The motivation for the most recent changes in Australia’s Renewable Energy Target (RET) is to ensure that RECs created from solar water heaters and photovoltaics (PV) do not continue to crowd out large-scale renewable generation, particularly wind farms.

This is to be achieved by splitting the RET into small scale and large scale targets from 2011. But despite these changes, the spot price of RECs has not risen, and there is no evidence that prices in long-term contracts have increased.  Why is this so?

One of the difficult issues in the recent changes to the RET, was what should be done about the growing surplus of RECs – mainly from solar water heaters and PV - that will be created before the RET changes take effect at the end of this year. 

For the year to date, more than 9 million PV RECs have been created. By comparison just 100,000 PV RECs were created in 2007.  To put this in perspective, AGL’s recently announced Macarthur wind farm – the largest in the southern hemisphere - can be expected to create about the same amount of RECs in a year, as are currently being created from PV in less than three weeks.

Many factors account for the phenomenal growth of PV: a very rapid decline in the installed cost of PV, state-based feed-in tariffs and generous federal subsidies (initially funded mainly by Government rebate and subsequently entirely by electricity users, through the RET).

Installed 1.5 kW residential PV systems now trade for as little as $1900 in some States, and handsome feed-in tariffs for PV are available for many years. Any reasonable assessment shows PV to be a very profitable investment for households.  Furthermore, new regulations come into force that are likely to boost PV RECs even further - from 29 June 2009 off-grid solar PV installations up to 20 kW will be eligible for solar credits.

Two months ago, consultants to the Department of Climate Change forecast an accumulated REC surplus of 16.2 million,  and RECs from solar water heaters and PV of less than 11 million by the end of 2010.

But the Department of Climate Change and its advisors have consistently under-forecast the creation of RECs from solar water heaters and PV: for 2010 so far RECs from these sources already exceed 11 million, and the total for the year is likely to be at least twice the Department’s consultant’s forecast.  The accumulated surplus of RECs from all sources by the end of 2010 is more likely to be above 23 million – about 50% more than the Department’s consultant’s forecasts.

A surplus of 23 million RECs is more than the large scale RET target for the next two years combined. As such, the large surplus may depress REC prices in the short term thereby contributing to the deferral of renewable generation investment. Deferral matters: every year that a wind farm is deferred is one less year of REC production.  While the 23 million surplus is large in the short term, it is only 3.5% of the total RET target to 2030.  To make up the lost ground due to investment deferral, even more investment will be needed if the RET demand is to be met over the duration of the scheme.

In other words, the RET targets by 2020 will only be met if very significant investment in large-scale renewable generation capacity starts soon.

But there are significant barriers to investment in large scale renewable generation, not least low wholesale electricity prices, transmission access challenges and the substantial task of developing capital markets and supply chains.

Many of these challenges are not well understood. For example, it is not widely appreciated that achieving the RET by 2020 will require capital markets to deliver more than three times as much capital for renewable generation than has been delivered to fossil fuel generation over the history of the National Electricity Market.

It is much too soon to predict an aggregate REC shortfall over the life of the RET, but any reasonable projection of supply and demand suggests that this outcome is eminently possible, if not over the entire life of the scheme, then at least for many years.

If the mandatory REC obligation is not met, a tax-effective penalty of $92 per un-surrendered REC is payable. REC prices should surely rise to this level if the market is confident that REC supply will not meet REC demand.

The fact that the REC price is not currently reflecting this possibility may suggest that market participants think this outcome is unlikely.

On the other hand it may reflect heavy discounting of the possibility of future high prices even if the REC market is undersupplied. This may be because market participants are skeptical that a future Government will allow REC prices to be sustained at the penalty level.

This is an issue that merits serious discussion by industry and Government.

Rob Jolly and Bruce Mountain are directors of Carbon Market Economics