The federal government’s Emissions Reduction Fund will be unlikely to purchase carbon abatement at “least cost” because companies will most likely inflate the price of their emissions reduction activities, new research by energy and carbon market analyst RepuTex has uncovered.
According to the research, inflating the price of reductions – a practice known as “bid shading” – will be widespread under the ERF, with some companies bidding in more than 15 times their actual cost of cutting emissions.
RepuTex executive director Hugh Grossman said there would be a large discrepancy between the intended ERF design and its operation in practice.
“The Clean Energy Regulator has advised companies that the best strategy for success at an Emissions Reduction Fund auction is to bid ‘the lowest price’ at which it is worth your while to undertake a project, Mr Grossman said.
“However, analysis indicates that companies are actively seeking to bid the highest clearing price so that they can generate greater returns. Business typically sells at the highest price, not at the lowest.”
Mr Grossman said bids could be up to 15 times higher than the cost of reducing emissions.
“Many projects, such as large waste sector bidders have negative marginal abatement costs, but rather than sell that abatement cheaply, companies will look to exploit their cost advantage to maximise their returns.”
The first ERF auction is due to occur on April 15-16, with RepuTex saying up to 45 million Australian Carbon Credit Units are likely to be sold.
At the lowest price, it would cost the government around $250 million to purchase all emissions reductions.
However, with the inflated bids Reputex expects, the government would have to pay over $800 million for the same amount of abatement – more than three times the cost of actually creating the reductions.
The Clean Energy Regulator is actively trying to limit the price it pays for reductions by not disclosing a benchmark or ceiling price prior to the first action, using ambiguity to maintain competitive bidding.
However, a lack of market transparency could work against it, RepuTex says.
”With only one bid per project over a single round, with no information as to other bids available, proponents are provided with a clear incentive to overstate their bid, rather than be locked into a low price contract,” Mr Grossman said.
“So the opaque nature of the market may actually see bid prices rise.”
Because bids would be inflated as high as possible, the notion the government would buy abatement “from cheapest cost to highest cost” would not be possible.
“The underlying cost of a project is now irrelevant for companies. Regardless of the cost of a project, all companies will seek to bid the highest clearing price, which will float in line with supply volumes,” Mr Grossman said.
“This will create a false abatement cost curve, where low cost projects that would have been expected to be contracted first will actually be bid far higher, making it impossible for the Regulator to purchase the lowest cost abatement first.
“As companies inflate their bids, analysis indicates that the average price of abatement will climb higher.
“This may create an opportunity for participating companies to exploit market conditions and identify the highest floating price, while the government will wind up paying more for each tonne of abatement that it purchases.”