Unit 3, 4 Kennedy Street, Kingston ACT 2604

Australian Industry Greenhouse Network Ltd

Unit 3, 4 Kennedy Street, Kingston ACT 2604

PO Box 4622, Kingston ACT 2604

T +61 2 6295 2166 | F+61 2 6232 6075

| W

18 May 2015

Review of the Victorian Energy Efficiency Target

Energy Sector Development Division

GPO Box 4509

Melbourne Vic 3001

Dear Sir

Response to Review of the Victorian Energy Efficiency Target

The Australian Industry Greenhouse Network (“AIGN”) welcomes the opportunity to respond to the Review of the Victorian Energy Efficiency Target.

AIGN represents peak industry associations and corporates with a strong interest in climate change policy. Its approach to this subject is guided by a set of principles, a copy of which is attached. Collectively, those entities represented by AIGN are responsible for some 60% of Australia’s annual emissions of greenhouse gases, with a number of AIGN members operating large manufacturing facilities in Victoria.

We note that with the cessation of the Environment & Resource Efficiency Plans (“EREP”) program, which excluded those sites registered by the Victorian Environment & Protection Agency from participation in the VEET, there is now some consideration of the inclusion of “large businesses and industry” in the scheme. In responding to the Review, AIGN will primarily comment on issues around the setting of future targets and the possible inclusion of large business in the VEET.

In considering this response, the members of the Review should note AIGN’s broad range of members, and resultant wide diversity of views on greenhouse and energy policy. This response accords with the views of our members in general. However, at times there are variations in the positions of individual members on specific issues. It is therefore important that the Review considers AIGN’s comments alongside any responses made to the Review by our members.

BACKGROUND

AIGN advocates a climate change policy environment that delivers least-cost, environmentally-effective and equitable outcomes for Australia. It is important that policies applying in this area are stable, predictable and avoid complexity to help minimise investment uncertainty, while ensuringthat Australian export- and
import-competing industries are not exposed to costs not faced by these industries in other countries.

As the recent Federal Energy White Paper noted,“energy is an enabler of improved productivity and competitiveness within the Australian economy”. Given the structure of Australia’s economy, it is important for reasons of competitiveness that Australia has competitively priced energy, and that the Government at both the national and state level avoid policies and programs that are implemented in the absence of market failure or that do not address the underlying market failure specifically, and therefore run the risk of encouraging irrational decision-making.

australian industry greenhouse network1

Response to Review of the Victorian Energy Efficiency Target

18 May 2015

Our preference is that climate change policies should be implemented at the national level to avoid the costly duplication that may arise from a competing set of national and state-based mitigation policies. AIGN is aware that under the Council of Australian Governments (“COAG”), a considerable amount of work has already been undertaken to remove competing policies particularly in the area of energy efficiency, where the proliferation of policies added to industry costs for no appreciable outcome.

Rather than an area of government intervention, AIGN considers that investment in energy efficiency is fundamentally a business decision, which is impacted by a wide range of considerations. There is no evidence of market failure, as highlighted by the significant recent investment in response to rising energy prices. Policy that narrowly focuses on reductions in the use of energy implies that the use of one factor of production (energy) can be minimised without regard to the opportunity costs associated with other inputs.

Any consideration of new policy measures should be developed transparently to engender broad community input support, and AIGN would look forward to the opportunity for ongoing consultation. It notes that a number of the recommendations, if accepted, would require changes to existing regulation and hence further consultation.

VICTORIA’S INDUSTRIAL BASE AND INVESTMENTS IN ENERGY EFFICIENCY

As with Australia’s economy, Victoria’s economy is led by a range of industries that have developed here due to the availability of, and access to, competitively-priced energy and resources. Indeed, our natural resources advantage underpins our prosperity. Australia’s energy endowment and energy industries should continue to provide competitive advantage to the economy.

Energy costs have, however, increased substantially over the past decade, although moderating in the last few years. As energy costs have increased, it is clear that there is an even stronger incentive for industrial businesses (both large energy producers and large energy users) to minimise their energy use in order to save money. This has been highlighted by a number of surveys:

In a survey conducted by the Australian Food & Grocery Council[1] of its members, it was noted that the greatest response by firms to increased energy costs has been investment in energy efficiency measures through internal capital (95%).

In an Australian Industry Group (“Ai Group”) survey[2] that evaluated the impact of higher energy costs, it was reported that Ai Group members had been taking action to reduce their carbon intensity “…through the adoption of energy efficiency measures in response to several years of high energy costs and anticipated carbon constraints”.

The adoption of measures designed to improve energy efficiency has impacted positively on Australia’s overall emissions performance.

Climateworks noted recently that, “Since 1990, the overall emissions intensity of Australia’s economy has almost halved and emissions per capita have decreased by approximately 25% over this period (ABS 2012, 2013a; DOE 2014)”[3].

The PricewaterhouseCoopers’ ‘Low Carbon Economy Index 2014’ highlighted that over the period 2008 to 2013, Australia reduced emission intensity by 4.6%, whilst on average, GDP grew by 2.6% pa.

The end result has been that, as the consultancy firm Trading Nations Consulting commented in a recent report,“Australia has performed better than most other developed economies in constraining emissions growth since 1990. Its modest increase in total emissions of 2.4% from 1990 to 2012 compares favourably with Canada (+42%), Japan (+8.6%) and the United States (+2.7%)(page 6, Climate Policy and Australia’s Resources Trade).”[4].

The above findings demonstrate that in an environment of rising energy costs, examining the cost-effective use of energy is an indispensable part of business management, which both large energy producers and large energy users undertake as a matter of course. (This issue is considered further in the next section.)

AIGN POSITION ON ENERGY EFFICIENCY

In the area of investment in energy efficiency, there is no evidence of market failure, as highlighted by the significant recent investment in response to rising energy prices. Rather than an area of government intervention, AIGN considers that investment in energy efficiency is fundamentally a business decision, which is impacted by a wide range of considerations.

AIGN has recently prepared a detailed paper, titled ‘Business Decision-making Paper’, which examines the current drivers and barriers for the adoption of energy efficiency measures in the Australian industrial sectors, and outlines framework principles for government policies designed to promote further investment in energy efficiency as part of a greenhouse gas (“GHG”) mitigation program. A copy of the paper is available on AIGN’s website at

The AIGN paper highlights that a policy that narrowly focuses on reductions in the use of energy implies that the use of one factor of production (energy) can be minimised without regard to the opportunity costs associated with other inputs. Such an approach may translate into lower growth for the Australian economy as it isolates one aspect of a business and considers it out of context, thus leading to poor policy design.

Investment, and hence production decisions, are driven by the combined costs of all inputs and best reflects a firm’s perspective of the economic environment and their competitiveness within it. Investment decisions within the industrial sector are largely based on being able to secure long-term, competitively-priced supplies of raw materials, energy and labour. Decisions by business on capital investment, which take time to mature and are typically large (as compared to current expenditure), have to be based on predicted returns and meet a range of other key business priorities.

Although many constraints to energy efficiency investment can be identified, some reflect the rational decision-making of energy users and do not of themselves represent market failure. Importantly, energy is not considered in a vacuum by industry, but as one of a range of factors contributing to performance and profitability. As a general rule, higher energy efficiency equals better performance and profitability, but this does not mean that every opportunity to invest in energy efficiency should, or can, be realised.

In response to some commentary that a lack of internal capital is the major impediment to investment in energy efficiency, it should be noted that while capital is constrained in many situations, the real issue is in prioritising the capital (‘capital efficiency’). Businesses are not homogenous, and what makes sense for one business may present different costs and benefits to another business in terms of energy efficiency. Firms must have regard to many other considerations (eg. product quality, market conditions and level of demand, marketing, competitors’ actions, other production inputs, and occupational health and safety, to name a few), and not just the benefits and costs of improved energy efficiency.

If improving energy efficiency is foregone in favour of other more cost-effective opportunities, this is a rational decision in the best interests of the business. It is not a reflection of market or information failure for a firm not to prioritise investment in energy use, but rather it reflects a rational perspective that a firm will seek to maximise its return on investment.

INVESTMENT AND COMPETIVENESS CONSIDERATIONS

Large industrial businesses (eg. smelters and refineries in the aluminium supply chain, steel mills, etc) incur energy expenditure in the order of hundreds of millions of dollars, so that energy costs impact directly on profitability. Typically, trade-exposed energy users are price-takers in competitive global commodity markets, and any inefficiencies adversely impact on their competitiveness, so there is every incentive not to waste energy. Core production processes of industrial companies are subject to intense business improvement focus, and therefore negative or low-cost, short payback, substantial improvements are rarely found.

Companies have a number of options to determine where to invest in energy efficiency in the Australian economic context, such as from a greenfield site, to major process improvements, to bolt-on improvements (eg. installation of variable speed drives). The impediments to increasing the energy efficiency of existing operations are larger than for new operations, where measures can be integrated into the design and process requirements. However, given the current state of the Australian economy and international competition for investment capital, the focus tends to be on bolt-on improvements as companies frequently find they are not able to achieve payback from new, larger projects.

Additionally, decisions on where returns can be maximised do not solely relate to the Victorian or Australian environment, but are also taken on a global scale. For example, a decision on an energy improvement opportunity in an Australian subsidiary may be competing for funding with a similar opportunity in another market. In this context, general market conditions and growth prospects, as well as government policy, will have major roles to play. Obviously, in the context of an environment where energy costs are increasing, business will focus more on identifying and implementing energy savings where capital investment is otherwise attractive.

Government policies and programs that are implemented in the absence of market failure, or that do not address the underlying market failure specifically, run the risk of encouraging irrational decision-making. This is particularly the case when the form of intervention is obligatory and prescriptive.

PROPOSED POLICY APPROACHES TOWARDS INDUSTRIAL ENERGY EFFICIENCY

As investment in energy efficiency is fundamentally a business decision, the success of policies and strategies to promote greater uptake of energy efficiency measures will depend primarily on the business case for such investments.

Rising energy costs and the pressures of global competition pose continuing challenges for industrial extraction and manufacturing sectors. In order to maintain the international competitiveness of Australian industry, it is critical that the national policy framework provides the right environment for large industrial operations to continue to invest in Australia.

From industry’s point of view, the formula for a step-change in energy efficiency is relatively straightforward:

A competitive industry = a profitable industry

A profitable industry =investment and replacement of capital stock

Investment = new energy-efficient technology

New technology = step-change in energy efficiency

Governments can best support investment in industrial business efficiency by providing a stable, nationally integrated, industrial, energy and climate change policy environment in which policy risks are minimised.

In AIGN’s opinion, in no area is the risk of poor policy development at the industrial level greater than in the area of energy efficiency policy. Past schemes, such as the Federal Government’s Energy Efficiency Opportunities (“EEO”) program, imposed increased costs for industry and duplicated other Government policies with little additional impact. Whilst recognising the gradual removal of a number of state-based arrangements, the plethora of these schemes has caused unnecessary duplication and cost to industry.

We would hope that, from the perspective of the Victorian Government in reviewing its approach towards climate change,any consideration for implementing new policies would only apply in an environment of demonstrated market failure or where there is strong evidence that a national approach is not working or has not been attempted. To consider the inclusion of large businesses within VEET on the basis of the removal of the Resource Efficiency Action Plan(“REAP”) would be to send wrong signals and just add to duplication and costs at a time of intense competitive pressure.

SPECIFIC RESPONSE TO THE CONSULTATION PAPER SETTING FUTURE VICTORIAN ENERGY EFFICIENCY TARGETS

AIGN appreciates that the VEET is designed to reduce GHG emissions whilst encouraging the efficient use of electricity and gas,together with investment, employment and technology development in suppliers of goods and services, which reduce the use of electricity and gas by consumers. It is noted that the Government is looking to a new target with a “view to strengthening it even further”.

A number of AIGN members that operate large manufacturing plants in Victoria have, in the past, been excluded from VEET as they have been registered by the Victorian Environment & Protection Agency Review under the Environment Resource Efficiency Plans (“EREP”) program. The exclusion was on the basis of already being required to undertake energy efficiency upgrades and, as such, any activity under VEET would not be additional.

Considerable investment in appropriate upgrades has been undertaken, reflecting previous comments around the incentive for investments in new plant at a time of rising energy costs, particularly for those sectors that are trade-exposed. The opportunities for continuing energy savings are therefore reduced, although they vary between large users. As a result, large energy users are less likely to benefit from inclusion in the VEET than small and medium-sized energy users. Whilst the EREP program was abolished by the former Government, AIGN considers the case for the exemption from VEET remains for large users.

AIGN’s response to the Review questions are provided below. As our focus is on the large industrial sector, not all questions are of relevance and a response is therefore not provided to those questions. It is also difficult to answer some questions that relate to past experiences given that our members have by and large not been participants in the VEET.

Question 1:New VEET target.

Response:AIGN would propose the adoption of option 1 – 5.4 ml tonnes of CO2 per year for a three year period from 2016 to 2018 - to minimise any additional costs to the Victorian economy and consumers from moving to high certificate prices owing to a higher target. This option would also minimise the impact of the “saturation” of the market by lighting upgrades which means VEET targets are “to be increasingly met by business activities and the higher cost residential activities.”

Question 2:Comments are invited on the modelling approach used to determine the costs and benefits of the VEET scheme.

Response:No comment.

Question 3:Which greenhouse gas coefficient should be used to quantify the reduction in greenhouse gas emissions achieved by the VEET?

Response:Maintain existing marginal coefficient for consistency sake.

Question 4:The Department has valued greenhouse gas emissions reduction attributed to the VEET scheme by adopting a carbon valuation series that was produced by the Federal Climate Change Authority as part of its 2014 Targets Progress Review.

Response:No comment.

Question 5:Business participation: Is there a case to exclude any business sector(s) from participation in the VEET scheme?

Response:Rather than looking at this question from the perspective of excluding any business sector, AIGN does not believe the case has been made for inclusion of any large scale industrial sector.

Given the evidence provided as to how industry has responded to higher energy prices through increased investment in energy efficiency, AIGN believes there is no evidence of market failure that necessitates State Government intervention. Investment in energy efficiency is fundamentally a business decision, and the success of policies and strategies to promote greater uptake of energy efficiency measures will depend primarily on the business case for such investments.

The risk is that the inclusion of industry within VEET will impose increased costs and duplicate other Government policies,with little additional impact. It will be in conflict with the gradual removal of a number of State-based arrangements, and the plethora of such schemes has caused unnecessary duplication and cost to industry.