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A Switch in Time: Enabling the electricity sector's transition to net zero emissions

A Switch in Time: Enabling the electricity sector's transition to net zero emissions

Policy BriefApril 2016

ContentsKey Points 01Executive Summary 02Section 1: Change is inevitable and offers opportunities. Managed badly it can be destructive. 05Section 2: Modelling approach 08Section 3: Modelling results 10Section 4: Recognise and address risks 18

Acknowledgements This analysis is based on modelling commissioned by The Climate Institute from Jacobs, with support from AGL, GE and Hydro Tasmania. This report was written by Olivia Kember, with input from Erwin Jackson and John Connor. We would like to thank David Blowers, Peter Cowling, Cameron Reid, Hugh Saddler, Kathryn Smith, Colin Wain and Tony Wood for their reviews of the modelling and Christian Bennett, David Blowers, Cameron Reid, Colin Wain and Tony Wood for their comments on drafts of the text.Any errors remain the responsibility of the author.

The Climate Institute is Australia's leading climate policy and advocacy specialist. Backed primarily through philanthropic funding, the Institute has been making solutions to climate change possible, through evidence based advocacy and research, since 2007.To support us please visit www.climateinstitute.org.au/donate

Platform GLIDER

Key Points

• 1

1 The global switch to clean energy is an unstoppable trend, to be accelerated through the implementation of the Paris Agreement. Countries agreed in Paris to limit climate change to 1.5-2°C above pre-industrial levels. Achieving these temperature goals requires capping the total amount of greenhouse gases released to the atmosphere. This limit is known as a carbon budget.

2 Energy emissions must progressively decline to net zero by mid-century for a 75 per cent chance of limiting temperature rise to less than 2°C, and an even chance of achieving the 1.5°C goal. This can only be achieved by switching to zero or near-zero emission energy sources.

3 Australia’s electricity market lacks a framework for orderly replacement of old, inefficient and high-carbon coal stations with cleaner power. The Climate Institute commissioned modelling of policies under discussion against the emission reductions needed for the electricity sector to play its part in achieving the <2°C goal.

4 Our modelling finds a modest carbon price rising to $40 per tonne by 2030 would produce emission reductions similar to the government’s current national 2030 target of 26-28 per cent below 2005 levels, but this would result in:

+ almost no replacement of existing high-carbon power stations with clean energy;

+ a collapse in clean energy growth followed by stagnation through most of the 2020s; and

+ 98 per cent of the sector’s 30-year carbon budget used up in the first ten years.

5 This means that climate action after 2030 would need to be more extreme – more than 80 per cent of the coal-fired generation fleet would have to be closed in less than five years and new clean energy capacity would have to jump four-fold and keep rising. The impacts of such a disruptive shift would be felt across the economy.

6 Measures that directly target an orderly phase out of high-carbon generation over the next 15-20 years and de-risk clean energy investment would smooth the sector’s emission reduction pathway and reduce the risks of disruptive adjustment in the futures. These measures are necessary for timely decarbonisation and investment predictability.

7 Australia’s electricity sector needs a policy framework that:

+ is consistent with a predictable pathway to net zero emissions by mid-century, and a 1.5-2°C national carbon budget;

+ starts systematically retiring existing high-carbon generators on a timeline that ensures all have exited by 2035;

+ facilitates replacement of high-carbon generation with zero or near-zero emission energy;

+ provides a well-funded and well-planned structural adjustment package for communities affected by generator closure;

+ strategically deploys energy efficiency policies to minimise costs to energy users and further reduce emissions; and

+ includes a carbon pricing mechanism that is capable of scaling up over time to provide a bankable signal for investment consistent with net zero emissions by mid-century. There is a low probability that a price of sufficient strength and reliability will emerge quickly, so the measures listed above are needed to deliver a timely transition.

Executive Summary

• 2

Cleaning up Australia’s electricity system is central to national prosperity in a world committed to achieving net zero emissions. Failure to implement a long-term decarbonisation plan carries severe and growing risks.

Clean energy1 is a major global growth industry: global investments in renewable power generation now outstrip new investments in fossil fuel power generation. Governments, businesses and communities around the world are shifting to clean energy, an unstoppable trend that will be accelerated with implementation of the Paris Agreement.

Countries agreed in Paris to limit climate change to 1.5-2°C above pre-industrial levels.2 Achieving these temperature goals requires capping the total amount of greenhouse gases released to the atmosphere. The limited amount of emissions is often called a “carbon budget” (see Box 1 for an explanation of carbon budgets). To stay within the carbon budget, emissions need to decline to net zero levels. For this reason, countries also agreed in Paris to achieve net zero emissions. To give a 75 per cent chance of limiting temperature rise to less than 2°C, and an even chance of achieving the 1.5°C goal, emissions from energy must progressively decline to net zero by mid-century.3 This can only be done by switching from high-carbon to clean energy sources.

However, in Australia clean energy growth faces an uncertain future. The sector’s history of short-term and short-lived policies has inflicted significant damage to the investment environment for all electricity supply technologies. A key obstacle is the lack of a framework for orderly replacement of the old, inefficient and high-emitting coal stations that dominate our electricity system with newer, cleaner power sources. Although clean energy technology costs are falling, existing coal stations, as fully depreciated assets, remain more competitive than new generation. Their continued operation underpins the sector’s high emissions and deters investment in clean energy. The scale of this problem is such that the closure of one or two coal generators would do little to enable the long-term transition needed.

This situation creates several major risks, including: + prolonged uncertainty over Australia’s approach to

climate and energy policy, further damaging investor confidence in the electricity market;

+ failure to make a timely transition to clean energy, requiring disruptive policy adjustments to enable a rapid “catch-up” with the carbon budget underpinning our Paris commitments;

+ growing mismatch between the existing regulatory regime and new technologies and business models starting to enter the market;

+ growing conflicts between stakeholders as shareholder, investor and community activism tries to make up for policy and regulatory gaps; and

+ unexpected and disorderly generator closures for which the electricity system, energy users, and local communities and workers are unprepared.

Although both major political parties have acknowledged the need to achieve net zero emissions, existing climate and energy policies provide no prospect of reaching this goal. The government has committed to review Australia’s climate policy settings over the next 18 months, with a view to achieving its post-2020 emissions reductions target and implementing its commitments to the Paris Agreement. More detail is expected on Labor Party policy before the election. Policy that puts Australia’s electricity sector on a credible path to net zero emissions by mid-century or earlier is urgently needed.

To inform the development of plans to modernise and decarbonise Australia’s electricity sector, The Climate Institute commissioned one of the nation's leading electricity market modellers to assess various policy options against the transformation of the electricity system necessary to achieve emission reductions consistent with the <2°C goal. These scenarios reflect policies under public discussion rather than policies endorsed by The Climate Institute. The modelling illustrates the direction and magnitude of the impacts of these policy options on the electricity sector, and indicates potential consequences beyond the sector. Given the limitations of modelling exercises, these should not be taken to be a comprehensive accounting of all the costs, benefits, and risks of each policy approach.

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Key conclusions from The Climate Institute’s research are:

1. Weak policy settings risk stalling clean energy investment and blowing the carbon budget.Over 90 per cent of electricity needs to be generated from clean sources by 2050. Policy that fails to drive early and sustained emission reduction makes the future achievement of Australia’s commitments harder and more risky.

For example, relying solely on a modest carbon pricing mechanism (e.g. safeguard, baseline and credit, emission trading scheme) starting at $17/tonne in 2020 and rising gradually to $40/tonne by 2030 would achieve a reduction in electricity emissions in line with the government’s current 2030 target of 26-28 per cent below 2005 levels. But it would also result in: + stagnation in clean energy. Through most of the

2020s clean energy generation remains barely above levels achieved under the Renewable Energy Target (RET), assuming it is met. New clean capacity grows by about 1,000 megawatts (MW) annually –about a 60 per cent decline from the pre-2020 capacity growth expected under the RET.

+ almost no replacement of existing high-carbon generators with cleaner capacity. A carbon price signal of this level would likely affect generators’ market shares but have minimal impact on new investment decisions.

+ consumption of 98 per cent of the sector’s 2020-2050 carbon budget within the first ten years.

After 2030, achieving the long-term commitments of the Paris Agreement would only be possible if: + over 80 per cent of existing coal capacity is retired

within five years and all coal capacity closed by the mid-2030s;

+ annual clean energy capacity entry scales up to four-fold to nearly 5000 MW; and

+ more than 550 million tonnes of negative emissions, or offsets, are sourced either within the sector or elsewhere in the economy.

This approach (“Weak Start Carbon Price” scenario) would cause significant disruption to the physical electricity system, the energy market, energy workers and businesses, and communities where existing coal generators are a source of economic activity. Transformation of this scale and speed might not even be feasible. Figure S1 shows the scale and speed of post-2030 emission reduction necessary in this scenario.

2. A comprehensive policy package that delivers a credible path to net zero emissions by mid-century is necessary.A carbon pricing mechanism on its own is unlikely to provide a sufficiently reliable signal for the timely replacement of existing high-carbon generators with clean energy sources, as it would need to reach and maintain prices of around $100/tonne. A carbon price consistent with the <2°C goal reaches $70/tonne in 2020 and $100/tonne in 2030 (“2°C Carbon Price” scenario). However it is unlikely that such a strong price would emerge within the required timeframe; even if it did investors would be unlikely to see it as sufficiently secure and robust.

Buttressing a weak carbon price signal with other sector-specific policies to exit high-carbon generators and de-risk clean energy investment can provide a stable investment pathway for timely transformation. Modelling shows that combining a Clean Energy Target of 50 per cent by 2030 and a 45-year operating lifetime limit on existing coal generators drives clean energy growth instead of stagnation in the 2020s. Key outcomes of this scenario (“Clean In Carbon Out”) are: + clean energy capacity grows by 2,500 MW per year

over the same period, or 2.5 times the amount driven by the Weak Start Carbon Price;

+ retirement of coal generators is spread out over time to average 1,500 MW annually to 2035;

+ the reliance of clean energy investments on a subsidy declines from about 50 per cent of their revenue to barely 4 per cent by 2030;

+ halving of the emissions gap between the 2°C Carbon Price and the Weak Start Carbon Price scenarios; and

+ requirement for 290 million tonnes of offsets to achieve the carbon budget.

This scenario reduces electricity emissions by 45 per cent below 2005 levels in 2030. This is in line with the Climate Change Authority's recommended minimum national target, but uses up 79 per cent of the carbon budget by 2030. Ambitious energy efficiency can further reduce emissions and help minimise costs, but must be deployed as part of a coherent strategy to manage impacts on the electricity market. This was examined through the Low Demand Clean In Carbon Out scenario, which combines lower projections of electricity consumption with faster deployment of distributed solar and battery storage to create a context of ongoing low demand for grid-based electricity. This scenario more than achieves the desired thirty-year carbon budget, indicating that reducing demand through energy efficiency can make an important contribution to the emissions goal. However, in this scenario the market remains in a state of oversupply which depresses wholesale prices during the 2020s, despite the ongoing exit of traditional coal generators. This means that new clean energy is heavily reliant on a subsidy for investment, which in turn creates a higher degree of policy risk that potential investors may find unacceptable. Managing the interaction of these policies requires a strategy that recognises the tensions between them.

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3. Orderly replacement of existing high-carbon generators improves predictability for investment and community transition.Sustaining clean energy growth requires a greater level of investor confidence and better market signals than can be provided by a weak carbon price signal and an expanded clean energy scheme. As the Clean In Carbon Out scenario shows, adding a sustained phase-out of high-carbon capacity helps de-risk clean energy investments by reducing the need for subsidies.

Following the expected closure of Northern power station in South Australia in May 2016, the next signalled closure is not until 2022, when AGL has announced Liddell power station (NSW) will be retired. It is important to note this retirement is based on internal decision making – our modelling suggests that, even with a weak carbon price, there is no strong economic rationale for Liddell or any other station to exit the market, despite the fact that by 2020 many stations will be well over 40 years old.

However, closures may occur with little warning. As the recently announced retirements of South Australian coal stations have shown, unexpected closures can impose significant stress on communities, present risks to system operation and require rapid changes in market processes to maintain stability of the electricity supply.

In contrast, a planned phase-out of high-carbon capacity minimises shocks to the operating and investment environment. Planned closure allows everyone to prepare for the next steps: economic transition for communities and workers, rehabilitation of mines and power stations, rational consideration of flow-on opportunities and risks and, crucially, timely investment in new and cleaner sources of power.

RecommendationsThe Climate Institute concludes that an orderly transition will reduce overall economic and social costs and risks compared with a delayed transition that results in abrupt changes and disorderly closure.

To meet a 1.5-2°C carbon budget, Australia’s electricity sector needs a policy framework that: 1 is consistent with a predictable pathway to net zero

emissions by mid-century, and a 1.5-2°C national carbon budget;

2 starts systematically retiring existing high-carbon generators on a timeline that ensures all have exited by 2035;

3 facilitates replacement of high-carbon generation with zero or near-zero emission energy;

4 provides a well-funded and well-planned structural adjustment package for communities affected by generator closure;

5 strategically deploys energy efficiency policies to minimise costs to energy users and further reduce emissions; and

6 includes a carbon pricing mechanism that is capable of scaling up over time to provide a bankable signal for investment consistent with net zero emissions by mid-century. There is a low probability that a price of sufficient strength and reliability will emerge quickly, so the measures listed above are needed to deliver a timely transition.

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2˚C carbon budget of 1760mt CO2e

Figure S1. Reducing emissions earlier lessens disruption and risks of future transition.

Section 1. Change is inevitable and offers opportunities. Managed badly it can be destructive.

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The world is moving toward net zero emissions and Australia needs to catch up or be left behind.

Clean energy is a major global growth opportunity. The Paris Agreement will accelerate global efforts to limit warming below 1.5-2°C, technology investment trends are shifting away from high-carbon to clean energy, and pressures for Australia to modernise will only increase. Australia is currently missing out on clean energy growth because the policy framework for the electricity sector is not geared towards a timely replacement of our ageing high-carbon assets with newer, cleaner capacity.

The electricity sector is undergoing rapid changes. Globally, renewable energy investment has overtaken investment in fossil fuel power. Consumers are becoming producers of solar power. Consumption is flattening in traditional sectors but emerging in new areas like passenger transport; storage offers the potential to radically change power systems. New industries are emerging to improve energy management and compete with traditional business models.

A key driver of these trends is the need to limit dangerous climate change. Some 150 countries have renewable energy targets,4 39 have established carbon markets or carbon taxes,5 and many are taking steps to reduce their use of traditional high-carbon power generation.6 These efforts will be accelerated under the Paris Agreement, in which 190 countries have committed to progressively strengthen their emission reduction efforts in order to limit global warming to 1.5-2°C (“1.5-2°C goal”).7 Achieving these temperature goals requires capping the total amount of greenhouse gases released to the atmosphere. This is often called a “carbon budget” (See Box 1 for an explanation of carbon budgets). To stay within the carbon budget, global emissions need to decline to net zero levels and below (negative emissions can be achieved through technologies to remove carbon from the atmosphere). For this reason, countries also agreed in Paris to achieve “a balance between anthropogenic emissions by sources and removals by sinks of greenhouse gases in the second half of this century”, or net zero emissions. To give a 75 per cent chance of achieving the <2°C goal, and an even chance of achieving the 1.5°C goal, emissions from energy must progressively decline to net zero by mid-century in order to remain within the required carbon budget.8 This can only be done by switching from high-carbon to clean energy sources.

Australian leaders in business and politics have expressed support for achieving net zero emissions. Companies and investors are starting to plan for this transition - for example, BHP Billiton has stress-tested its portfolio against several pathways to the <2°C goal.9

Several key participants in Australia’s electricity market have also articulated their support for the <2°C goal and have called for policies that would drive greater sectoral emissions reduction. For example, Origin Energy “supports the progressive decarbonisation of the electricity sector in Australia and an eventual goal of net zero emissions by 2050 or earlier”, and has called for policy to consider three interlinked issues: “support for the deployment of renewable energy at significant scale, closure of highly emissions intensive coal-fired power stations; and an explicit cost of carbon abatement”.10

Addressing climate change is not the only driver for the global shift toward clean energy. Other important objectives for countries include air quality and health improvements, energy security and industrial development. Australia’s world-class clean energy resources provide opportunities to gain all of these benefits.

The transition to clean energy is blockedDespite Australia’s abundant clean energy resources, our country’s electricity supply is among the world’s most emission-intensive, due to the dominance of its ageing coal stations. This is a major factor in the Australian economy’s higher emissions intensity compared with other developed countries. Australia’s high-carbon electricity contributes to a higher amount of carbon emissions per unit of GDP than the global average – in other words, Australia relies more heavily on high-carbon economic activities than its peers.11 This becomes an increasing disadvantage in a world that is acting to reduce greenhouse gas emissions. Reorienting the economy toward a more competitive and lower-carbon basis cannot be done without tackling the electricity system. Currently, however, Australia’s electricity market contains several obstacles to the transition to clean energy: + Design: The market does not explicitly value

emissions or emission reduction, providing an effective subsidy to high-emitting electricity sources that undermines the competitiveness of lower-emission energy.

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+ Oversupply: The market has a significant over-supply of generation capacity.12 The potential for this capacity to return to the market in future is a deterrent to investment in new capacity.

+ Depressed wholesale prices: Surplus capacity suppresses the wholesale price of electricity, requiring greater policy support for large-scale clean energy investments to be financially viable.

+ Policy uncertainty: A history of unstable energy and climate policy and ongoing uncertainty over future policy has created an environment of significant uncertainty for the sector amd damaged investor confidence. Policy uncertainty is a key barrier both to exit of high-carbon capacity and entry of clean energy.

+ Realisation of exit liabilities: The costs of withdrawal include not just foregone revenue but also redundancies, site remediation and rehabilitation, presenting significant barriers to exit.

Failure to address these obstacles will prevent Australia from taking advantage of the global shift to clean energy and exposes the electricity system and its customers and the broader public to shocks. Symptoms are already visible: underinvestment in remediation, which contributed to the fire at Hazelwood power station; sudden closures, such as Alinta’s decision to bring forward the closure of its Port Augusta power stations; a freeze on investment in new large-scale renewables; and a reversal of the decline in electricity emissions, which are projected to rise for the next fifteen years.13

Each of these trends reduces the resilience of the power system and increases costs and risks: potential underinvestment in remediation transfers the costs of rehabilitating sites to the public; unplanned closures prevent workers and communities from preparing for the future and could expose regions to insecurity of supply; stagnation in renewable energy investment redirects capital to other countries, weakens the industry, and contributes to high electricity emissions; and rising emissions increase the difficulty for Australia to achieve its emission goals and keep within a 1.5-2°C-consistent carbon budget.

A recent series of retirements is about to end with the expected closure of South Australia’s Northern power station in May 2016. This leaves some 25 GW of coal-fired capacity providing around 70 per cent of Australia’s electricity. The next generator to exit is expected to be Liddell, which AGL has announced will be retired in 2022. Importantly, the Liddell closure is based on internal decisions rather than electricity market dynamics. Our modelling suggests that even with a weak carbon price there is no strong economic rationale for Liddell or any other high-carbon power station to be retired, even though several will be over 40 years old.

This indicates that in the absence of firm new policies future closures are highly speculative. At this rate, it would take many decades for Australia to phase out existing coal plants, whereas achieving the 1.5-2°C goal requires the replacement of all these generators over the next 20 or so years.

The next two years are criticalThe sooner we act, the better placed we are to manage the transition to net zero emissions. Over the next 12-18 months, policymakers need to lay the groundwork for emissions reductions towards a net zero emissions economy.

If our electricity system continues on its current path until 2030, it becomes very hard to reduce emissions fast enough and deep enough to keep within a 1.5-2°C carbon budget. Addressing the current challenges facing the sector is therefore not just important but urgent. This should be done through measures consistent with the net zero goal in order to end the short-term, chaotic approach that has contributed to the current situation.

In the absence of new policy, the electricity sector would burn through its entire carbon budget to 2050, 20 years ahead of schedule. This is a possible rather than likely outcome – it is more plausible that Australia will strengthen existing policies or adopt new ones to reduce electricity sector emissions. There is bipartisan political support for greater emission reduction, and both major political parties support a ‘market mechanism’ to cut emissions, although they do not agree on the mechanism itself. However, a market mechanism per se will not necessarily achieve the 1.5-2°C goal.

Shifting from the present emission-intensive electricity to the near-zero emission electricity required presents technical and logistical challenges. These can be better managed if the transition takes place over several decades – which means we need to start as soon as possible. Deferring the transition doesn’t prevent it from happening; it simply compresses the time within which it must take place, dramatically increasing the difficulty of the task. Replacing such a large share of generation in a very short time period requires rapid changes in, among other things, transmission capabilities, grid management systems and market rules, none of which are designed to adjust rapidly to a changing environment.

These challenges are exacerbated if the carbon budget is spent too quickly. If the budget is exhausted, negative emissions may be required. These may need to be accessed either within the sector, which would require reliance on still emerging technologies like bioenergy with carbon capture and storage, or from other parts of economy. There is no guarantee that sufficient negative emissions or offsets will be available.

In theory, a strong, reliable, technology-neutral carbon price is widely considered to be the most efficient or optimal policy to achieve the necessary emission reductions. However, as Energy Australia noted in a recent submission to the Climate Change Authority: “Even an astutely designed emissions reduction policy with a relatively high carbon price signal will struggle to catalyze this reallocation unless it is perceived by investors to be politically secure and robust at the outset.”14 Given the urgency of the situation, the low likelihood of such a policy emerging within the required timeframe, and the risk that investors would not perceive it to be sufficiently secure and robust, it is appropriate to assess the efficacy of alternative policies.

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These policies may also act as a bridge to the eventual emergence of a suitably strong and reliable carbon price.

The CIimate Institute commissioned leading electricity market modeller Jacobs to test a range of policies and policy combinations against the emission reductions needed for the electricity sector to play its part in achieving the <2°C goal. The modelling is intended to examine how alternative approaches can contribute

BOX 1: BUDGETING FOR A 1.5-2°C WORLDThe Paris Agreement reiterated the commitment, already agreed by over 190 countries, to limit global warming to less than 2°C above pre-industrial temperature levels. Countries also committed in the Paris Agreement to pursue a temperature limit of 1.5°C. These commitments impose a physical cap on the total amount of greenhouse gases that can be released this century. This is known as a carbon budget.The carbon budget arises from the fact that the global climate system is not affected by emissions in any given year, but by the total amount of greenhouse gases in the atmosphere. Scientists have calculated that, to limit warming to 2°C with a reasonable level of probability, the world can emit no more than 590-1240 billion tonnes of carbon dioxide from 2015 on.15 As the table below shows, to have a 75 per cent chance of avoiding 2°C warming and an even chance of avoiding 1.5°C warming, global energy emissions must decline to net zero by mid-century. The concept of net zero emissions is gaining traction, with political and business leaders expressing support. Prime Minister Malcolm Turnbull said last year: “Paris is not the end of the journey. It is a step along the way to achieving a net zero-emissions world. That is what we need to do in order to safely arrest global warming”.16 Leader of the Opposition Bill Shorten announced the Australian Labor Party’s (ALP) pledge to achieve net zero national emissions by 2050.17 The Australian Climate Roundtable, comprising peak industry, social and environmental organisations, issued a joint statement in June 2015 calling for climate action, and noting that noted Australia will eventually have to reduce net emissions “to zero or below”.18

However, the pathway to net zero matters as much as the endpoint, because of the need to keep within the carbon budget. If we assume that Australia consumes one per cent of the global carbon budget (Australia currently accounts for around 0.3 per cent of the global population), this means the country can emit roughly 8-9 billion tonnes of greenhouse emissions between 2013 and 2050. At current rates we would burn through this budget before 2030. Making our budget last until 2050 means cutting emissions immediately – and carrying on cutting them all the way to net zero or below.Calculating a carbon budget for the electricity sector may be based on, as in this analysis, the sector’s response to a global policy targeting the <2°C goal (see next section, Modelling Approach). Alternatively, the sector may be allocated a share of a national budget, based on analysis of emission reduction opportunities across the national economy. Logistical limits and social and economic concerns strongly influence the achievable rate of emission reductions. For example, electricity emissions cannot be expected to fall instantly from over 200 million tonnes a year to zero – physical, regulatory and economic constraints on the construction, connection and integration of new clean energy sources mean that this process needs to be done over several years. Similarly, managing price impacts and the transition of affected communities can be better done if the process is spread over a longer period. All these factors argue for immediate action to drive a more gradual and less disruptive transition.

Temperature goal Net zero deadline

CO2 emissions from energy

All greenhouse gas emissions

1.5°C (>50% probability, >75% of avoiding 2°C) 2045-2055 2060-2080

<2°C (>66% probability) 2060-2075 2080-2100

to reducing electricity emissions to net zero. These policies are theoretically less efficient than a reliable 2°C-consistent carbon price, but have a better prospect of practical implementation and operation, and thereby better address the risk of inadequate action toward zero-emissions electricity. Importantly all of the alternative policies assessed can be implemented alongside or in advance of an economy-wide carbon price, and as such do not prevent one from developing.

Table 1. Net zero emissions deadlines for the Paris Agreement temperature goals.19

Section 2. Modelling approach

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The Climate Institute commissioned Jacobs to model a range of scenarios representing policy options currently under discussion: + First base case - 2°C Carbon Price: This scenario

defines what the electricity sector needs to do in the most efficient global transition to the <2°C goal. The Intergovernmental Panel on Climate Change’s (IPCC) 2°C-consistent global carbon price is applied to the electricity sector. This global carbon price starts at about A$70/tonne in 2020, rises to A$110 by 2030 and continues to rise to about A$275 by 2050 (all $2014).20 The change driven by this policy – sustained shift to zero-emissions electricity and a decline in emissions such that the sector emits no more than 1,760 million tonnes between 2020 and 2050 – sets the sector’s carbon budget for this modelling exercise. The other scenarios represent attempts to meet the same carbon budget with different policies and along different emission trajectories.

+ Second base case - Weak Start Carbon Price:. This scenario could be a proxy for a national baseline-and-credit or cap-and-trade scheme set at a level that reflects carbon prices currently seen in existing markets and company disclosures. A carbon price of $17/tonne is applied from 2020, rising by 8 per cent per year to reach $40/tonne in 2030. Thereafter the carbon price jumps to the levels needed to achieve the 1,760 million tonne carbon budget. To represent the lack of perfect foresight in the market, the model is “blinded” during the 2020s to the abrupt price rise that occurs from 2030. Investment made in the 2020s is done on the expectation that the initial price trajectory would continue out to 2050.

This scenario demonstrates the likely divergence from the optimal 2°C pathway under a “realistic” or “weak” carbon pricing mechanism, the scale and speed of the policy adjustment and catch-up action needed in order to meet the carbon budget, and some indications of the risks and economic disruption caused by this type of transition.

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Several policies are then added to the Weak Start Carbon Price scenario to test their ability to close the emissions gap and reduce the risk of post-2030 disruption. In these scenarios, the amount the carbon price rises from 2030 is reduced depending on the amount of emission reductions achieved in the 2020s. + Clean In: This scenario is a proxy for any clean

energy subsidy targeting 50 per cent zero- or near-zero-emission generation by 2030. A certificate scheme targeting 50 per cent clean energy generation (i.e. emitting less than 0.2tCO2e/MWh) by 2030 is added to the Weak Start Carbon Price.

+ Carbon Out: This scenario is a proxy for any regulated phase-out of emission-intensity generation. A 45-year operating lifetime limit is imposed on traditional coal stations. When generating units have operated for 45 years they must either retire or retrofit carbon capture and storage to comply with an emission performance standard of 0.2tCO2e/MWh.

+ Clean In Carbon Out: The 50 per cent Clean Energy Target and the 45-year lifetime limit on coal generators are combined.

Sensitivities + 50-year Carbon Out: Coal generating units are

required to close at 50 years or retrofit carbon capture and storage.

+ 50-year Clean In, Carbon Out: This scenario combined the 50-year lifetime limit and the 50 per cent Clean Energy Target.

+ Low Demand Clean In Carbon Out: A low grid demand sensitivity is constructed using low energy demand projections and an accelerated deployment of distributed solar PV and storage. This is applied to the best performing scenario Clean In Carbon Out. This tests the scenario’s resilience in an environment of ongoing flat demand for large-scale generation, which has the potential to result from ambitious energy efficiency and/or step-changes in innovative distributed energy technologies.

Key assumptions + Technologies: The scenarios assume availability of

a range of renewable energy technologies, battery storage, and carbon capture and storage (CCS) for the sequestration of emissions from fuel combustion. CCS was available for application to coal, gas and bioenergy emissions from 2030. No CCS-coal emerged in the modelling, while CCS-ready gas was built before 2030. In all scenarios except one, all technology costs are based on those used by the International Energy Agency for its 450 ppm scenario. In Low Demand Clean In Carbon Out, storage costs decline faster based on CSIRO’s future energy storage trends, and constraints on the uptake of distributed PV were relaxed.

+ Demand: All scenarios except Low Demand Clean In Carbon Out are based on AEMO and IMO central demand projections. Low Demand Clean In Carbon Out was based on AEMO and IMO low demand projections. None of the scenarios assume an expansion of electricity consumption into sectors where it currently does not play a role, such as electric vehicles. Although electrification of vehicles and industrial processes is highly desirable if it involves a switch to clean energy, calculating the emissions and carbon budget implications of such a switch would require consideration of the emissions and carbon budgets of transport and industrial sectors which is beyond the scope of this exercise.

For more details of the modelling, see Jacobs, 2016. Electricity Sector Impacts of Policies to Cut Emissions of Greenhouse Gases.

Section 3. Modelling results

• 10

EmissionsWeak policy puts achievement of the Paris Agreement commitments at severe riskModelling of the electricity system under a 2°C Carbon Price shows that the electricity sector will emit 1,760 million tonnes of greenhouse gases between 2020 and 2050 to achieve the <2°C commitment. We have defined this figure as our 30 year carbon budget for the electricity sector. The 2°C Carbon Price reduces emissions rapidly in the 2020s (average annual fall of 6 per cent year on year) for total decadal emissions of 1,010 million tonnes. Approximately 57 per cent of the 30-year carbon budget has been consumed by 2030, by which point the emission intensity of electricity is 0.27 tCO2/MWh. The pace of emission reduction slows thereafter (2 per cent year on year), and annual emissions through the 2030s and 2040s average 37 million tonnes. By contrast the Weak Start Carbon Price reduces emissions by 2 per cent year on year during the 2020s, and decadal emissions total 1,730 million tonnes. By 2030, 98 per cent of the 30-year carbon budget has been consumed, and the emission intensity of electricity is still high at 0.67 tCO2/MWh. Emissions decline in line with the government's current 2030 target of 26-28 per cent below 2005 levels, but meeting the carbon budget

requires a massive decrease in post-2030 emissions. Even the replacement of all high-carbon capacity within five years with near-zero carbon generation still exceeds the budget by 550 million tonnes. Aside from the practical considerations of such a systemic shock to the system (and broader economy) there is no hope of meeting the budget without accessing 550 million tonnes of negative emissions, or offsets (see Box 2 below). With these, average net emissions throughout the 2030s and 2040s are at 6 million tonnes per annum.The Clean In Carbon Out scenario closes half the emissions gap between the 2°C Carbon Price and the Weak Start Carbon Price. During the 2020s, emissions reduce by just over 3 per cent year on year, for total decadal emissions of 1,390 million tonnes, and consumption of 79 per cent of the 2020-2050 carbon budget. By 2030, emission intensity of electricity is 0.43 tCO2/MWh. Emissions decline by about 45 per cent below 2005 levels, in line with the Climate Change Authority's recommended minimum national target. Thereafter, meeting the carbon budget requires the use of 290 million tonnes of negative emissions, roughly half the amount needed under the Weak Start Carbon Price, for annual average emissions through the 2030s and 2040s of 24 million tonnes.

Figure 2. Emission trajectories, including negative emissions, by scenario, and the government’s current 2030 target prorated for electricity.

Em

issi

ons

(milli

on to

nnes

CO

2e)

0

50

100

150

200

2050204520402035203020252020

Weak Start Carbon Price

2˚C Carbon Price

Clean In Carbon Out

Low Demand Clean In Carbon OutCurrent government targetof 26-28% below 2005 levels

2˚C carbon budget of 1760mt CO2e

• 11

The Low Demand Clean In Carbon Out scenario comes in well within the 30-year carbon budget. Electricity consumption is significantly lower to begin with, as are emissions, which then decline by an average rate of 4 per cent during the 2020s for total decadal emissions of 900 million tonnes. The post-2030 shock is completely avoided in this scenario, and both emissions and emission intensity continue to decline smoothly, with average annual emissions through the 2030s and 2040s of 43 million tonnes.The other policies modelled (50 per cent Clean Energy Target only, 50-year Lifetime Limit, 45-year Lifetime Limit, 50-year Clean In Carbon Out) were less effective than the combined policies in the Clean In Carbon Out scenarios. On its own, the 45-year lifetime limit scenario did not retire enough capacity to have much impact on emissions in the 2020s, as the impact of the initial generator exits was offset by higher capacity utilisation by remaining coal generators. The 50-year limit did not retire enough capacity before 2030 to have much impact at all. The Clean Energy Target on its own forced new generation into the market which eventually forced out some high-carbon generators, but not enough to prevent ongoing oversupply. Because of their limited impact on emissions, none of these scenarios are discussed further except for the 50 per cent Clean Energy Target. Its impact on the market is discussed on p. 14.

Weak Start Carbon Price2˚C Carbon Price

Clean In Carbon Out Low DemandClean In Carbon Out

Carbon Out

Weak Start Carbon Price2˚C Carbon Price

2050204520402035203020252020

Emis

sion

s (m

illion

tonn

es C

O2e

)

Clean In

Clean In Carbon Out

50-year Clean In Carbon Out

Low Demand Clean In Carbon Out

50-year Carbon Out

0

50

100

150

200

Figure 4. Emission trajectories by scenario.

Figure 3. How much of the carbon budget is consumed by 2030?21

• 12

BOX 2: CLOSING THE GAP – THE USE OF NEGATIVE EMISSIONS OR INTERNATIONAL UNITS

2°C goal

Cos

t of c

arbo

n ($

2014

/tC

O2e

)

Current targets

20502045204020352030202520200

$50

$100

$150

$200

$250

$300

0

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100

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200

Clean In Carbon Out (incl. offsets)

Weak Start Carbon Price (excl. offsets)

2050204520402035203020252020

Em

issi

ons

(milli

on to

nnes

CO

2e)

Weak Start Carbon Price (incl. offsets)Clean In Carbon Out (excl. offsets)

Figure 5. Gross and net emissions for key scenarios using negative emissions or offsets to reach the carbon budget.

Figure 6. Global carbon price paths.

The Weak Start Carbon Price requires over 550 million tonnes of negative emissions to meet the <2°C carbon budget, and the Clean In Carbon Out scenario still requires about 290 million tonnes. Where might these come from? Negative emissions may be procured within the electricity sector if bioenergy combined with carbon capture and storage (bio-CCS) becomes widely available. Availability of bio-CCS or other negative emissions technologies is found to be necessary in global achievement of the 1.5-2°C goal, particularly in scenarios where action is delayed.22

Modelling for The Climate Instiute by Jacobs in 2014 found bio-CCS could play a significant role in Australia, with a capacity to remove and displace up to 65 million tonnes of CO2 equivalent (MtCO2-e) annually by 2050. However, domestic bio-CCS capability is not going to develop without specific policy support to overcome technical and investment challenges.23

If bio-CCS cannot provide negative emissions, they must be sourced elsewhere in the economy and/or internationally.

International carbon units can be an important transitional measure as they may reduce the costs of achieving short-term emission reduction targets. However, the use of international units does not enable countries to avoid the transition to a net zero domestic economy.

Despite the current low prices for carbon units produced through the Clean Development Mechanism, the outlook for units is uncertain. As the Paris Agreement requires all countries to target emission reductions (compared with only a subset of countries under the Kyoto Protocol), there is a strong incentive for countries to provide preferred access to any carbon units that they produce to their own domestic industries. In a world limiting climate change to 1.5-2°C, all countries will need to achieve net zero emissions. In this environment, the international trade of units will be severely constrained.

To illustrate this Figure 6 shows two indicative price paths for internationally traded units over the period from 2020 to 2050. One is the global price of carbon under a <2°C scenario and the other is the global price for a scenario consistent with the commitments that countries have currently made.24

In both cases global prices are substantially higher than current levels. If the emissions intensity of Australia’s electricity sector does not fall substantially it could become increasingly exposed to carbon prices of this magnitude.

• 13

Generation and capacityDrawbacks to delaying the inevitable transitionExisting coal generators need to exit; managing the transition means we need to start early. As Figure 7 shows, meeting any <2°C carbon budget cannot be done without reducing high-carbon generation. The more electricity produced by sub-critical coal station in the short term, the less later. While the 2°C Carbon Price drives a sustained decline over about 12 years, the Weak Start Carbon Price does little to affect coal generation in the early 2020s, which remains at about 150 TWh annually. A small decline in the late 2020s is not enough to forestall plummeting coal generation in the early 2030s, resulting from the adjustment of the carbon price to meet the carbon budget. The central and low demand Clean In Carbon Out scenarios show how this trajectory can be smoothed. Indeed, in Low Demand Clean In Carbon Out, because coal generation starts at around 100 TWh and declines steadily thereafter, complete phase-out is deferred to 2040. Unsurprisingly the retirement of ageing high-carbon capacity follows the same pattern. The 2°C Carbon Price drives the immediate retirement of about 6,000 MW of coal. By contrast the Weak Start Carbon Price drives almost no retirement for the first decade, resulting in the need to close about 10 GW of sub-critical coal in 2031 alone. This is roughly equivalent to all of the coal stations in Victoria plus New South Wales’ biggest generator. Even if this scale of retirement is possible in such a short time frame, it would be massively disruptive for the electricity system as a whole, and particularly for the regional communities where these coal stations are located. By contrast, the central and low demand Clean In Carbon Out scenarios drive more gradual retirement, of between 1 and 3 GW each year in the 2020s and 2030s.

Clean energy needs to grow to over 90 per cent of generation, so why waste a decade?All scenarios need very significant clean energy growth to achieve the <2°C budget. Clean energy eventually needs to provide over 90 per cent (about 300 TWh annually) of electricity. In the Weak Start Carbon Price scenario, clean energy is stagnant during the first half of the 2020s, with a slight increase from about 2027. Thereafter, however, the need to achieve the carbon budget drives a four-fold increase in clean energy generation from around 65 TWh in 2025 to about 180 TWh in 2032 and further fast growth thereafter. Again, the speed and scale of this adjustment would present major disruptive challenges to clean energy industries and the electricity system.

Cle

an e

nerg

y ge

nera

tion

(GW

h)

Weak Start Carbon Price

2˚C Carbon Price

Clean In Carbon Out

Low DemandClean In Carbon Out

205020452040203520302025202050000

100000

150000

200000

250000

300000

350000

Figure 9. Clean energy generation by scenario.

Coa

l gen

erat

ion

(GW

h)

2050204520402035203020252020

Low DemandClean In Carbon Out

Clean In Carbon Out

Weak Start Carbon Price2˚C Carbon Price

0

50000

100000

150000

200000

Figure 7. Coal generation by scenario.

Ret

irem

ent o

f coa

l gen

erat

ion

(MW

)

Low DemandClean In Carbon Out

Clean In carbon Out

Weak Start Carbon Price2˚C Carbon Price

2050204520402035203020252020

-10000

-8000

-6000

-4000

-2000

0

Figure 8. Retirement of coal generators by scenario.

• 14

Clean energy investmentRisks to reliance on subsidy for investmentFor most of the 2020s, the Weak Start Carbon Price sees minimal new clean energy construction because the scenario’s low carbon prices do little to stimulate investment. Approximately 11,000 MW of new clean capacity is installed, but about half of this is solar PV that is not driven by the policy, and most arrives in the later 2020s as a response to expected higher future carbon prices. Adding a 50 per cent Clean Energy Target (CET) should ensure construction of a further 15,000 MW of clean capacity by 2030. However, as Figure 10 shows, in the 50 per cent Clean Energy Target scenario, new investments are dependent on this subsidy for roughly half of their revenue. This has two key implications for investment. First, it means that the CET subsidy is large (averaging $2.7 billion annually) and that the investments it drives are very exposed to changes in the CET’s policy settings. As demonstrated in the 88 per cent fall and flatlining of renewable investment during 2014 and 2015, due to uncertainty over the Renewable Energy Target, the risk of policy instability is a significant deterrent to investors. Some energy analysts have warned that even a 2 per cent increase in costs arising from higher risk premiums would be enough for projects to be cancelled.25 Secondly, the wholesale prices in this scenario are already depressed by surplus capacity and would be depressed further by the low short-run marginal costs of clean energy entering the market. Unless a future policy were implemented to raise wholesale prices, following the expiry of the subsidy period, new clean energy assets could be exposed to wholesale prices too low to provide sufficient return on investment.Under the Clean In Carbon Out scenario reliance on the subsidy declines over time, as the ongoing withdrawal of high-carbon generation prevents the build-up of surplus capacity. The market itself should then signal the need for new capacity entry. This produces a lower total subsidy (averaging $0.4 billion annually), but more importantly an improved investment environment. However, this impact is heavily influenced by demand. Under the Low Demand Clean In Carbon Out scenario the absolute level of the CET is also lower. Notwithstanding the lower target, the market remains in a state of oversupply despite the retirement of coal stations, forcing the CET to bear the burden of incentivising new investment. This results in a total subsidy of ($1 billion) and again produces a situation where investments under the CET are very exposed to policy changes and post-subsidy to low wholesale prices.

Figure 10.Revenue share of clean energy investments across scenarios including a 50 per cent Clean Energy Target.

Rev

enue

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h (p

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ntag

e)

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2030202920282027202620252024202320222021

Carbon componentof wholesale priceSubsidy Wholesale price

excluding carbon

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2030202920282027202620252024202320222021

Clean In

Clean In Carbon Out

Low Demand Clean In Carbon Out

• 15

Costs and risks included in the modelling Costs and risks excluded from the modelling

System costs + Capital expenditure on generation,

transmission and distribution + Operating costs + Fuel + Carbon sequestration costs (eg transport) + Generator retirement + Generator revenuesElectricity price impactsGenerator profitsRisks flowing from policy uncertainty + Assets in the 2020s stranded by leap in

carbon price from 2030Risks of different demand levelsTechnology costs

Risks flowing from policy uncertainty + Higher costs of energy investments + Deterred investment in new projectsWorkforce impacts + Of generator closures + Of clean energy investmentRisks of technology costs being materially higher or lower than modelledCosts of abrupt mass retirements + Economic impacts on regions Costs of abrupt major scale-up in clean energy + Risks of labour and equipment shortages + Risks of regulatory incompatibilityCosts of abrupt electricity price rises + Hardship for vulnerable consumers + Cost blow-out for commercial users + Energy efficiency opportunities foregone due to lack of signal prior to price riseRisks of inability to undertake required rapid closures / clean energy scale up + Electricity system failures and loss of supply + Price shocks + Costs of achieving additional emissions reductions elsewhereCosts of domestic investment in developing new clean energy technologiesHealth impacts + Air pollution + Community stressRisk of failure to meet international commitments + Reputational damage + Diplomatic costs + Economic retaliation

Table 2. Costs and risks included in the modelling and those excluded.

CostsAcknowledging costs beyond those modelledIn terms of spending on the electricity system, the Weak Start Carbon Price and the 2°C Carbon Price cost about the same (NPV $225 billion, 7 per cent discount rate). But the Weak Start Carbon Price scenario contains many more significant risks of disruptive economic impacts and costs within and outside of the electricity system. Although calculations of these other costs is beyond the scope of the modelling undertaken by Jacobs, discussions of the relative costs of the modelled scenarios is incomplete without acknowledgement of the range of potential costs and their impacts. Table 2 outlines key costs that are not included within the modelling. Some of the costs would affect the relative costs of the scenarios. Other costs might be applicable to all scenarios.Valuing risk managementSome of the key risks and costs outlined in the right-hand column of Table 2 are likely to be better managed through scenarios that provide smoother and more predictable emission reduction pathways. This suggests that, although the Clean In Carbon Out scenario costs $50 billion more over the modelled time

period (NPV $276 billion) than the Weak Start Carbon Price, it could provide significant benefits for that extra cost, in terms of reducing the risks of creating price, system and economic shocks and potentially exceeding the carbon budget. It is notable that the 2°C Carbon Price would address these risks as well for a lower total cost – but this scenario appears to face overwhelming political obstacles. While not directly comparable, due to the different technology cost assumptions, the Low Demand Clean In Carbon Out scenario (NPV $164 billion) indicates that costs of transformation could be significantly reduced by policies that lower electricity demand, such as energy efficiency measures. This scenario drives enough emissions reduction in the 2020s to avoid any disruptive adjustments in the 2030s, and minimises price rises. It does, however, increase the dependence of clean energy investment on policy support.In the absence of – or to provide a pathway toward – a carbon price signal like the 2°C Carbon Price, the extra spending required in the Clean In Carbon Out scenario may be considered the cost of risk reduction. In other words, paying an extra $50 billion over 30 years is the premium to insure against the severe risks associated with the Weak Start Carbon Price scenario.

• 16

Extra emissions(3%, central)

Cos

t of e

xcee

ding

car

bon

budg

et ($

2014

milli

on)

-$80,000

-$60,000

-$40,000

-$20,000

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$20,000

$40,000

$60,000

$80,000

$100,000

Extra emissions(3%, 95th percentile)

Weak StartCarbon Price

Clean InCarbon Out

Low DemandClean In Carbon Out

Figure 12. Costs of exceeding the carbon budget.

Valuing failure to reduce emissions.If the carbon budget is exceeded – if, for example, the Weak Start Carbon Price’s sudden deep reduction in emissions in the early 2030s is impossible to achieve, and/or 550 million tonnes of negative emissions required under the are unavailable – then the extra emissions present a problem. They must be added to the emission reduction task of the rest of the economy, or to other countries. Or if they are not offset by deeper emission reductions elsewhere, they contribute to climate change which imposes costs on economic growth, environmental systems, health, and security. Estimates of the economic damage caused by an additional tonne of greenhouse gas emissions – the “social cost of carbon” - have been developed by the United States for use in regulatory analysis.26 Long-term costs of climate change are discounted to represent what society should be willing to pay in the present and near future. The US estimates are based on different discount rates and different probability distributions. The 3 per cent average pathway is considered the “central estimate”, while the 3 per cent 95th percentile pathway reflects a 1-in-20 risk of significantly greater climate sensitivity. It is recognised that the method used is at best incomplete (multiple aspects of climate change impacts are excluded), and so these numbers should be considered lower bound estimates of the actual costs.27 Table 3 shows US estimates converted to Australian dollars.28

These estimates may be applied to the emissions that need to be offset under the Weak Start Carbon Price and the Clean In Carbon Out scenarios in order to meet the sectoral carbon budget. If the 550 million extra emissions under the Weak Start Carbon Price cannot be offset, they impose a social cost of $28-83 billion. Note that these costs would be increased if, in addition, the pace of replacement of high-carbon with low-carbon generation were not able to match that in the modelled scenario, resulting in even more extra emissions.In the Clean In Carbon Out scenario the costs of failing to achieve 250 million tonnes of extra emissions are ($15-36 billion), while Low Demand Clean In Carbon Out produces emission savings worth $23-69 billion due to its overachievement of the <2°C carbon budget. While the post-2030 trajectory of each policy demonstrates deep emission reductions in an effort to achieve the 2°C budget and thereby avoids the social costs of the additional emissions, this analysis makes clear that there are risks to the assumptions that this will be possible and that these risks can be costed. As Figure 12 indicates, these costs are significant.

Figure 11. Resource costs by scenario (NPV, 7 per cent discount rate).

Weak Start Carbon Price2˚C Carbon Price

Clean In Carbon Out

Difference in resource costs = ‘insurance premium’ to reduce disruption risks post-2030

Res

ourc

e co

sts

($20

14 b

illion

)

0

50

100

150

200

250

300

YearCentral estimate (3%

discount rate, average)$/tCO2e

More risk-averse estimate (3%, 95th

percentile)

2020 51 148

2030 61 183

2040 73 221

2050 84 256

Table 3. US central and more risk-averse estimates of the social cost of carbon (converted to A$2014).

• 17

BOX 3: MANAGING THE INEVITABLE RISE IN WHOLESALE PRICESAgeing generators will eventually need to be replaced. As fully depreciated assets are replaced by new capacity, there is an inevitable rise in wholesale prices. The smart thing to do is manage this through forward planning and ambitious energy efficiency. Currently, wholesale electricity prices are fairly low, reflecting the surplus of supply. Wholesale prices have begun to rise slightly in recent months as supply has tightened – due to growth in demand and the retirement of some generators as well as other short-term factors. However, the achievement of the Renewable Energy Target (RET) is likely to depress prices. Modelling for AEMO has forecast further slight rises in wholesale prices out to 2020, as the effect of demand growth is offset by the increased capacity introduced under the RET.28 Likewise, the NEM futures market reflects widespread expectations of gradually increasing wholesale prices.29 Beyond 2020, wholesale prices will eventually rise further as surplus capacity closes and new capacity is needed. This is a core design feature of the electricity market. In all the core scenarios, wholesale prices converge around the long-run marginal costs of new investment, remaining around $110-120 as new clean generators continue to replace older, high-carbon generators throughout the modelled period. However, the scenarios differ in terms of the timing and trajectory of this rise. In the 2°C Carbon Price scenario, the wholesale price would immediately rise to levels required for significant replacement of capacity. In the Weak Start Carbon Price scenario, the failure to spur any transformation of the power supply means that most of this effect is deferred until 2030 – at which point the wholesale price doubles. Clean In Carbon Out results in a gradual ramp-up of wholesale prices over this period. In contrast, the lower system costs in the Low Demand Clean In Carbon Out scenario are reflected in lower and more slowly rising prices over the whole modelled period.

Retail prices are less affected, as wholesale prices make up less than half of the retail price. In the 2°C Carbon Price, residential prices rise immediately but then decline gradually over the rest of the period. In contrast, the Weak Start Carbon Price delays the rise for a decade and then rises abruptly. In Clean In Carbon Out, the retail price increases by an average of 3 per cent annually over about 12 years, before declining. Across all these scenarios prices eventually start to decline. Assuming no direct interventions are made to help consumers manage bills (e.g. through energy efficiency policies), the share of average household income spent on electricity is roughly 2-4 per cent (differing slightly from state to state) across all core scenarios throughout the modelled period.

In the Low Demand Clean In Carbon Out scenario, residential retail prices flatline for about fifteen years before starting to rise very slowly. Spending on electricity remains slightly below 2 per cent of average household income.

Time 2°C Carbon Price Weak Start Carbon Price

Clean In Carbon Out

Low Demand Clean In Carbon Out

2021-2030 125 59 74 48

2031-2040 114 126 133 76

2041-2050 107 119 121 99

Table 4. Average annual wholesale prices across key scenarios ($/MWh).

Time 2°C Carbon Price Weak Start Carbon Price

Clean In Carbon Out

Low Demand Clean In Carbon Out

2021-2030 32.9 24.5 27.6 26.7

2031-2040 33.5 34.5 36.0 27.8

2041-2050 32.2 33.2 34.3 31.2

Table 5. Average annual residential retail prices across key scenarios (¢/kWh).

It is important to note that rising electricity prices do not have to equal rising electricity bills. Research suggests that a range of energy efficiency measures could offset the impact of price rises on many consumers. Modelling of ambitious economy-wide emission reduction efforts undertaken by ClimateWorks Australia found that by accelerating the uptake of available technologies from 2020, Australia could halve the amount of energy use per household and per square metre of commercial space by 2050. This effect would more than offset higher electricity prices resulting from policies to decarbonise electricity. ClimateWorks notes: “This implies that an average household electricity bill would be around 30 per cent lower (adjusted for inflation) in 2050 than today, because energy efficiency gains outweigh power cost rises”. Moreover, this analysis finds that if per capita income is assumed to grow at a rate of 1.2 per cent per year, the share of household income spent on electricity falls by around half”.30

The Council of Australian Governments has agreed on a National Energy Productivity Program (NEPP), which, if fully implemented, could place substantial downward pressure on electricity demand. The NEPP contains commitments to expand and/or strengthen efficiency standards and disclosure requirements for equipment and residential and commercial buildings, among other measures. The NEPP has an overall target of a 40 per cent improvement in energy productivity by 2030 (from 2015 levels).31 However, analysis by ClimateWorks Australia finds a near-doubling of energy productivity is both necessary and achievable, and the Alliance to Save Energy is working with a range of businesses to develop pathways to double energy productvity.32-33 These efforts suggest that there is scope to strengthen the ambition of the NEPP to enable energy users to access the full extent of potential energy savings.

Section 4. Discussion: Recognise and address risks

• 18

The risks of a delayed transition to a clean electricity system need to be acknowledged Too slow a transformation means we need to achieve faster, deeper emission cuts thereafter – which requires multiple power station closures and hasty construction of replacement power sources in a very short space of time. There are several major risks associated with this outcome, all of which are only broadly outlined by the Weak Start Carbon Price scenario: + The electricity system itself faces potential shocks

to security and stability from the speed at which generation would have to be retired and replaced. The short time period allows little time to prepare, adapt to, and invest in the challenges facing generation, transmission, distribution and auxiliary services. The slow rule-change processes within the regulatory system mean that regulations would be unlikely to facilitate the required changes efficiently.

+ The pace of change will make it hard for market participants to make good decisions, increasing the risk of misallocated resources.

+ Electricity users would face a price shock due to the sudden shift in generation sources. The potential to manage this through energy efficiency would be severely impaired by the lack of early signalling of the eventual price rises.

+ Communities where traditional coal generators are an important source of economic activity face employment shocks, which could have long-term impacts if not addressed. This risk also extends to communities dependent on aluminum smelting as these facilities have traditionally relied on cheap coal-fired generation. Communities are also at risk from unplanned, underfunded retirement, which could transfer to the public the costs of liabilities such as redundancies and site remediation. The Latrobe Valley, the Hunter Valley and Collie are particularly exposed to these risks.

+ Clean energy industries would struggle to scale up in time. During the stagnant decade where the industry has very little to do, Australia would lose expertise and capital, and delay development of one of the most important economic sectors of this century. The jump in annual installations from 500 MW to 4,500 MW would require rapidly sourcing a much larger workforce and much more equipment, potentially creating labour shortages, wage rises,

higher construction costs and a greater reliance on imported workers and materials than would otherwise be the case. The recent LNG construction boom in Queensland provides an example; the simultaneous construction of multiple similar large-scale assets resulted in major shortages of labour, equipment and accommodation, and cost overruns, as well as associated boom-busts in related industries and affected communities.

+ Uncertainty over the future availability and cost of negative emissions.

The risks of policy weakness need to be addressedModelled climate and energy policies have several features which their real-world counterparts lack. In theory, the best policy for electricity sector decarbonisation is a carbon price. It internalises the cost of carbon pollution, it can be adjusted reasonably easily and it allows companies flexibility in their responses. However, to be optimally effective a carbon price needs to be optimally implemented – in other words, it needs to be consistent with long-term objectives, reasonably predictable, and reliable. Modelled carbon prices, for example, assume efficient implementation and perfect foresight, such that future carbon price trajectories are visible and able to be relied on by theoretical investors. Modelled clean energy subsidies similarly contain the assumption that the policy environment will remain stable. The recent history of many domestic and international policies demonstrates these assumptions are unlikely to be accurate in practice. The risks of relying on weak carbon pricing Putting a price on carbon is widely recognised as a critical policy intervention to reduce emissions. Carbon prices can improve the competitiveness of lower-carbon options, encourage energy savings, allow flexibility in responding to the price signal, and raise revenue that can be used to smooth transitions for communities and industries. However, it is notable that very few of the carbon prices currently operating are capable of providing a robust investment signal on their own. Many are bolstered by policies specifically targeting clean energy and energy efficiency – which sometimes act to further depress carbon prices.

• 19

Notwithstanding its volatile history in Australia, carbon pricing – whether fixed taxes, the result of emissions trading or other market mechanisms, or set by private companies to drive internal investment decisions – is becoming an increasingly normal feature of business operations. As well as publicly established carbon prices, such as the carbon market in the European Union, pilot markets in China, and carbon trading in some states and provinces in the United States and Canada, more than 1,000 major companies either use an internal carbon price or plan to start doing so soon.37 The levels of carbon pricing vary from over $100/tonne to less than $1, but most emissions are priced well below $15/tonne.38 This applies both to carbon markets and taxes and to companies’ internal carbon prices. Although this level of pricing will affect decision-making across the economy, it has minimal impact on investment decisions in the electricity sector, where a carbon price above $70/tonne is necessary to enable new clean generation to outcompete fully depreciated high-carbon generation. Moreover, most carbon prices have a history of volatility and/or a tendency to fall well below levels predicted by models. With the exception of some countries where strong carbon pricing has benefited from many years of solid political support (e.g. Norway, Sweden), most carbon prices operating today are well below the optimal level indicated by the IPCC, and their future trajectory

is very uncertain. Most carbon pricing schemes are implemented in specific political and economic contexts where short-term impacts and the interests of powerful stakeholders are often accorded greater priority than the long-term climate objective. The political dynamics of carbon market implementation have often resulted in weak initial market parameters that may then be frequently changed (e.g. introduction and then freezing of a rising carbon price floor in UK; introduction and then abolition of the carbon price in Australia; New Zealand’s decision to prolong the introductory two-for-one permit deal), or that face obstacles to adjustment despite a failure of the scheme to have the expected effects (e.g. the lengthy contested efforts within the EU to reduce the permit surplus in the ETS; the ongoing imbalance between demand and supply that has seen Kyoto credits fall from $20/tonne to less than $1). Although the appetite for carbon pricing appears to be growing globally, investors are also likely to factor in some probability that future carbon prices will face similar pressures to those faced today. This creates a very wide margin for uncertainty. This means investors may apply an uncertainty discount in even short-term carbon price forecasts, and significantly discount the prospect that long-term carbon prices may reach the levels needed to achieve net zero emissions.

Renewable energy now makes up about 40 per cent of South Australia’s (SA) electricity generation. By this metric, the state has made significant progress toward a cleaner energy supply. However, the state government and electricity market institutions have only recently recognised the need to address other requirements for a smooth transition to a zero-emission electricity system. These include technologies and processes to manage the integration of high levels of intermittent generation. The imminent withdrawal of the state’s remaining coal-fired power station is now forcing attention to these issues, and the SA government is developing a strategy to meet its new commitment to zero net emissions by 2050. But the SA experience is less a template than a signal to other governments of the need to plan ahead for the transition to zero-emissions electricity.In mid-2015, power company Alinta announced its Flinders Operations (the Leigh Creek coal mine and coal-fired power stations Playford B (already mothballed) and Northern) would close between March 2016 and March 2017. In August it announced the closures would take place by March 2016. Leigh Creek closed in November and the closure of Northern was later extended to May 2016. The short period between announcement and implementation of the closure plans did not give the affected community, the state government, or energy market institutions much time to prepare for the impact of the closures on the Port Augusta economy and the South Australian electricity system. These closures affect 430 jobs. Port Augusta faces an uncertain future. The area has excellent solar and wind resources, various companies have expressed interest in developing renewable energy projects and there is strong local interest in attracting renewable

energy investment. However, at this stage it is not clear whether any of the potential projects will be developed. Also unclear is whether Alinta’s former employees will be able to access new renewable energy or other jobs.The withdrawal announcement of the power stations from the National Energy Market has created a range of short- and medium-term concerns about the security and stability of SA's electricity supply. The Australian Energy Market Operator has noted that, under normal operating conditions, SA’s electricity system remains secure and reliable. However it is heavily reliant on the uninterrupted operation of transmission links with Victoria, and new means of providing support services like frequency and voltage control need to be found. AEMO is currently developing a work program to examine how to manage potential challenges to SA’s electricity system over the next ten years, including through changes to the regulatory framework and market rules. However, AEMO has also noted that some challenges may arise before such changes have taken effect, so interim solutions under the current rules and regulations need to be found. In other words, changes on the ground are occurring and may continue to occur well before the electricity market is ready for them.34

Positively, the SA government has recognised that it faces not just immediate challenges, but also an opportunity to set a long-term strategy. Short-term supply and security issues are being addressed through initiatives like the purchase of up to 481 GWh of low-carbon electricity (<0.4tCO2/MWh).35 Longer term, the government has also announced a commitment to net zero emissions and is developing a roadmap for achieving this.36

BOX 4: LEARNING FROM THE SOUTH AUSTRALIAN EXPERIENCE

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While it seems probable that Australia will eventually re-introduce a broad-based carbon price in some form, it seems much less likely that it will, on its own, be able to drive electricity decarbonisation, given the necessity for a strong signal ($70/tonne and above) to be demonstrably stable over more than a decade.

The risk of depending on clean energy subsidiesGrowing Australia’s clean energy supply is central to the modernisation and decarbonisation of the power system. Despite Australia’s natural advantages and significant expertise in clean energy, investment in this area has been beset by frequent changes in the policy environment, culminating in the government’s 2015 decision to cut the large-scale Renewable Energy Target from 41 GWh to 33 GWh. This move followed the repeal or attempted abolition of several other climate and energy policies and a protracted period of uncertainty over the RET’s future. As a result, investment in large-scale renewables plunged in 2014, down 88 per cent from the previous year. 2015 saw minimal improvement. Even if debate over the policy has been resolved, there remain real questions as to whether the RET will be achieved. Certificate prices have risen to levels that should drive new investment, but the liable entities under the scheme – the power companies – face a significant disincentive to invest. Additional renewable generation squeezes the revenues across the rest of their portfolio, both by competing for market share and by lowering the wholesale price across the market. This dynamic, whereby the RET drives new generation into an already oversupplied market, reducing market revenues for all suppliers and relying increasingly on subsidy revenue via certificates, would be exacerbated by a future expansion of the RET, or indeed by any future Clean Energy Target, Low Emissions Target, Contract for Difference, or Feed-in Tariff. While some non-RET capacity would eventually be forced out of the market, the most economically-marginal, rather than the most emission-intensive generators would leave. This process would be unpredictable, unreliable and inconsistent with an efficient transition to a clean electricity system. And as more and more investment is driven by the policy subsidy than by the market, the greater the financial cost of the subsidy, and the greater its vulnerability to future adjustment.Relying on clean energy support to shoulder the burden of emission reduction offers relatively quick and easy results in the short term but on its own fails to provide long-term investment stability, as indicated by Figure 10.

The risks of ongoing policy uncertainty.Policy predictability is vital for efficient investment in a sector with long-lived assets, but ongoing policy turmoil over the last decade has reduced market expectations of the stability of current and future policies. Absence of policy in the face of significant challenges also imposes costs by creating uncertainty. These costs may be expressed in higher risk premiums, sub-optimal investment decisions and ultimately higher costs to consumers. Investing in plant with lower upfront costs but higher ongoing costs and higher carbon costs will result in customers paying more over the long term. Analysis for the government’s UNFCCC Taskforce warned that higher perceived policy risk could increase energy project risk premiums by 4 per cent, noting that policy risk “reduces

investment in the energy sector, and results in higher energy prices and business input costs.39 Modelling by CSIRO for the industry stakeholder group the Future Grid Forum found carbon policy uncertainty resulted in power prices 17 per cent higher than they would have been with a stable carbon policy signal.40

Recognising that real-world policy may be less effective than its modelled version does not mean that policymakers should give up on designing the best policy they can. Resilience of the policy framework to real-world conditions may be more valuable than the theoretical efficiency of modelled options.

Climate and energy policy need to be integrated in a long-term strategy to provide stability for efficient investmentConsistency between long-term goal and short-term policy settings neededIt is not certain that future Australian governments will follow through on the national commitment to avoid 1.5-2°C warming – but there is a strong possibility that they will, and electricity market participants are increasingly aware of this. At the same time, the prospect of strong future emission reduction action is not enough to drive investment in the absence of supporting policy. If short-term emission reduction and energy goals are inconsistent with long-term targets, investment may be inefficiently directed, cost more and/or be deterred. Clarity on the long-term objective creates a level of confidence and stability in the system and enables the development in the short-term of policies capable of delivering the long-term objective.

Policy makers should deploy all key levers conscious of the need to manage the tensions among themPolicy that prices carbon at politically sustainable levels may not drive the replacement of high-carbon assets with low-carbon ones. Policy that incentivises zero-emission generation, such as a Clean Energy Target, does not ensure the timely exit of high-carbon generators. Policy that ensures timely exit, such as a regulated limit on plant emissions or operating life, does not ensure that replacement generation is clean enough. Energy efficiency policies reduce costs to energy users and reduce the overall cost of building a new clean energy system, but may contribute to market oversupply and deterrence of new investment.

In the absence of – or in the lead-up to reliable political and public support for a sufficiently strong carbon price, each of these other measures has an important part to play in a package to achieve Australia’s Paris Agreement commitments. A moderate carbon price internalises some part of the cost of emissions, and can raise revenue that can help communities and workers. Clean energy support ensures that new investment is consistent with climate goals. Phase-out of high-carbon generation reduces emissions, addresses oversupply and enables preparation for community transition. Energy efficiency reduces costs and emissions. The combination of these elements can address the various risks discussed above, and provide sufficient stability and predictability for investment in a pathway toward net zero emissions.

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Predictability is also very important for other stakeholders. Communities, governments and electricity market institutions face higher risks from ongoing uncertainty over the future direction of the electricity system. As recent events have shown, unplanned generator closures harm communities and create shocks to the electricity market. These could have been avoided if early preparation had been undertaken to ensure community and system resilience. Further shocks are inevitable if we fail to anticipate the system’s transition, but they are avoidable if we begin planning now. A long-term, comprehensive strategy allows everyone to prepare for the next steps: investment in new and cleaner sources of power, economic transition for communities and workers, and rehabilitation of power stations and mines.

RecommendationsTo meet a 1.5-2°C carbon budget, Australia’s electricity sector needs a policy framework that: 1 is consistent with a predictable pathway to net zero

emissions by mid-century, and a 1.5-2°C national carbon budget;

2 starts systematically retiring existing high-carbon generators on a timeline that ensures all have exited by 2035;

3 facilitates replacement of high-carbon generation with zero or near-zero emission energy;

4 provides a well-funded and well-planned structural adjustment package for communities affected by generator closure;

5 strategically deploys energy efficiency policies to minimise costs to energy users and further reduce emissions; and

6 includes a carbon pricing mechanism that is capable of scaling up over time to provide a bankable signal for investment consistent with net zero emissions by mid-century. There is a low probability that a price of sufficient strength and reliability will emerge quickly, so the measures listed above are needed to deliver a timely transition.

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1 This report uses the term clean energy to include any form of electricity that produces less than 0.2 tonnes of greenhouse gases per megawatt hour (tCO2e/MWh).

2 UNFCCC, 2015. ‘Adoption of the Paris Agreement’. FCCC/CP/2015/L.9/Rev.1. https://unfccc.int/resource/docs/2015/cop21/eng/l09r01.pdf.

3 Joeri Rogelj, Michiel Schaeffer and Bill Hare, 2015. ‘Timetables for Zero Emissions and 2050 Emissions Reductions: State of the Science for the ADP Agreement’, policy brief, Climate Analytics. http://climateanalytics.org/files/ca_briefing_timetables_for_zero_emissions_and_2050_emissions_reductions.pdf.

4 REN 21, 2015. Renewables 2015: Global Status Report. Frankfurt School UNEP Collaborating Centre for Climate & Sustainable Energy Finance. http://www.ren21.net/status-of-renewables/global-status-report/.

5 World Bank, 2015. State and Trends of Carbon Pricing. World Bank, Washington DC. http://www.worldbank.org/content/dam/Worldbank/document/Climate/State-and-Trend-Report-2015.pdf.

6 Chris Littlecott, 2015. G7 Coal Scorecard: Benchmarking Coal Phase Out Actions. E3G, London. https://www.e3g.org/docs/G7_Coal_Scorecard_Report_-_E3G,_October_2015.pdf.

7 UNFCCC, ‘Adoption of the Paris Agreement.8 Rogelj et al., Timetables for Zero Emissions.9 BHP Billiton, 2015. ‘Climate Change: Portfolio Analysis’.

BHP Billiton, September. http://www.bhpbilliton.com/~/media/5874999cef0a41a59403d13e3f8de4ee.ashx.

10 Origin Energy, 2016. ‘Submission on Special Review Second Draft Report – Australia’s climate policy options’, submission to the Climate Change Authority, 19 February. http://www.climatechangeauthority.gov.au/sites/prod.climatechangeauthority.gov.au/files/submissions/2016/SpecialReport2/Origin.pdf.

11 World Resources Institute, 2016. CAIT Climate Data Explorer [online database]. http://cait.wri.org/historical, last accessed 10 April 2016.

12 For example, AEMO estimates that surplus capacity within the National Electricity Market is not expected to be absorbed (by a combination of demand growth and generator retirements) until 2023-24, assuming all announced retirements are implemented. AEMO, 2015. Electricity Statement of Opportunities.

13 Department of the Environment, 2015.Australia’s emission projections 2014-15. http://environment.gov.au/climate-change/publications/emissions-projections-2014-15.

14 Energy Australia, 2016. ‘Re: Special Review, Second Draft Report – Australia’s carbon policy options’, submission to the Climate Change Authority, 22 March. http://climatechangeauthority.gov.au/sites/prod.climatechangeauthority.gov.au/files/submissions/2016/SpecialReport2/Energy%20Australia.pdf.

15 Joeri Rogelj et al., 2016. ‘Differences between carbon budget estimates unravelled’, Nature Climate Change 6, 245–252 http://www.nature.com/nclimate/journal/v6/n3/full/nclimate2868.html.

16 The Australian, ‘Paris climate summit: Malcolm Turnbull eyes carbon target lift’, 30 November 2015.

17 Bill Shorten and Mark Butler, 2015. ‘Labor Commits to Net Zero Pollution by 2050’, Media Release, 27 November.

18 Australian Climate Roundtable, 2015. ‘Joint Principles for Climate Policy’, 29 June.

19 Rogelj et al., Timetables for Zero Emissions.20 IPCC, 2014, Climate Change 2014: Synthesis Report.

Contribution of Working Groups I, II and III to the Fifth Assessment Report of the Intergovernmental Panel on Climate Change [Core Writing Team, R.K. Pachauri and L.A. Meyer (eds.)]. IPCC, Geneva.

21 Because the Low Demand Clean In Carbon Out scenario is based on a lower demand forecast than the core scenarios, caution should be applied in making comparisons with these other scenarios. It is, however, included in these figures as an illustration of how lowering demand (e.g. through energy efficiency policies) can change the impact of the Clean In Carbon Out scenario.

22 Luderer et al., 2013. ‘Economic mitigation challenges: how further delay closes the door for mitigation targets’, Environmental Research Letters 8:3, http://dx.doi.org/10.1088/1748-9326/8/3/034033.

23 The Climate Institute, 2014. Moving Below Zero: Bioenergy with carbon capture and storage. The Climate Institute, Sydney.

24 Current targets are consistent with global warming of roughly 3°C. Carbon price paths based on IPCC, Climate Change 2014: Synthesis Report.

25 Based on informal discussions with a number of energy analysts.

26 Interagency Working Group on Social Cost of Carbon, United States Government, 2013. Technical Update of the Social Cost of Carbon for Regulatory Impact Analysis. http://www.whitehouse.gov/sites/default/files/omb/assets/inforeg/technical-update-social-cost-of-carbon-for-regulator-impactanalysis.pdf.

27 See The Climate Institute, 2014. Counting All the Costs: Recognising the carbon subsidy to polluting energy. The Climate Institute, Sydney. http://www.climateinstitute.org.au/verve/_resources/TCI_SocialCostOfCarbon_PolicyBrief_September2014.pdf.

28 Frontier Economics, 2015. Electricity Market Forecasts: 2015. A report prepared for the Australian Energy Market Operator (AEMO). http://www.aemo.com.au/Electricity/Planning/Forecasting/National-Electricity-Forecasting-Report/NEFR-Supplementary-Information.

29 ASX Energy, ‘Base Future Prices’, last accessed 15 March 2016. https://asxenergy.com.au/.

30 ClimateWorks Australia, 2014. Pathways to Deep Decarbonisation in 2050: How Australia can prosper in a low carbon world: Technical Report. ClimateWorks, Melbourne. http://climateworksaustralia.org/sites/default/files/documents/publications/climateworks_pdd2050_technicalreport_20140923.pdf.

31 COAG Energy Council, 2015. National Energy Productivity Plan 2015–2030. https://scer.govspace.gov.au/files/2015/12/National-Energy-Productivity-Plan-release-version-FINAL.pdf/.

32 ClimateWorks, Pathways to Deep Decarbonisation.33 Australian Alliance to Save Energy, 2016. ‘2xEP: Doubling

Australia’s Energy Productivity’ (website). http://www.2xep.org.au/.

34 AEMO, 2016. Update to Renewable Energy Integration in South Australia: Joint AEMO and Electranet Report. AEMO, February.

35 Government of South Australia, 2015. ‘Low Carbon Electricity Supplies and Services’, Display Tender DSD028461.

36 Government of South Australia, 2015. South Australia’s Climate Change Strategy 2015-2050.

37 CDP, 2015. Putting a price on risk: Carbon pricing in the corporate world. https://www.cdp.net/CDPResults/carbon-pricing-in-the-corporate-world.pdf.

38 World Bank, State and Trends of Carbon Pricing.39 Warwick J. McKibbin, 2015. Report 1: 2015 Economic

modelling of international action under a new global climate change agreement. McKibbin Software Group.

40 CSIRO, 2013. Change and choice: The Future Grid Forum’s analysis of Australia’s potential electricity pathways to 2050. CSIRO, Canberra. https://publications.csiro.au/rpr/download?pid=csiro:EP1312486&dsid=DS13.

ENDNOTES