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Exposure drafts of the legislation to implement the Carbon Pollution Reduction Scheme

CHAIR (Senator Hurley) —I declare open this sixth hearing of the Senate Standing Committee on Economics inquiry into the exposure drafts of the legislation to implement the Carbon Pollution Reduction Scheme. On 11 March 2009 the Senate referred the exposure draft to the economics committee for inquiry. The draft reflects the government’s white paper on climate change released in December. These documents affirm the government’s commitment to a medium-term target range of reducing emissions by five per cent to 15 per cent of 2000 levels by 2020 and a long-term emissions reduction target of 60 per cent below 2000 levels by 2050.

The government has released six draft bills for public comment. The Carbon Pollution Reduction Scheme Bill 2009 is the main bill and covers the arrangements for the scheme. A second bill relates to the consequential amendments needed to the National Greenhouse and Energy Reporting Act 2007. The Australian Climate Change Regulatory Authority Bill 2009 will establish the authority that will administer the scheme. The remaining three bills are technical bills in case the charge for the permits issued is at some stage considered taxation. This inquiry will focus on issues relating to these bills. A separate Senate inquiry will consider aspects of climate change policy more generally. This committee is due to report to the Senate by 14 April 2009.

These are public proceedings, although the committee may agree to a request to have evidence heard in camera or may determine that certain evidence should be heard in camera. I remind all witnesses that in giving evidence to the committee they are protected by parliamentary privilege. It is unlawful for anyone to threaten or disadvantage a witness on account of evidence given to a committee, and such action may be treated by the Senate as a contempt. It is also a contempt to give false or misleading evidence to a committee. If a witness objects to answering a question, they should state the grounds upon which the objection is taken and the committee will determine whether it will insist on an answer. If it does, a witness may request that the answer be given in camera. Such a request may also be made at any other time.

I welcome Mr Nelson and Dr Simshauser. Do you wish to make an opening statement?

Dr Simshauser —Yes, we do. If you don’t mind, I will hand that over to Tim Nelson.

Mr Nelson —Thank you, Madam Chair. AGL is a strong supporter of the Carbon Pollution Reduction Scheme legislation. We believe it is critical that the scheme be implemented on time to provide investment certainty. Without regulatory certainty there will be delays in investment, and security of energy supply could be compromised in the medium term.

AGL is Australia’s leading integrated energy company, with 3.2 million customer accounts. We have over 170 years of experience and we operate retail and merchant energy businesses; coal, gas and renewable power generation business; and an upstream gas portfolio. We are the largest private owner and operator of renewable energy assets, and we are looking to further expand this position by exploring a suite of low-emission gas fired and renewable energy generation development opportunities.

There will be a number of impacts on AGL as a result of the implementation of the Carbon Pollution Reduction Scheme. These can be summarised as increased wholesale energy and compliance costs and investment incentives. AGL is Australia’s largest retailer of electricity and gas. In 2007-08 the greenhouse gas emissions produced in association with the supply of AGL customers totalled 53.3 million tonnes. This is around 10 per cent of Australia’s greenhouse gas emissions. While AGL will not be required to purchase AEUs for the predominance of those wholesale energy costs, those wholesale energy costs will change as carbon is priced into generator and gas producer decisions.

That said, AGL believes that energy efficiency is likely to play a significant role in minimising cost impacts on consumers. The South Australian and Victorian governments have already implemented residential energy efficiency schemes, and the New South Wales government is in the process of implementing a similar scheme. A national approach to energy efficiency policy is likely to provide significant benefits for residential, commercial and industrial consumers of energy.

In terms of investment incentives, the Carbon Pollution Reduction Scheme will provide investment certainty for new gas fired and renewable power projects. Power stations generally have asset lives of several decades, and certainty about their long-term prospects is vital to secure capital. The scheme will allow energy companies like AGL to integrate carbon pricing into business decision making and to invest in capital with these types of long asset lives.

We have already started putting in place systems and processes for managing these risks and opportunities. This is largely because emissions trading was an election commitment of both major parties in the lead-up to the 2007 Commonwealth election. AGL believes it would create significant regulatory uncertainty and sovereign risk if the proposed Carbon Pollution Reduction Scheme were not implemented.

There are two primary changes to the scheme that AGL believes may be considered by government to enhance investor certainty. These are the introduction of deferred settlement for liable parties as a transitionary measure and an extension of assistance provided through the Electricity Sector Adjustment Scheme. With regard to deferred settlement, businesses with large carbon liabilities will be required to purchase Australian emission units to manage the risks associated with forward contracting of their products. As such, there is likely to be a significant increase in the working capital of many businesses. Given the current state of credit markets, there may actually be a barrier to businesses raising this working capital efficiently. Deferred settlement would be a mechanism for overcoming this short-term issue.

In summary, it is critical that the scheme be implemented as quickly as possible. There are already significant costs being imposed upon the community as a result of the uncertainty being created by the ongoing discussion about the scheme and its potential start date. Investors will not be able to proceed with new intermediate and baseload power station projects until the details of the scheme are finalised. As these projects have significant development time frames, it is critical that the scheme be finalised to allow companies like AGL to work towards providing a secure and stable energy supply for our customers.

CHAIR —Thank you, Mr Nelson. And thank you to AGL for your comprehensive submission. I have some more detailed questions, so if other members have general—

Senator BUSHBY —You may go into your detailed questions.

CHAIR —Right. Your submission to the green paper argues that the waste facilities and forestry should not be included. Can you elaborate a bit on these concerns.

Mr Nelson —Essentially the concerns we have with those sectors being covered are around measurement. We think that they are far better off being included in the scheme through an offset provision. That way, companies that are in a position with greater measurement of their facilities and that have been doing it for longer can then apply to the government to essentially have any emission reduction or abatement created through an offset provision.

CHAIR —You are saying just waste and forestry. What about other companies that may be in a position where they feel that they should benefit from this offset provision?

Mr Nelson —Essentially it is all about coverage. If the sector is covered there should be an implicit economic incentive to go about creating abatement because the increased costs that the business is incurring can be avoided by reducing emissions. Really, with the coverage of the waste sector, given the measurement uncertainties for some of the facilities—not all of the facilities—we thought that was an easier administrative way of making sure that sector received the same economic incentives as other sectors.

CHAIR —I am not quite certain how the offset would work in with the trading. How do you envisage that happening?

Mr Nelson —Essentially there would be no allocation or liability of permits for companies in that sector, but to the extent they could then go to the regulator and say, on a measured basis, ‘We have reduced our emissions by X tonnes,’ we are able to create Australian emission units—in a similar way to the reafforestation provisions under the current bill.

CHAIR —Thank you for that. I also want to explore international links. I think your submission suggested they be restricted in the first years to provide more stability to the scheme. Professor Warwick McKibbin in Canberra was suggesting to the committee that that be a permanent feature, that we perhaps have a central independent system and that we do not have that kind of international trade. Do you is see that that could be permanent or do you support the idea it should only be in the first years?

Dr Simshauser —In terms of international linkages, one of the things we see as quite an important feature of the current legislation is the ability to draw in CERs from abroad. That is obviously going to provide some degree of price stability. Linking into other markets could actually exacerbate volatility and we do not think that is a good thing. So I think we are probably on a very similar page to Professor McKibbin from that perspective. That is how we distinguish that.

CHAIR —As Professor McKibbin acknowledged, down the track, as more countries came into an emissions trading system it would be desirable for global companies to have some sort of trade. I think he was suggesting that it would be through a central facility much like the Reserve Bank. Would you also support that kind of concept?

Dr Simshauser —This is along the lines of the independent carbon bank. There is some merit in that, in our opinion. We think it is a reasonably elegant solution in a way. I suppose we almost look at the CERs as the equivalent of that to try to create that stability. Our observation of what has occurred in the European Union is that you have had some very wild fluctuations in the price of carbon permits in that market. If that were the primary linkage to markets abroad it would more than likely run the risk of importing that same level of volatility into our markets. So we think that the approach that the legislation currently envisages, with an unlimited access to CER markets, is going to be the best way to dampen that risk of volatility of price, as distinct from the European Union, where there are quite definitive limits over how many CERs those countries can import. For example, the England and Wales market can only import I think nine per cent of CERs; that is the limit of the amount of CERs that they can bring in. Consequently, once you have exhausted that bucket, you are then having to deal within country for the balance of your compliance commitments, and that is where you run the risk of high levels of volatility. Volatility in a market like carbon will not be a good thing for anyone.

Senator BUSHBY —Thank you for coming along this morning. In your opening statement you referred to energy efficiency playing a big role, and you mentioned some of the measures that a couple of the states have made. We have seen a lot of talk recently—and I actually saw a gentleman from CHOICE on TV this morning repeat it—about how one of the problems with the current proposal is that, under the cap-and-trade system, if households do become more efficient, if they spend money on solar energy and put it back into the grid, that will reduce the ask overall for other players; it will reduce how much industry might have to reduce to meet their overall target. What are your thoughts about that aspect of the current legislation, given that you made the comment that energy efficiency at a household level will be important? If that is just going to be lost by industry taking it up, it is not really going to solve much, is it?

Dr Simshauser —Maybe I can answer that in two parts. I may not be directly answering your question, at great risk—I definitely will not lose it on the second part. We see energy efficiency as a really important part of the overall framework. If you look at any economy around the world trying to tackle climate change right now, they generally have a three-pronged approach. The first will be some form of emissions trading or a variant thereof, the second will be a renewable energy target—and there are good reasons as to why they sit side by side—and the third will be energy efficiency. It is critical that we try and exhaust all avenues to take on the task that we have in front of us. Insofar as energy efficiency making it easier for incumbent industry, my response would be that, if that is the case, it is more than likely going to be a transient issue. Over time, fundamentally, we all know where we need to get to, and we need to pull every lever we have at our disposal to get there. We cannot look at this as a three-, five- or 10-year issue. There is a very long glide path we have to try and tackle this over. If we go down one path and in the process it lightens the structural pain that is going to occur in other parts of the economy, I do not see that as a bad thing.

Senator BUSHBY —That last statement sums up your thinking: if that is the way the legislation is heading then that is part of the adjustment process, effectively.

Dr Simshauser —Correct. I think it is far better to try and get a balanced portfolio. Let’s not focus on what will happen in the intervening three-year period; let’s focus on where we are heading over a 50-year time frame. This is a long-term game that we are collectively trying to tackle. I do not accept that focusing on energy efficiency and lightening the load for others in industry is a terrible sensible argument to pursue in the context of a centennial issue.

Mr Nelson —Just to elaborate on that answer, households can take quite measured and strong action under the Carbon Pollution Reduction Scheme legislation as it stands by buying Australian emission units and voluntarily surrendering them. If a household want to create extra scarcity in the market, that is an option available to them.

Senator BUSHBY —They can, but that would obviously be at great personal sacrifice. That would be a good thing if people chose to do that. But, in terms of households doing their bit, any way you look at it, households becoming more efficient is a good thing, whether it is from a climate change perspective or otherwise. I think there is a body of thought among people who are doing that that they are doing their bit to lower emissions overall. If it is basically compensated by industry taking a slower route to the end point that Mr Simshauser was talking about, in the overall mix, that may well be part of the structural process, but it does not give a lot of incentive to households to do their bit and to make the investments in infrastructure that might help bring down emissions.

Dr Simshauser —I understand the argument. All I can say is that, whatever the structural path we go down, everything that people do will make a difference. Sitting back and using the argument of, ‘Well, if I do this, it’s just going to get swamped,’ is the same as saying, ‘Everything that Australia does gets overtaken by one of our northern neighbours sequentially.’ It is just not a logical argument.

Senator BUSHBY —Surely the scheme as it is set up should provide incentives for people to take action. If you want to go out there and do your bit to help tackle the problem and by doing your bit, all you are doing is making it a take a little bit longer for industry to adjust, that takes out a bit of the incentive and a bit of the feel good factor out of doing your bit to help.

Mr Nelson —There are some pretty simple ways in which the legislation could be amended to take account of that. Essentially, for the targets that have been set for the first three financial years of the scheme, there could be a mechanism whereby any recognised action that is taken by households could be used to slightly adjust those targets. I do not see it as a problem which cannot be overcome given the current structure of the scheme.

Senator BUSHBY —I am pleased to hear that there are, in your view, ways to overcome that, because I think that that is a problem—particularly given, as you said, that energy efficiency should play a big role. But it may not play as big a role as it should if the incentive is not there.

Mr Simshauser —I will add to that point. I believe that any trade off, if that is what we can call it, that occurs in that space between energy efficiency and industry is only going to be transient at the end of the day. It is not as if their actions are going to be locked in stone and disregarded in perpetuity. As we go through and deal with our next gateway targets, everything that people do will ultimately be accounted for. Where you are heading to is the notion that industry will free ride off that. That will only be a transient issue.

Senator BUSHBY —But it will be a transient issue.

Mr Simshauser —That is right.

Senator BUSHBY —It will exist; it will occur. If, as you said, Mr Simshauser, we are trying to get all avenues of attacking the problem working together then this might undermine that aspect of it a little bit. But I will move on from there. In general, are you locked into long-term contracts or short-term contracts with your clients? How does your industry work?

Mr Simshauser —We have quite a big portfolio. It would be in general biased towards shorter term deals over one- to three-year time frames. However, an organisation our size has a vast number of very long running contracts as well.

Senator BUSHBY —The majority are short term. Given the length of time that there has been discussions about the likelihood of an emissions trading scheme, would that have been factored into the majority of the contracts that you have written in the last two or three years?

Mr Simshauser —Increasingly so. That is correct. A contract will have a price or a re-opener in it—one of the two.

Senator BUSHBY —With the longer term contracts, we have heard from other energy providers around the country—particularly from WA, where apparently the tendency is to do things on long-term contracts—that many of their contracts are 10- to 15-7 year contracts or even longer. They were written well before the ETS was around and there is no scope to incorporate the increased cost factor that may arise from it. Do you have any scope? On the whole, from what I heard from you just then, with most of your business being short term, you have the ability over a relatively short period to incorporate any increased costs.

Mr Simshauser —That is fair to say, yes.

Senator BUSHBY —You mentioned that there were two main changes that you would like to see to the contract. One was to do with the conservation of electricity. The other one was—

Mr Simshauser —Deferred settlement.

Senator BUSHBY —deferred settlement. How important are those changes to your support for the scheme?

Mr Simshauser —We see those two changes as very important. One of the things that, I guess, distinguishes the Australian model from what has transpired in the European Union—and I am dealing specifically with deferred settlement in the first instance—scheme. As I am sure you would be aware, there was a vast amount of free allocation. Consequently, for compliance purposes firms did not have large working capital requirements. They were not really required to participate greatly in auctions to procure their permits. Secondary trade was probably more convenient in fine tuning, rather than establishing vast compliance hedge books going forward. Obviously, that is not a good analogy for Australia. We are designing quite a different approach for a whole range of reasons.

That will bring with it a fairly sizeable requirement for working capital to deal with compliance. In any industry you tend not to be paid in advance; there is usually some delay. In the power market there is, in general, a six-week delay between the timing of the electrons being punched into the grid and the settlement of those at the wholesale level, and then at the retail level it can be as much as three months after the consumption point. So you will have this requirement for large working capital to establish your compliance positions. In the current environment we think that is going to be pretty tough. Again, we do not see it as a particularly difficult problem to solve. The analogy we put is that it is almost like the taxation system, where you would bid for your compliance position, those permits would be held in escrow or something similar and then drawn down and paid for once they are actually submitted for compliance, which would give you adequate time to establish your working capital position.

There is also the issue of whether the federal government would be taking on any credit risk. They would take on no more than they currently do with the taxation system. The other suggestion we would have in order to make sure that it is not something that would be a gain by industry is that, to the extent that people have bought positions intended for compliance and then subsequently opt to trade that position, they would need to basically settle their position before drawing down those certificates.

Senator BUSHBY —I want to come back to the overall question of the importance of the amendments to your support. If the government were to defer settlement, that would defer a lot of the money it would have received and used for compensation. For how long are you talking about deferring the settlements?

Dr Simshauser —Really, it would line up with either settlement in the industry or compliance settlement.

Mr Nelson —I think it is fair to say that, over time, as credit markets start to improve, the need for a deferred settlement mechanism will start to abate as markets become more used to dealing with the increased working capital requirements.

Senator BUSHBY —I think what you say makes a lot of sense but, looking at it from the perspective of government, they would need to start compensating from day one because prices will go up and they will not want to borrow more money because they have already borrowed a lot. How do you think the compensation for electricity needs to be changed?

Dr Simshauser —Our general view is that we believe that the impacts of the scheme will last longer than five years. I do not think that is a terribly contentious position, and I think most of the modelling work that has been done by the federal government points to that. It will really have an impact over a greater period of time so our suggestion is to extend the time frame rather than the volume over the first five-year period. Take the ESAS, which in its design is really quite adequate, it really is just the length of time and the volume of permits allocated in that.

One thing that stands out to us is that, by and large,  black coal generators have missed out on that. The impact on black coal generators is expected to occur later than in southern Australia, where the impacts will be acute much earlier on in the scheme. So the general thrust of it is in the right direction, and we think it should be extended from five years to 10 years and going through the same process to do the measurement. We do not think it is feasible for us. We are trying to be pragmatic about this but we do not think it is feasible to try to cram a bigger number into a five-year window, because all that will do is take an already exhausted pie and cut it up even more harshly than is already being done. We do not think that is a sensible policy option, but we do think that extending it from five to 10 years would be an important step. The Electricity Sector Adjustments Scheme is not a production subsidy. Plants will close down whatever the time frame, based on the fundamental and underlying economics of the power grid.

At the end of the day, behind this, as you recall, we are basically accounting for about 50 million tonnes of CO2 directly or indirectly in our business and we are really talking now to the indirect exposure that we have. What this really is all about, from our perspective, is making sure that the counterparties that we deal with stay intact financially upfront so that they are able to make their transition out of the industry as rationally and smoothly as you can expect under the circumstances.

Senator BUSHBY —Regarding the two major changes you have just outlined—and I think you have given some fairly cogent reasons supporting your argument—what if those changes were not made? What impact would that have (1) on your support for the scheme and (2) on your industry?

Mr Nelson —In terms of the direct impact on AGL, neither of those changes that we have suggested are really going to benefit AGL directly. We are a business that has a strong balance sheet. We are in a much better position than most of the other players in our industry. The changes we have suggested are really to ensure that the transition is as seamless as possible. That is really the only benefit that AGL sees out of this—it is about providing that investment certainty. As to whether or not we would still support the scheme, we would support the scheme but we think that the ESAS should be reviewed at some point in the future.

Senator BUSHBY —But, as I understand it from what Dr Simshauser was saying, if the scheme went ahead without those changes it would have consequences for the energy market and potentially for the economy.

Dr Simshauser —It is fair to say that there will be impacts on generators of varying degrees as a result—that is correct. It is not really an electron issue per se. It is a balance sheet issue and the ability of those organisations to transition and move into a place where they can redirect their capital and build the next fleet of power stations, which presumably will be quite different from the fleet that we have at the moment.

Mr Nelson —On the balance of what has been put forward, given that the scheme is required for us to build the next fleet of generation, that is the primary objective for AGL—to get the regulatory certainty. To answer your question, we would still support the scheme.

Senator BUSHBY —The prime reason for your support for the scheme is that you want the regulatory certainty?

Mr Nelson —Without a doubt.

Dr Simshauser —Absolutely. Tim and I were talking last night. We do not know how many inquiries we have now been through dating back from 1999.

Senator BUSHBY —We are getting closer. This one is actually on the legislation!

Dr Simshauser —Which we greatly appreciate. I think we are inquiried out! For us, we just really want to see rubber hitting the road because, really, any delays or further uncertainty around the process is going to make it very problematic for us going forward.

Senator FURNER —On the last statement you made, we have heard from others that we should actually defer the scheme and some have indicated that we should go to Copenhagen with no scheme whatsoever. In your opening statement, you mentioned the concern that delay would affect the security of energy supply and create uncertainty. What would be the consequences of not having a legislative framework in place this year for energy markets?

Dr Simshauser —Maybe I can answer this through an alternative scenario. Let’s assume, for example, that the legislation is sent off to paper heaven and we just end up in a policy vacuum. Everyone out there knows something is going to come sooner or later, so it is still going to be priced into the marketplace in terms of the risk capital that people put on the ground. When we go and talk to bankers and to equity capital markets, they might say, ‘We know there’s nothing happening in the next year or two, but we know and you know that something is going to come sooner or later—it’s just a matter of when. If you come to us and you want to invest in this wind farm or that gas fired generation plant, you need to actually put your assumptions in around emissions trading.’ Then we go through that process of what we put in and, quite honestly, that is going to end up being a very elongated process. At the end of the day, the other side of the table is going to price that uncertainty—they have to price uncertainty—and every time you price uncertainty there is a risk that you will overprice it. If you start overpricing that risk you will see that manifest itself in higher electricity prices to consumers. Then you are starting to talk about a deadweight loss scenario.

Senator FURNER —So it is a domino effect right through business and consumers, basically.

Dr Simshauser —That is the risk, yes.

Senator FURNER —You have been operating in New South Wales for some time. I understand you have been dealing with climate change for at least the last decade. You have been operating under a scheme called the Greenhouse Gas Abatement Scheme. Since that scheme has been in place, how many energy companies or emissions intensive firms have either shut down or relocated, citing this New South Wales scheme as the reason behind their moving out of the state?

Mr Nelson —My understanding is none.

Senator FURNER —It had no effect whatsoever?

Mr Nelson —There has been no industry that I am aware of that has relocated on the back of the GGAS.

Dr Simshauser —In fact, in my former lives in the industry, at utilities in both Queensland and South Australia, it actually generated investment in the plant. Millions of dollars were committed to existing power stations to increase efficiency because there was an opportunity for those businesses to respond to that policy setting, reduce greenhouse gas emissions and make a dollar out of it.

Senator FURNER —Does the sign of the CPRS show that we have learnt lessons from the New South Wales scheme, do you think?

Mr Nelson —Without a doubt. I think most people in the industry have been looking at these issues for as long as we have. We would say that the CPRS represents, in our view, a very well-designed scheme based around cap and trade, which is, as far as I can tell talking to people both within Australia and internationally, universally regarded as the best way of dealing with this public policy issue.

Dr Simshauser —If I can add to that, one of the things that we believe was a very elegant part of the design was the unlimited CERs. We think that is the thing that is going to bring the price stability that the European scheme is lacking and that is a very desirable part of the scheme, trying to create some sort of price stability in a commodity market. I should just add: the national electricity market is the world’s riskiest market. There is no commodity. It is a very little known fact, but it is the world’s riskiest market. Players like Origin and AGL are the biggest players in that market. We do not really need risk added to that already risky market, so we think that that CER part of the framework is quite important to try to assist companies transitioning.

Senator FURNER —And what parts of your generation portfolio do you think will do well out of carbon price?

Mr Nelson —Without a doubt, the renewable generators that we have within our portfolio—the gas-fired generators. To give you a feel for that, we own 645 megawatts of hydrogeneration assets. We own the Torrens Island Power Station in South Australia and the Somerton peaking plant in Victoria. Without a doubt, those assets that have a lower emissions intensity than the market average will benefit under the CPRS.

Senator XENOPHON —Further to Senator Furner’s questions about GGAS, you have said that it has not caused any impact on investment. I think that is a given. But do you see GGAS and this scheme as being similar in their scope? One was a baseline and credit scheme; this scheme is quite different.

Dr Simshauser —You are right; you have touched on an important point. There is a design difference between GGAS and a cap-and-trade scheme.

Senator XENOPHON —It is a fundamental design difference, isn’t it.

Dr Simshauser —That is correct. The GGAS was important in some respects as a transitionary measure. It was a well thought out scheme in the context of the environment that industry was facing. If we were to go down a baseline and credit scheme for emissions trading more generally across the economy as a template, it would bring some problems with it because, fundamentally, if we are going to pursue that, ultimately you will still want to set a cap in place.

Senator XENOPHON —Can I just indicate I am not supporting it based on a credit scheme, but there are fundamental design differences. I think Danny Price from Frontier Economics, who was responsible for designing and implementing the scheme for the Carr government, was quite critical of the current cap and trade. Is your main concern one of certainty rather than scheme design? You have not been so much focused on the scheme design, per se, as the need to have some investment certainty with whatever scheme is in place. Is that fair in terms of your emphasis of AGL’s point of view?

Mr Nelson —Senator, without a doubt the CPRS from our perspective is preferable for providing regulatory certainty. In any type of baseline and credit scheme the big problem from a company that will be operating in the market’s perspective is the lack of transparency because for every single sector a baseline has to be set. So rather than being able to operate on an aggregate supply and demand basis it is very, very difficult to work out where emission reductions will be coming from on the basis of data as it is flowing through. From our perspective and from most of the entities that we talk to in the market today—those being the electricity and the gas markets—are of the view that the CPRS represents a more superior design from their perspective.

Senator XENOPHON —But there is no reason why you could not incorporate elements of both in terms of having a baseline intensity and also having a cap and trade. You can have a hybrid; it is not impossible.

Dr Simshauser —That is correct. Technically you could design a scheme like that, Senator.

Senator XENOPHON —In terms of AGL’s position that supports this, you have a lot of gas to sell, so obviously that is good for you because it is less energy intensive. That is correct in terms of advocacy of the scheme?

Dr Simshauser —Yes.

Senator XENOPHON —You also get the most compensation for the Loy Yang power station. Is that yours as well?

Mr Nelson —We own an equity share of 32.5 per cent of it.

Senator XENOPHON —A significant share, but you get a fair wad of compensation because it is a brown coal generator, is that right?

Mr Nelson —Indirectly, yes. We have an undertaking with the ACCC that we are not allowed to talk with Loy Yang about those types of matters regarding price.

Senator XENOPHON —It is not a criticism. You will get a fair wad of compensation indirectly with Loy Yang. In terms of your retail arm you also get a percentage of the price. That is how it is structured in terms of your cost structures or your profit structures? Again, it is not a criticism.

Mr Nelson —Actually most of our residential customers are still on regulated tariffs. Our ability to pass through costs is essentially determined by the regulator.

Senator XENOPHON —But your commercial customers, your business customers, that is not the case though, is it?

Mr Nelson —It is a competitive market, yes.

Senator XENOPHON —If prices go up, presumably your income will go up by virtue of that simple function?

Dr Simshauser —Income will go up but only gross income not net income. Our expectation is that this price of carbon will come in as a revenue line, but it will also go out as a cost line. We certainly do not have any forecast inside AGL that is predicting some sort of profit-take out of emissions trading as a result of rising prices to consumers. As we mentioned earlier we are facing about $1 billion worth per annum. If you take $20 or $25 a tonne in terms of increased costs, we expect that our revenues will go up by the exact same amount.

Senator XENOPHON —You are bound to pass on your unregulated charges to industry though, won’t you? You are not constrained in the same way, apart from competition?

Mr Nelson —You are right. Competition is the constraint.

Senator XENOPHON —Finally, I think Senator Hurley asked you about the issue of waste facilities in forestry and you argued about them not being included in the CPRS, then you said there were measurement issues. Is that something that is insurmountable in terms of dealing with those measurement issues, because I know that the waste industry is quite concerned about the way they are being treated under the current scheme?

Mr Nelson —It is a time frame issue really. Essentially how quickly can we get to the point where, for every waste facility that would be covered, you would be confident in the accuracy of the emissions. In terms of the overall scheme of things I think waste is about 15 million tonnes out of the broader economy. It is very much an issue for the people in the waste sector but in terms of the broader impacts on the economy, I think you would say that it is pretty limited.

Senator XENOPHON —You have talked about GGAS. Do you think GGAS could work on a national basis with some modification to take into account the concerns you have raised?

Mr Nelson —There is one fundamental difference with GGAS and the CPRS, which I do not think can be overcome unless you redesign GGAS, and that is GGAS’s targets are on an intensity per capita basis. To get an absolute emission reduction target as proposed with the CPRS you would have to change the end objective of GGAS. Could all of the other elements of GGAS work at a national level? I think, without a doubt, they could. Would they be as efficient as the CPRS? In our view, no.

Senator XENOPHON —You could change the objective though, couldn’t you?

Mr Nelson —Yes.

Dr Simshauser —But I believe that if you change the objective there would be two consequences of a baseline and credit, or a variant thereof, in the place of a cap-and-trade system. What the baseline and credit will do, theoretically at least, is suppress the price relative to a cap and trade, the reason being that obviously if you are under the cap you are a net seller and if you are over the cap you are a net buyer for that increment. That is what we see as the benefit in lowering the price.

Senator XENOPHON —It changes the merit order, does it?

Dr Simshauser —That is correct. The flip side of that is that that is going to make the task of demand side abatement much tougher because you have now suppressed the clearing price of commodity plus emissions. So, all things being equal, if you have a lower price you have less incentive for the demand side.

Senator XENOPHON —But you could go for a tougher target, couldn’t you?

Dr Simshauser —Yes, you could.

Senator XENOPHON —That is the flip side of it, is it?

Dr Simshauser —Let’s go down the path of a tougher target. If you lower the greenhouse intensity my sense is that southern Australian power stations will be bankrupt about five times faster because there is no money to deal with the structural adjustment issue; there is no pool created to do so. That is going to be a very acute issue for South Australia and Victoria. That is the only downside I can see with the baseline and credit. It is very good for New South Wales, Queensland and Western Australia. I believe that all of those states will fare reasonably well out of it, but my one concern with a baseline and credit and a more aggressive sort of baseline is that there is a great risk that it will accelerate the damage to southern Australian power stations.

The reason is that in Australia the dispersion of emission intensities of our power plant is so vast. We are not congested around a central mean. For example, if you take Playford power station in South Australia and Hazelwood in Victoria, they are almost four times higher in intensity than a combined cycle gas plant, so the task of adjustment for those businesses becomes much tougher because there is no ability for them to deal with transition. I am not talking about holding the plant for an artificially longer period in the market place. It is just how those firms transition themselves out and replace their capacity with cleaner technologies. That is the only concern I have about a baseline and credit scheme. It is the one issue that I have never been able to get clear in my head or solve the problem of.

CHAIR —There is a question on notice from Senator Cameron.

Senator CAMERON —I have a couple of questions. Could you give us your view on the proposition by Colonial First State that for every dollar of carbon risk there is a dollar of carbon opportunity. I would like to hear your views on that. The other question is about the feelgood factor. What is more important: getting a feelgood factor for everyone in the country or taking the economic and environmental decisions in the interests of the country? You also spoke about having regulatory certainty and, if you did not get that, there being security of supply issues. I suppose the South Australian example is one of the examples. Are there any other examples where, if you do not get this regulatory certainty, the security of supply could be affected? That is a huge issue from my perspective.

CHAIR —If you could give a written submission to the committee secretariat, that would be good.

Dr Simshauser —That will be fine, Chair. We will be sure to do that.

CHAIR —Thank you for your evidence here this morning. I call Mr Paul Curnow.

[9.24 am]