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Increasing carbon prices could mean higher electricity price

Increasing carbon prices could mean higher electricity prices in the short term

First published in Energy and Environment on August 1 2019.
Increasing carbon prices will not be an instant fix to drive electrification of the economy warns Transpower.

The National Grid operators report on low emissions industrial heating says there is a common belief Increasing the carbon price will drive electrification.

“This is true in NZ, although in the short- to medium-term this effect may be more muted than expected.”

As the carbon price rises, the cost of coal, gas or other fossil fuels used in process heat applications will naturally also rise. However, electricity prices are also affected by a rising carbon price. Electricity prices are set by the marginal producing unit – in NZ this is currently typically coal or gas or hydro generators, with the latter valuing the cost of its water against the former.

“An increase in carbon price can lead to an increase in electricity prices in the short- to medium-term, even when more renewable electricity is being added (as the marginal units set the price). As observed in this section, this mutes the incentive for companies to transition to electricity based on carbon price expectations alone. Thought should be given to what additional measures could catalyse the commercial incentive to electrify.”

On the other hand, higher carbon prices will encourage more investment in renewable generation and the decommissioning of fossil-fuel generation, leading towards a higher proportion of renewables. This is already occurring with generators lining up renewable portfolios.

“As thermal plant continues to be displaced – or reserved for dry-year rather than normal-year operations – the carbon-price component of the electricity price can be expected to fall. It is difficult to predict the interplay of these factors, but one can expect the impact of carbon prices on electricity prices to be close to linear initially but to fall off – potentially rapidly – at higher carbon prices and in the medium- to long-term. By contrast, the impact of carbon prices on gas and coal is purely linear, without let-up.”

First published in Energy and Environment on August 1, 2019.

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