Ross Garnaut has warned that flawed regulation is partly responsible for Australia’s surging cost of electricity, and called for a regulatory overhaul to minimize the limited impact of a carbon price on electricity prices and energy security.

In his final updated paper on the climate change, dealing with the electricity sector, Garnaut has noted that Australians continue to enjoy relatively low electricity prices by world standards, but that our reliance on coal means the electricity sector must be overhauled to address the emissions-intensive nature of the Australian economy.

And he tackles one of the most controversial of current political issues, and the key to the Coalition’s campaign against the Government’s carbon price scheme, rising electricity prices. The paper explores how rising network costs and the lack of certainty around a carbon price have driven large price rises in the sector in recent years, but Garnaut also believes poor regulation has contributed to the rapid rise in prices. He blames flaws in the framework regulating electricity producing monopolies, price-capping incentives for firms to over-invest, a generous appeals process, too-high reliability standards and continuing state ownership as all contributing to escalating prices, on top of the need to replace ageing infrastructure.

Without regulatory reform, he warns, these pressures will combine with rising coal and gas prices to continue driving up electricity costs in the future.

He proposes a series of reforms to strengthen and establish new regulators within the sector and establish as truly national (WA and NT apart) market. These will, he argues, reduce the impact of a carbon price and reduce price pressures.

Garnaut also notes that the Renewable Energy Target and other state-based renewables schemes are also driving up costs, and should be phased out once a carbon price is in place – the same recommendation as in his original 2008 report.

The paper takes head-on claims from the electricity sector, and in particular the transnational owners of the Hazelwood and Yallourn power plants, in relation to the CPRS, that massive assistance was required to ensure that the plants continued to operate. Garnaut terms the risk of energy security concerns from a carbon price “low – if not negligible” and says they can be addressed by ensuring a fully national electricity market is in place that will prevent problems associated with “too big to fail” suppliers. In Garnaut’s view, operation of those plants will continue to be profitable even as the economy transitions to greater reliance on gas or, if gas prices are too high, renewables. In any event, he notes, both plants are likely even long after the establishment of a carbon price has driven a shift to gas and renewables, to continue to operate in a non-baseload capacity, firing up during the warmest months to provide peak power. Garnaut also notes that it doesn’t take a carbon price to threaten the collapse of a power company, citing the impact of the GFC on Babcock and Brown.

However, he recommends that owners of the most emissions-intensive plants be given temporary access to government loan guarantees to ensure a smooth transition to a carbon price, a conclusion unlikely to please electricity generators who demanded, and received, commitments worth hundreds of millions of dollars from the Rudd Government as transitional assistance under the CPRS.

Garnaut also considers, without naming it, the Coalition’s plan to pay the owners of Hazelwood and Yallourn billions of dollars to shut them down, and finds it unworkable. He warns that the cost of paying the owners to shut them down would be less than the real cost to consumers via higher electricity prices.

The Auction for Closure requires government to prescribe the natural pathway to market exit. Those bidders successful at the auction will be constrained in their ability to respond to changing market conditions such as higher gas prices, lower capital costs for low-emissions technologies or strong demand growth. Government is poorly place to make decision of this kind.

The main benefit of the Auction for Closure approach is that it tells potential investors in low-emissions generation that future electricity prices will be higher. It is not clear that this is necessary. Firms are making their own judgement about the likelihood of high emissions generators reducing their production, and about the effect that this will have on electricity prices.

What’s missing from the paper is a detailed assessment of the impact of a carbon price. Garnaut notes previous Treasury modeling on the impact of a $23 a tonne carbon price, which would have increased household electricity bills by 20%. Now, he says, the impact would be smaller due to the subsequent rises in electricity prices. He reiterates that compensation should be provided via tax cuts, the transfer payments system and, for low-income households, energy efficiency measures that will yield ongoing savings.

While there’ll be a final report from Garnaut at the end of May, this is the last update of his original report. And in a passing comment on the electricity market, it’s hard not to see Garnaut taking the opportunity to have a not-so-subtle dig at Australian business and politicians and their attitude toward economic reform, which he’s been engaged in as a key Government adviser for nearly three decades:

Many people in Australia, including many in business leadership roles, distrust markets. They fear that market outcomes will be seriously disruptive, and dislike the uncertainty with which market outcomes are associated. There is a deep Australian yearning for the certainties of controls and subsidies. However, while markets are imperfect, the general experience is that they are more effective than any other mechanisms for ensuring that supply is available reliably to meet demand. I see no reason why the electricity market is different from others.