The Electricity Allocation Factor within the CPRS
Background
In Victoria, Alcoa operates:
- Portland Aluminium smelter, established 1986, with around 600 employees
- Point Henry smelter, established 1963 with around 600 employees
- Point Henry Rolling Operations, established 1965 with around 350 employees
- Anglesea Power Station, established 1969, with around 100 employees
Combined, they are Victoria’s largest exporter and provide around $200m a year in direct wages as one of the largest employers in regional Victoria.
The Electricity Allocation Factor (EAF)
Once the Carbon Pollution Reduction Scheme (CPRS) is operating, power station operators will experience significantly increased costs associated with permits for their carbon emissions that they ‘pass through’ to power purchasers.
For Alcoa, a large user of purchased electricity from a brown-coal source, this ‘cost pass through’ represents a significant additional cost that could prematurely close Australian facilities.
To prevent such carbon and jobs leakage the draft CPRS proposes that assistance be provided to Emission Intensive Trade Exposed (EITE) sectors, to partially ameliorate these power price rises.
The formula proposed in the draft CPRS to calculate the amount of assistance includes an “electricity allocation factor” (EAF). The EAF represents the carbon intensity of power generation (in tonnes of CO2 per megawatt hour (MWh)) that will determine how many carbon permits the power producer will need to purchase from Government or the market place.
Each permit the power producer buys will come at the traded value of carbon permits and they will seek to pass this full cost onto their customers. Example as follows:
- ‘Power station X’ produces 8.5 million MWh p.a. and emits 1 tonne of CO2 for every MWh
- ‘Power Station X’ is therefore required to purchase 8.5 million carbon emission permits for that year.
- A permit costing $20 each would represent an additional cost of $170 Million in that year.
When not borne by international competitors, costs such as these would quickly drive some Australian business to closure. To avoid this, the draft CPRS proposes that aluminium smelters (as an EITE industry) would initially receive permits equivalent to 94.5% of this cost pass through – assuming an electricity allocation factor of 1.0 (1 tonne of CO2 per 1 MWh of generation).
The Problem with an EAF of 1.0
Draft CPRS modelling concludes that market forces will mean a power station can only pass on a maximum EAF of 1.0 because the market price of power may be set by power providers producing less than 1.0 tCO2 per MWh. In an unlimited market a customer would not buy more expensive power (with an embedded EAF greater than1.0) when cheaper (EAF less than1.0) is available.
However, Alcoa’s smelting facilities at Portland and Point Henry are defined by the following constraints in terms of their electricity supply:
1: They are dependent on maintaining long-term (20-30 years) electricity supply agreements;
2: They are financially constrained to relying on electricity sourced from within the Victorian NEM region to meet their electricity needs; and
3: Within the Victorian NEM region, they are constrained to relying on electricity supplied by Victorian brown coal generators which typically produces around 1.25 to 1.6 t CO2 per MWh and because they cannot internalise the carbon price risk, they will pass this full amount through in any long-term contracts.
These constraints have been independently verified by KPMG in a 2009 review of the Electricity Allocation Factor Impact on Victorian Aluminium Smelters.
The net difference in initial cost to the two Victorian smelters from an EAF of 1.0 instead of 1.25 is around $40M and this would increase as the price of carbon rises above $20/t.
This dilemma could be solved by allowing the EAF to be changed, provided the smelter company could demonstrate they had taken reasonable measures to reduce the carbon intensity of their power supply to 1.0 t CO2/MWh. This is the position Alcoa is asking Government and Opposition stakeholders to support in the upcoming negotiations about the CPRS. The Opposition has recognised this in its proposed CPRS amendments.
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