 79% to 70% from 2007 to 2014, and from 63% to 53% for black coal fired plants, on average (Fig. 3).

If market outcomes led to the closure of black rather than brown coal generation capacity, emissions could be significantly higher than if brown coal plants closed.

That said, a prima facie case for intervention does not mean that any intervention that achieves the desired primary outcome is welfare enhancing. In the case of the payment for closure scheme, Riesz et al. (2013) question its merits and conclude that it should not be pursued. Their main argument is that payments for closure may create a vicious cycle that exacerbates barriers to exit. They argue that power plant operators will be looking to get paid to exit once the example is set, postponing exit because of perceived chances of future government payments.

Policy intervention aimed to facilitate early retirement of power generation plant must be well designed and implemented. If not there is the danger of wasting taxpayers’ or consumers’ money and introducing perverse incentives.

Economic theory holds that absent specific distortions or market failures, the first-best policy intervention is a carbon price, through an emissions trading scheme, carbon tax or similar arrangement, especially if it generates revenue that can be used to reduce other taxes (Helm and Pearce, 1990, Parry and Williams, 1999). A carbon price at a sufficient level can result in societally efficient exit of high-emissions plants, as the operating costs of the highest emissions intensive plants are increased by the greatest amount. By contrast, addition of renewable energy capacity may not result in efficient exit outcomes as it will tend to reduce revenue for all existing generators and may drive lower-emissions plant to close.

A carbon price was in place in Australia during 2012–14 but was abolished. Existing policies aimed at reducing emissions include the Renewable Energy Target (a portfolio standard with tradable certificates) and the Emissions Reductions Fund (a government funded scheme to subsidize agreed actions to reduce emissions). Neither of these results in incentives for emissions intensive power plants to close. Yet Australia has an emissions target in place of a 26%-28% reduction in emissions from 2005 to 2030. To be on track to meet this target through domestic reductions would require comprehensive changes, and would likely include the cessation of using brown coal for electricity generation (Denis et al., 2014).

In the absence of an effective carbon pricing signal, closure by one or more plants could be achieved through direct regulation. However in light of recent experience with the political economy of climate policy in Australia it appears unlikely that a government would choose a pure regulatory approach that singles out power stations and imposes the full cost of early closure on the owners of that station. The alternative of government payments for closure suffers from the downsides laid out above and would involve undesirable on-budget transfers.

In this paper, we investigate options for policy approaches that overcome the difficulties of direct regulation and government subsidies for closure. We propose a market mechanism for regulated closure of highly emissions intensive power stations. The scheme would use a market mechanism to identify the most cost effective plant to close down and source the payments from the remaining power stations. This would be done in a way that would provide further incentives for reducing emissions by the remaining power plant fleet. We argue that such a regulated market mechanisms could solve the political difficulties and problems of information asymmetry that plague government payments for closure and direct regulation for exit respectively. We provide empirical illustrations that suggest that the closure costs are lower than the likely societal benefits of closure.

We intend this paper as a starting point for further research and to inform policy considerations. The paper also provides an overarching contribution to the literature on policy mechanisms for transition of electricity generation infrastructure.

Section  2 establishes the rationale and proposes a market mechanism for regulated plant closure designed to achieve plant exit that takes into account carbon emissions. Section  3 contains empirical illustrations. Section  4 concludes.

Section snippets

A market mechanism for regulated plant closure

If the case for policy intervention to close one of Victoria’s brown coal fired generators as laid out above is accepted, then the question is which policy mechanism to apply. Three in-principle approaches exist (Nelson et al., 2015): government funding (or subsidies) for plant closures, a market-based solution, or direct regulation.

Here we describe an approach that is a hybrid of direct regulation and market mechanisms.

Empirical illustrations

Here we provide some empirical illustrations of the possible effects of the closure of one of Victoria’s large brown coal fired power stations, in the context of the mechanism proposed in Section  2.

Conclusions

Australia has overcapacity in electricity generation that includes a number of highly emissions intensive brown coal fired plants, a renewable energy target mechanism which brings new capacity into the grid, but no carbon price signal. In this situation, it is possible that black coal generators will be closed down ahead of more polluting brown coal generators, because running costs of brown coal plants are lower.

This would mean missing out on opportunities to reduce emissions, and realizing

Acknowledgements

The idea laid out in this paper was discussed in outline form with a number of colleagues and experts. We also received helpful referee comments. Thanks to all.

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