Brian Fallow: Increase small price to pay for ETS

Mighty River Power's Nga Awa Purua geothermal power station is a new-generation plant. Photo / Rotorua Daily Post

It is natural, I suppose, for people to look with narrowed eyes and curled lips upon any new cost they face.

Hence the suspicion that has greeted announcements by Mercury Energy and Contact Energy that they will raise their retail electricity prices by a little over 3 per cent as a result of the emissions-trading scheme which will cover their sector, along with transport and industrial processes, from the start of next month.

The introduction, after years of rancorous debate, of a price on carbon will increase the cost of fuel for gas-fired and, even more, for coal-fired generation.

It will have to be reflected in the prices at which those generators offer power into the wholesale market; they cannot be expected to run their turbines at a loss.

And if those plants are required in any given period to keep the lights on, they will set the spot price.

That is the way the market works.

But what does that mean for the consumer's power bill?

And are the sorts of increases Mercury and Contact have announced reasonable?

Calculating what the impact of carbon pricing on wholesale and, eventually, retail power prices will be turns out be a task of fiendish complexity, given the structure of the industry and the complexities of its wholesale market.

Fortunately, we don't have to attempt it.

It has been done for us by the stationary energy and industrial processes technical advisory group, a committee of private sector representatives and officials who had to wrestle with what would be the appropriate basis for compensating large trade-exposed industrial emitters for the impact of emissions trading on their electricity costs.

The number settled on - though some large emitters argue it is on the low side - was just over half a tonne of carbon dioxide per megawatt/hour.

A megawatt/hour is 1000 kilowatt/hours, the units used in residential power bills.

The average household uses about 8000 kilowatt/hours a year.

Applying the same emission factor, that is four tonnes of CO2 a year.

But actually it is only half that.

The Government has decided, as a transitional measure for the first two and a half years of the scheme, that the taxpayer will pick up the bill for half of the cost (even though it is not the taxpayer's behaviour that needs to change).

A generator will only have to surrender one emission unit for every 2 tonnes emitted.

It has also capped the price at $25 a tonne.

On that basis the additional cost per household should average $50 a year, which is pretty close to the indicative figure of $5 a month that Mercury has announced.

To put it in context, the ETS-related retail increases announced so far equate to about six months' worth of normal inflation in electricity prices, which according to the Ministry of Economic Development have risen by more than 30 per cent, or twice as much as the CPI, over the past five years.

The Reserve Bank estimates the ETS, including the impact on petrol and diesel prices, will raise the CPI by 0.4 per cent over the year ahead.

That is slightly less than the expected impact of the increase in tobacco tax and of course only a fifth of the impact of raising the GST rate on October 1.

If there is an element of opportunism about the retail price rises it relates to timing.

Although the meter starts running on July 1, generators and other emitters don't have to front up and surrender emission units to the Government until the end of May next year.

So if power companies want to start recovering that cost now, there ought to be some allowance for the time value of money.

Sometimes people ask why power companies whose generation assets are largely or wholly renewable should also get the benefit of the general uplift in wholesale prices arising from the ETS.

Their costs after all have not risen.

Well, that's just the way markets work.

If you sell your house for more than it has cost you, are you an outrageous profiteer pocketing egregious windfall profits?

No. You are merely participating in market and the prices at which it clears send vital signals to both the demand and the supply side.

The foregoing discussion is about short-run marginal cost.

But the electricity market not only has to make it worth a generator's while to fire up existing thermal plant when needed, it also has to make it worthwhile to invest in new generation capacity.

Both are required to keep the lights on and the latter is all about long-run marginal cost.

The market is designed to ensure that whatever short-term factors blow prices around, the underlying trend in wholesale prices will keep rising to the point where it is commercially viable to build the cheapest next increment in generation capacity.

That is needed both to cope with demand growth and to allow for the closure of old power stations.

Carbon is clearly a factor in estimating the long-run costs of different generation options, with capital costs and the expected price path for fuels.

It has almost certainly put paid to any possibility of building coal-fired plant, unless and until carbon capture and storage technology becomes viable.

For gas-fired baseload plants, however, it is more likely that a lack of gas is a bigger problem than future carbon prices.

In any case, apart from gas-fired plant designed for a peaking role like that Contact is in the throes of commissioning at Stratford, all the new generating capacity committed to or under consideration is geothermal, wind or hydro.

This indicates that the prospect of carbon pricing, clearly on the cards for years now, has already had its desired effect in influencing generators' investment decisions.

It is not something which suddenly changes on July 1.