The Electricity Allocation Factor within the proposed 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)
Under the proposed Carbon Pollution Reduction Scheme (CPRS), power station operators would have experienced significantly increased costs associated with permits for their carbon emissions that they would have ‘passed through’ to power purchasers.

For Alcoa, a large user of purchased electricity from a brown-coal source, this ‘cost pass through’ represented a significant additional cost that could prematurely close Australian facilities.

To prevent such carbon and jobs leakage, the draft CPRS proposed 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 included an “electricity allocation factor” (EAF). The EAF represented the carbon intensity of power generation (in tonnes of CO2 per megawatt hour (MWh)) that would have determined how many carbon permits the power producer would need to purchase from Government or the market place.

Each permit the power producer bought would have come at the traded value of carbon permits and they would have sought 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 proposed that aluminium smelters (as an EITE industry) would have initially received 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 concluded that market forces mean a power station could 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 would have passed this full amount through in any long-term contracts.
 
These constraints were 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 would have been around $40M and this would have increased as the price of carbon rose above $20/t.
 
This dilemma could have be solved by allowing the EAF to be changed, provided the smelter company could demonstrate it had taken reasonable measures to reduce the carbon intensity of its power supply to 1.0 t CO2/MWh. This is the position Alcoa asked Government and Opposition stakeholders to support during the negotiations about the CPRS.

It is unclear at this stage how these same issues will be handled under the proposed carbon tax.


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