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Stage 2 Report:Economic Scenariosand Forecasts2009 10 to 2029 30A report to the Australia Energy MarketOperator (AEMO).

1 April 2010

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Stage Two: Economic Scenarios and Forecasts 2009-10 to 2029-30

1 April 2010

i

2010 KPMG, an Australian partnership and a member firm of the KPMG network of independent

member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.

The KPMG logo and name are trademarks of KPMG.

Liability limited by a scheme approved under Professional Standards Legislation.

Disclaimers

I nherent L imitations

This report has been prepared as outlined in the contract between the Australian Energy Market Operator (AEMO) and KPMG

dated 18 January 2010. The services provided in connection with this engagement comprise an advisory engagement which is not

subject to Australian Auditing Standards or Australian Standards on Review or Assurance Engagements, and consequently noopinions or conclusions intended to convey assurance have been expressed.

No warranty of completeness, accuracy or reliability is given in relation to the statements and representations made by, and the

information and documentation provided by AEMO as part of the process.

KPMG have indicated within this report the sources of the information provided. We have not sought to independently verify those

sources unless otherwise noted within the report.

KPMG is under no obligation in any circumstance to update this report, in either oral or written form, for events occurring after thereport has been issued in final form.

The findings in this report are subject to unavoidable statistical variation. While all care has been taken to ensure that the

statistical variation is kept to a minimum, care should be taken whenever using this information. This report only takes into accountinformation available to KPMG up to the date of this report and so its findings may be affected by new information. Should you

require clarification of any material, please contact us.

The findings in this report have been formed on the above basis.

Thi rd Party Reli ance

This report is solely for the purpose set out in contract and is for AEMOs information. This report has been prepared at therequest of AEMO in accordance with the terms of the contract between AEMO and KPMG dated 18 January 2010. Other than our

responsibility to AEMO, neither KPMG nor any member or employee of KPMG undertakes responsibility arising in any way from

reliance placed by a third party on this report. Any reliance placed is that partys sole responsibility.

We understand that this report may be provided to AEMOs external consultant. The external consultant is not a party to our

contract with AEMO and, accordingly, it may not place reliance on this report. KPMG shall not be liable for any losses, claims,

expenses, actions, demands, damages, liabilities or any other proceedings arising out of any reliance by the external consultant orany other parties on this report.

We understand that this report may be released into the public domain. Third parties who access the report are not a party to our

engagement letter with AEMO and, accordingly, may not place reliance on this report. Any third party accessing the report

acknowledges that it may not place reliance on the results and findings contained in the report. KPMG shall not be liable for anylosses, claims, expenses, actions, demands, damages, liabilities or any other proceedings arising out of any reliance by a third party

on this report.

Forecasting D isclaimer

Any economic projections or forecasts in this report rely on economic inputs that are subject to unavoidable statistical variation.They also rely on economic parameters that are subject to unavoidable statistical variation.

While all care has been taken to ensure that statistical variation is kept to a minimum, care should be taken whenever using thisinformation.

Any estimates or projections will only take into account information available to KPMG up to the date of the deliverable and so

findings may be affected by new information. Events may have occurred since we prepared this report which may impact on it andits findings.

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Contents

Executive Summary 3

1 Introduction 201.1 Structure of this report 21

2 Economic Summary, Risks and Scenarios 222.1 International Outlook 22

2.2 National Outlook 242.3 Scenario Development 252.3.1 Demographics 272.3.2 Carbon Pollution Reduction Scheme 272.3.3 Global Economic Outlook and Productivity Growth 28

3 Modelling Methodology, Data Sources and Estimation 313.1 Data Sources 313.1.1 Energy Sector Data 313.1.2 MM2 Variables 313.1.3 Other Customised variables 33

3.2 Forecasting Methodology 333.2.1 MM2 model 343.2.2 MM2 Sectoral Output Forecasts 353.2.3 Accounting for the CPRS 363.2.4 Overview of Demand and Price Models 363.2.5 Sectoral Energy Consumption Forecasts 383.2.6 Mixed use of Top-down and Bottom-up approaches for the final

sectoral demand forecasts 403.2.7 Mixed use of long-run and short-run models 403.3 Estimation Results 40

4 Forecasts Results for National and State Variables 424.1 National Economy Forecasts 424.2 State Economy Forecasts 474.2.1 New South Wales and Australian Capital Territory 474.2.2 Victoria 494.2.3 Queensland 514.2.4 South Australia 534.2.5 Western Australia 554.2.6 Tasmania 574.2.7 Northern Territory 59

4.3 Macro Forecasts Summary Tables 62

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5 Forecasts Results for Energy Market Variables 665.1 Electricity and Gas Prices 665.1.1 Note on the impact of the CPRS 665.1.2 Electricity and Gas Price Forecast Results 675.2 Energy Demand 695.2.1 Electricity and Gas Consumption Total 695.2.2 Electricity and Gas Consumption - Sectoral 725.3 New South Wales and the Australian Capital Territory 735.4 Victoria 755.5 Queensland 775.6 South Australia 795.7 Western Australia 815.8 Tasmania 835.9 Northern Territory 85

A Variable List 88

B Sectoral Forecast Results 86

C Electronic Appendix 108

D MM600+ Model 109

E Estimation and Specifications of Customised VariablesEquations 112

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3 2010 KPMG, an Australian partnership and a member firm of the KPMG network of independent




Executive SummaryIn early 2009, KPMG was engaged by the then National Electricity Market ManagementCompany (NEMMCO) (now the Australian Energy Market Operator (AEMO)) to provideenergy policy analysis, economic scenarios and forecasts, and electricity market inputs for the

National Electricity Market (NEM) regions. This data was used to support the production ofenergy and demand projections and to inform its 2009 Electricity Statement of Opportunities(ESOO). In late 2009, AEMO then engaged KPMG Econtech to update the key economic andenergy demand forecasts used for the production of the 2009 ESOO. These updated economicand energy demand forecasts were used as inputs into the Energy White Paper (EWP), which iscurrently being prepared by the Department of Resources, Energy and Tourism (DRET). Theupdated forecasts covered the NEM regions, Western Australia and the Northern Territory.

Following from our 2009 work, AEMO has engaged KPMG to provide three staged reports toinform its 2010 ESOO, relating to:

key known and possible energy policies and high level calibration of their impliedquantitative impacts (Stage 1 Report);

economic scenarios (medium, high and low) and electricity and gas market outcomes for theNEM regions and Western Australia and the Northern Territory (Stage 2 Report); and

semi-scheduled, non-scheduled and exempted generation, on a state/territory basis, byclassification as renewable or non-renewable and by specific fuel source (Stage 3 Report).

This report is the Stage 2 Report and it is intended to support the production of energy anddemand projections for the 2010 ESOO. The key difference between the 2009 and 2010 reportsrelate to the main scenario drivers. In the 2009 report, the main scenario drivers were developedwith reference to the Stage 1 Report. For the 2010 report, the main scenario drivers are to alignwith the scenarios developed for the EWP. In addition, the forecasts presented in this reportcover an expanded number of variables and regions than included in the 2009 report.

International Outlook

Since late 2009, the global economy has begun to exhibit signs of a recovery. Economicconditions have improved somewhat more rapidly than expected, leading the IMF to revise itsgrowth forecasts up to 3.9 per cent for 2010. The speed of recovery will likely varyconsiderably across different nations due to the uneven distribution of economic conditions,

policies and shocks experienced. Growth will be driven primarily by resurgent activity indeveloping countries, with Asian economies in particular exhibiting strong growth. Developednations on the other hand are likely to experience more sluggish growth rates.

National Outlook

The Australian economy has continued to surprise over the last few quarters, exceeding theexpectations of both markets and policy makers. A comparatively rapid recovery in thedomestic economy can be attributed to a range of factors, including the strong performance ofAsian trading partners, resilient consumer spending, the relative health with which theAustralian banking sector entered the financial crisis and a sooner than expected recovery in

dwelling investment. With global economic conditions continuing to improve, and domesticbusiness and consumer sentiment bouncing back to pre-crisis levels, overall economic growth

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should pick up in 2009/10. A full-fledged recovery is expected in 2010/11 as the economygathers pace in late 2010.

Scenario Development

The scenario specifications for this years Stage 2 Report are based on the conceptualframework for alternative economic and energy market developed by McLennan MagasanikAssociates (MMA)1in 2009. The MMA report was to provide a strategic framework in relationto AEMOs National Transmission Network Development Plan and the DRETs EWP. Takingaccount of different emission targets and energy market technology, MMA developed five keyscenarios and each of them has a further two possible emission target scenarios. The fivescenarios describe the potential state of the Australian stationary energy sector in 2030 and aredistinguished from each other through the following six dimensions:

Economic growth;

Population growth;

Carbon policy;

Centralised supply-side response;

Decentralised supply response; and

Demand-side response.

The first three dimensions have economy-wide implications, while the last three dimensions aremore specific to the energy sector. For this report we have developed three scenarios (medium,high and low) that are distinguished through economy-wide dimensions rather than electricitysector specific dimensions. Specifically, the three scenarios developed by KPMG Econtech aredistinguished from each other in terms of the following three broad factors:

the strength of global economic growth;

the strength of population growth; and

the assumed emission targets to be included in the Carbon Pollution ReductionScheme(CPRS).

The Energy White Paper prepared by DRET is concerned with long-term planning for theenergy sector under extreme change and uncertainty. The uncertain nature of developments inthe energy sector is managed by AEMO/DRET through the construction of alternative futurescenarios, each of which should be accepted as being possible but not necessarily likely. Fromthis point of view, the high and low scenarios developed in this report represent extreme casesrather than expected outcomes that could be interpreted as a confidence interval or sensitivity

1McLennan Magasanik Associates (MMA) (2009): Future Developments in the Stationary Energy Sector: Scenariosfor the Stationary Energy Sector 2030, Report to AEMO/DRET.

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analysis around a baseline. Table A provides a brief description of each scenarios maindrivers.

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Demographic Assumptions

Demographic assumptions are a key input into KPMG Econtechs forecasts. The growth of theworking-age population (the working age population is defined by the ABS as the 15-64 yearsage cohort) directly influences the size of the labour force and hence the economys long-termgrowth. The main sources of uncertainty within our demographic assumptions are aroundimmigration levels and the natural rate of increase in the population (i.e. fertility rates versusmortality rates). Accordingly, each scenario incorporates different assumptions governing thelong-run fertility rate and the ongoing level of net overseas migration.

The medium scenario assumes constant level growth in immigration and that the fertility rate is

held constant at 1.93. The high scenario assumes faster population growth, based on a higherlevel of net overseas migration and a marginally higher fertility rate of 1.93 (based on the2007/08 fertility rate). Conversely, the low scenario assumes slower population growth basedon a lower level of net overseas migration and a lower fertility rate of 1.73 (based on the2001/02 fertility rate).

We note that assumptions concerning net interstate migration (migration of Australian residentsbetween states) are constant across the three scenarios. Net interstate migration is assumed tocontinue at a constant level for each state, based on historical trends. Accordingly, NSW, VIC,SA and TAS continue to experience net outflows of interstate migrants over the forecast. QLD,WA and the ACT experience net inflows over the forecast. The NT is assumed to have zero netinterstate migration, as historical trends for the Territory are too volatile to forecast and average

out at a long-term rate which is close to zero.

Carbon Pollution Reduction Scheme

The uncertainty surrounding the CPRS is related to policy uncertainty as opposed to the globaleconomic situation. Any emissions policies and reduction targets set in Australia will becontingent on the nature of agreements reached at the international level. The failure of policymakers to reach a conclusive agreement at the recent Copenhagen summit has increased thelevel of uncertainty surrounding the details of the final CPRS. The MMA scenarios manage forthis uncertainty by incorporating a range of different emissions targets, which are in turn basedon modelling completed by the Commonwealth Treasury in conjunction with the Garnautreport. We have adopted the same assumptions for the medium, high and low scenarios,drawing upon Treasury estimates to develop alternative carbon prices under each scenario.

The medium scenario assumes an emissions reduction target of 15 per cent by 2020 (meaning areduction in emissions of 15 per cent below 2000 levels). This scenario, referred to as CPRS-15in the MMA report, is based on an assumption of a realistic multi-stage global framework ofmoderate emissions reductions. The Treasury estimates that if the CPRS were to be introducedin 2010/11, the nominal carbon permit price would be $32/t CO2e. Based on the governmentsamendments to the CPRS, announced 4 May 2009, a carbon price will be fixed at $10/t CO2 in2011/12 and a full scale CPRS has now been postponed to 2012/13. As such, the estimatedcarbon price has been inflated forward at a rate of 3.5 per cent per year, resulting in a carbon

price of $34.3/t CO2e in 2012/13.

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The high scenario assumes an emissions reduction target of 25 per cent by 2020. This scenario(CPRS-25) is based on an assumption of strong international involvement in an emissionstrading scheme, covering all emissions sources and all economies. Again, the carbon price isassumed to start at $10/t CO2e in 2011/12 before being raised to $51.4/t CO2e in 2012/13. Theestimated carbon price is based on Treasurys estimated price of $48/t CO2e in 2010/11,inflated by 3.5 per cent per year.

The low scenario assumes an emissions reduction target of 5 per cent by 2020. This scenario(CPRS-5) is based on an assumption of lower international involvement in an emissions tradingscheme, with a slow start to emissions reductions in both Australia and abroad. Again, thecarbon price is assumed to start at $10/t CO2e in 2011/12 before being raised to $24.6/t CO2e in2012/13. The estimated carbon price is based on Treasurys estimated price of $23/t CO2e in

2010/11, inflated by 3.5 per cent per year.

Under each scenario, the carbon price is assumed to grow by a real rate of 4 per cent per annumfrom 2012/13 onwards. This 4 per cent real growth rate has been used in numerous emissionsstudies around the world and reflects the fact that carbon permits are financial assets and are

bankable over time. It is based on a 2 per cent annual return and 2 per cent risk premium.

Global Economic Outlook and Productivity Assumptions

Developments in the global economy have a strong impact on Australias growth prospects. Asa resource based economy, external demand for commodities has a direct and significant impact

on Australian export earnings. The availability of credit from international sources dictates thecost of funding within the Australian financial sector. Accordingly, assumptions governing thespeed of recovery from the Global Financial Crisis (GFC) are a key determinant of domesticeconomic growth over the short to medium term. Our scenarios have been developed toincorporate a range of assumptions regarding credit availability, risk premiums and ultimately,global growth.

The medium scenario assumes a recovery in global growth to a moderate level by 2010/11.Under this scenario, a moderation in credit risk premiums and increased capital liquidityunderpin emerging growth of 1.15 per cent in 2009/10, picking up to a rate of 3.24 per centfrom 2010/11 onwards. Renewed economic activity flows through to increased demand forcommodities; the assumed impact is for rural and non-rural commodity prices (based on the

RBA index of rural and non-rural commodities) to appreciate by 5.5 per cent in 2010/11.

The high scenario assumes a strong global recovery from the GFC, led by rapid growth in Chinaand India. Global growth is assumed to reach a rate of 5.1 per cent by 2010/11, continuing overthe forecast period. Under this scenario, growth will be aided by lower credit risk premiums(below the medium scenario risk premium) and increased capital liquidity. Rural and non-ruralcommodity prices are assumed to appreciate by 9.5 per cent in 2010/11.

Conversely, the low scenario assumes a slow global recovery from the GFC, with continuedweakness in OECD economies and a slower start to industrial production in developingeconomies. Global growth is assumed to reach a rate of 2.1 per cent by 2010/11, continuingover the forecast period. Under this scenario, growth will be inhibited by continued tightness in

credit markets. Lingering risk aversion will see credit risk premiums remain at high levels

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(above the medium scenario risk premium) and low levels of capital liquidity. Weaker demandfor commodities will mean prices appreciate by a lower rate of 3.4 per cent in 2010/11.

In addition to external drivers of growth, the scenarios incorporate assumptions of domesticproductivity growth. The medium scenario assumes that technological innovation supportsproductivity growth of 1.5 per cent per annum over the forecast period. This value was chosenin accordance with historical rates, as well estimates used by the Productivity Commission andwithin the Federal budget papers. We note that the rate of 1.5 per cent is in accordance with therate used by Treasury in the 2009/10 budget papers, but below the 30-year historical average of1.6 per cent that is assumed by the Treasury in the 2010 Intergenerational Report. This arguablyconservative estimate of productivity growth reflects a continuation of the status quo;

productivity growth in Australia has slowed to an average of 1.4 per cent per annum over the

last decade compared to an average of above 2.0 per cent for the 1990s.2 This deceleration canbe linked to a number of factors including capacity constraints in the Australian economy andshocks that have affected specific industries (i.e. drought impacted on agriculture productivityand fast output expansion in mining meant productivity was sacrificed to achieve short termcapacity growth).

3 As such, a 1.5 per cent rate assumes a slight improvement in productivity

growth over the last ten years, reflecting an abeyance of industry specific shocks, but alsomanages for productivity constraints due to a saturation of technological progress.

The high scenario assumes a fast rate of productivity growth, at 1.75 per cent per annum overthe forecast period. This scenario simulates a situation in which productivity growth outpacesthe growth seen in recent years, and returns towards its long run (40 year) historical average. Of

1.75 per cent. This scenario represents a situation in which policy reforms, such as reducedindustry assistance, regulatory reform and strong investment in Research and Developmentpromote productivity growth. The low scenario on the other hand assumes a slower rate ofproductivity growth, at 1.25 per cent per annum over the forecast period. This simulates asituation in which productivity growth continues to moderate from the long run average, as aresult of weaker policy initiatives, slower human capital investment and a continuation ofcapacity constraints in the Australian economy.

2Treasury (2010), Intergenerational Report.3Banks, G. (2009), Back to the Future: Restoring Australias Productivity Growth, Presentation made to theMelbourne Institute/AustralianEconomic and Social Outlook Conference, 5 November 2009, availablewww.melbourneistitute.com.

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National Results

As illustrated in Chart A, national GDP growth slowed dramatically in 2008/09, dropping to arate of 1 per cent, compared to a rate of 3.7 per cent in 2007/08. This sharp moderation ineconomic growth reflects the impact of the Global Financial Crisis, which restrained growth inthe domestic economy in 2008/09.

Chart A: National GDP Forecasts Growth Rates

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

2002/03 2005/06 2008/09 2011/12 2014/15 2017/18 2020/21 2023/24 2026/27 2029/30

Med

High

Low

Source: KPMG Econtech estimates.

In spite of these impediments to growth, the Australian economy outperformed expectations in2008/09 by avoiding a technical recession. Going forward, growth will begin to pick up in2009/10 before a full-fledged recovery takes hold in 2010/11.

Under each scenario, the drivers of growth in the short run (2009/10 to 2011/12) will be thesame, although varying in magnitude. Under all scenarios, one of the key drivers of growth will

be the dwelling construction sector. Higher export volumes will also contribute positively toGDP growth, as an expansion in Chinese industrial production translates into increased demandfor bulk commodities. Export values will be boosted by an improved terms-of-trade, as stronger

external demand for commodities and subdued demand for manufacturing imports see exportprices rise relative to import prices. Additionally, strong consumption growth will underpinhealthy growth in retail trade, with the food, beverage and tobacco sector expected to performstrongly in 2009/10.

We note that divergence between scenarios becomes more pronounced over the medium tolonger term as the impact of the assumptions underlying each scenario builds. The impacts ofthe key drivers of the scenario are discussed below.

In 2009/10, differences between the scenarios are small as the majority of drivers do not takeaffect until 2010/11. From 2010/11, the impact of higher global growth (and hence externaldemand) and commodity prices see growth under the high and medium scenarios outpacegrowth under the low scenario, a gap which broadens in 2011/12.

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The overall impacts of the CPRSare evident in all three sets of forecasts; growth in 2012/13,which is the first year introducing the full scale CPRS into the economy, clearly softens,reflecting the impact of higher electricity prices, as well as a more broad based moderationfollowing above trend growth in the recovery period. Indeed, growth under all scenariosmoderates between 2010/11 and 2012/13, reflecting a return to normal macroeconomicconditions following above trend growth associated with a recovery in 2010/11. Notably, themoderation under the high case is less severe, despite the fact that carbon prices are higher.This result can be explained by the positive impact of stronger external demand and easingcredit conditions. Over the longer term, the impact of the CPRS on growth is relatively small,as businesses and consumers adjust consumption and new technologies lower the cost ofemissions abatement.

Further out, a continued divergence between the high, medium and low scenarios isunderpinned by demographic and technological factors. This is to be expected, as the impactof the demographic and productivity assumptions build over time. Under the low scenario,slower assumed population growth causes long run growth to be much weaker than that seen inthe medium scenario. This effect is exacerbated by lower productivity growth under the lowscenario.

Chart B: National Population Forecasts

19000000

21000000

23000000

25000000

27000000

29000000

31000000

2001/02 2004/05 2007/08 2010/11 2013/14 2016/17 2019/20 2022/23 2025/26 2028/29

Med

High

Low

Source: KPMG Econtech estimates.

Population forecasts under each of the scenarios are illustrated in Chart B. Under the mediumscenario, the population initially grows at a rate that is slightly higher than the historical longrun average. Over the long run, the population growth rate gradually returns to a pace similar tothat of the long run historical average. Higher growth in the short run reflects recent increasesin the fertility rate and a relatively high level of net overseas migration.

Inflation rates are lower (higher) under the high (low) scenario than those under the medium

scenario. Lower risk premiums at the global market level assumed under the high scenariocould lead to higher inflation rates by inducing excess demand. However, it is assumed that

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under the high scenario, the higher economic growth is induced by higher productivity and amore favourable investment environment which is accompanied by lower inflation and lower

borrowing costs in terms of the longer period trends.

State Results

The NSW economy held up better than expected in 2008/09, posting GSP growth of 0.4 percent. Economic activity was supported in part by consumer spending, which managed toexpand as a result of fiscal stimulus measures. Low interest rates also had a strong impact in thehighly geared NSW economy, allowing a moderate expansion in household disposable incomedespite a freeze on wage growth throughout the year. Notably, dwelling investment in NSW isexpected to take longer to recover than for the economy as a whole. NSW has a higher

proportion of multi-unit dwelling, making investment more reliant on developers, and it isexpected that banks will continue to be wary of financing high-risk apartment and townhousedevelopments.

The introduction of the CPRS is expected to have a minimal effect on NSW. The NSWeconomy is heavily reliant on services, especially property and business services, which is asector of the economy that will be relatively unaffected by the introduction of the CPRS.Indeed, the combined services sector is expected to be a driver of growth over the medium term,reflecting stronger demand for property services and healthier business activity across the board,which should support renewed growth in financial and business services.

Victoria (VIC) outperformed the national economy in 2008/09, as weak consumption growthwas more than offset by the strong performance of the housing market. Dwelling investmentexpanded by an impressive 7.8 per cent, as Victorian households responded positively to lowerinterest rates and the temporary First Home Owners Boost scheme. The outlook for 2009/10remains weak by historical standards. A heavy contraction in non-dwelling investment isexpected to weigh down on state final demand. Weak Manufacturing exports will be partiallyoffset by an improved winter crop production, boosting agricultural exports. Governmentexpenditure on urban transport infrastructure will provide some support, but overall, GSPgrowth in 2009/10 and 2010/11 is expected to be below the national average.

The introduction of the CPRS in 2012/13 will have a strong impact on emissions intensiveindustries in VIC. Brown coal fired electricity generators will be hit hard by the CPRS, whilst

manufacturers in VIC will suffer as a result of increased electricity costs. Growth shouldrebound in 2014/15 as previous investment is translated into increased output. Over the longerterm, healthy growth in services and manufacturing activity will see GSP growth maintainedabove 2 per cent, with the state economy settling into a more normal business cycle.

As a mining-dependent state, the Queensland (QLD) economy was shaken by the moderation incommodity demand and prices that occurred throughout 2008/09. At the same time, concernssurrounding job security and the erosion of household wealth through lower property andequities prices meant that consumer-spending growth recorded its weakest result in the last 12years. Further, the housing market was a significant drag on growth in 2008/09, with dwellinginvestment contracting by 6.9 per cent. The outlook in the short run is more optimistic;dwelling investment will remain subdued but an expansion in industrial production in China and

South East Asia will drive healthy growth in export earnings. Strong mining activity will be

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further supported by a continued expansion in coal seam gas production. Additionally, renewedconsumer confidence will underpin strong consumption growth. Accordingly we expect a rapidand strong recovery in the QLD economy in 2010/11, outpacing growth in the wider economy

by a considerable margin.

From a sectoral perspective, mining will continue to be a driver of growth over the mediumterm, although mining growth is expected to moderate to a more sustainable level in the mediumterm. QLDs long-term growth forecast is strongly cyclical, reflecting dependence on themining sector. A strong moderation in mining output will underpin a dip in GSP growth in2017/18. Agricultural production is expected to outperform that of the wider Australianagricultural industry, reflecting growing global demand for ethanol produced from sugar cane.Over the longer term, the services sector will be a strong performer, supported by consumer

demand on the back of high levels of interstate migration.

The South Australian economy outperformed the national economy in 2008/09, with stronggrowth in state final demand contributing positively to an expansion in GSP. Unlike the rest ofthe country, high levels of dwelling and business investment were sustained in South Australia,reflecting strong demand for housing as a result of gains in net overseas migration. Consumerdemand also continued to grow at a comparatively fast pace, on the back of a strong labourmarket and a low level of unemployment. Growth in the short run will be driven by animproved trade performance following renewed demand for mining outputs and a temporary

boost to automotive exports in late 2009. Stronger consumer demand will also support growthin consumer focused manufacturing sectors, including the textile, clothing and footwear

industry. We expect strong growth in 2009/10, followed by healthy but more moderate growthin 2010/11.

Over the longer term, net outflows of interstate migrants will see SA growth underperformcompared to the wider economy. Comparatively weak population growth will have a strongimpact on the construction sector, which is expected to exhibit sluggish growth over the forecast

period.

The Western Australian (WA) economy held up better than expected in 2008/09, postingpositive GSP growth of 2.4 per cent. Economic activity was driven by strong privateinvestment, reflecting the ongoing impact of mining projects within the state. Healthy growthwas also supported by consumption spending, which can be attributed to the effect of strong

wage growth associated with the previous commodity boom, and the resulting high averagelevels of income in the state. In the short run, the state should benefit from stronger globaldemand for commodities which will feed through to GSP growth via increased export earnings.Additionally, new investment in LNG projects and several major iron ore projects are expectedto contribute to GSP growth in the short term.

Importantly, the single sector focus of the WA economy makes it highly susceptible to cyclicaldownturns. This effect is illustrated in the medium to long term GSP forecasts which showgrowth moderating sharply in line with a turn in the commodities cycle around 2018. Notably,the utilities sector in WA is expected to be a strong performer over the forecast period. Growthin utilities output is a demand driven effect, as energy production and water supply are rampedup to meet growing demand from industry and residential consumers.

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The Tasmanian economy outperformed the national economy in 2008/09. Economic activitywas supported by comparatively strong consumer spending and private investment. Strong

private consumption, increased housing and building investment and government investmentwill support state final demand in the short term. Despite rapid falls in business investmentfrom the high levels seen in 2008/09, solid growth in state final demand will be supported bystrong dwelling investment. At the same time, Tasmanian demand for imports is set to moderatewith lower business investment; when combined with rising exports, this will result in animproved trade balance, supporting rapid growth in GSP in 2010/11.

Long-term growth for Tasmania is expected to be below the national average, reflecting in part,slower growth in the Tasmanian services sector, as well as lower overall population growth.Indeed, Tasmania will continue to experience a net outflow of interstate migrants, which will

weigh down on long-term growth prospects. In particular, the state construction sector willunderperform compared to the wider economy, reflecting weaker demand for housing.

The Northern Territory (NT) experienced strong growth in state final demand in 2008/09, whichwas supported primarily through heavy investments in private sector engineering construction.Despite strong domestic demand, weakened trade flows detracted from GSP, resulting in weakGSP growth of 1.0 per cent for 2008/09. Going forward, growth in the Northern Territoryeconomy will be driven by renewed consumer demand and an appreciation in export earnings.Whilst business investment will contract from recent highs, the resources sector will benefitfrom strong external demand for bulk commodities. This will flow through to income growth,supporting a solid expansion in household consumption. Consequently, the food, beverage and

tobacco sector is expected to experience strong output growth. Government spending onDefence and infrastructure projects will also support jobs in the region, keeping theunemployment rate well below the national average.

In contrast to the national trend of moderating growth in 2011/12, we expect strong growth tocontinue to 2011/12 in NT, before moderating with the introduction of the CPRS. Outputgrowth in 2011/12 reflects the strength of export demand and the ongoing impact of recentheavy investment in the mining sector. Over the medium term, growth will moderate in linewith a moderation in mining activity. Similar to the other resource-based states, trends over thelong run are expected o be highly cyclical. Overall, medium to long run growth should outpacethe wider economy, which is partly explained by stronger population growth. This shouldsupport solid consumer spending and activity in the construction sector. Services will also

benefit from healthy levels of consumption spending.

Energy Market Forecasts

Tables 1 to 4 present the key results of the energy market forecasts. These include forecasts oftotal electricity prices by state, gas prices by state, electricity demand by state and gas demand

by state. All demand forecasts are reported in terms of petajoules (PJ). Electricity prices arereported in terms of cents per kWh, while the gas prices are reported in an index form.

Overall, average total electricity prices are expected to grow at a faster pace over the forecasthorizon, compared to electricity price growth over the last 20 years. Faster electricity priceinflation can be attributed to the impact of the CPRS. Whilst residential electricity prices are

expected to grow more or less in line with inflation, a strong appreciation in non-residential

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electricity prices following the introduction of the CPRS should see electricity price inflationaccelerate in the medium term.

Gas prices on the other hand are expected to grow at a slower rate over the forecast horizoncompared to growth rates seen over the last 20 years. Slower growth rates over the forecastreflect the fact that gas prices have grown at a very fast pace over recent years due to surgingdemand for liquid natural gas. Slower gas price growth can also be attributed to lowerconsumer price inflation forecasts and more moderate economic growth.

Under the medium scenario, overall electricity demand is forecast to grow at a slower rate thanhas been seen over the past 20 years. A deceleration in electricity consumption growth canattributed to the following two factors.

Economic growth in general is expected to be slower over the next 20 years in comparisonto the last 20 years. The last 20 years saw the Australian economy grow at a healthyaverage of 3.19 per cent, driven by strong productivity growth throughout the 1990s andstrong export demand associated with the commodities boom. Growth is expected to slowin the next 20 years as a result of lower productivity growth and an ageing population.

Higher electricity prices due to the introduction of a CPRS will inhibit demand forelectricity to some degree.

The average growth of gas consumption over the next two decades is forecast to be similar to

that of the past two decades, although consumption growth varies considerably between states.More stable gas consumption growth reflects the fact that gas is more export oriented, whileelectricity is domestically focused.

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Table 1: Total Electricity Prices Average Growth Rates History and Forecast

Medium Scenario: Total Electricity Prices - Average Growth Rates

1991-1999 2000-2004 2005-09 2010-2015 2016-2020 2021-2030 1991-2009 2010-2030

history history history forecast forecast forecast history forecast

NSW&ACT -0.50% 1.68% 5.49% 3.56% 3.31% 2.78% 1.65% 3.13%

VIC 1.31% 2.80% 3.67% 4.43% 3.07% 2.87% 2.32% 3.36%

QLD 1.75% -1.96% 8.38% 5.23% 3.68% 3.25% 2.52% 3.92%

SA 0.30% 6.06% 1.83% 4.00% 3.12% 2.48% 2.22% 3.07%

WA -0.08% 0.75% 0.91% 4.50% 3.56% 3.26% 0.40% 3.69%

TAS 2.91% 3.54% 8.38% 4.83% 4.74% 3.86% 4.51% 4.35%

NT 0.47% 1.15% 0.11% 3.69% 1.33% 1.40% 0.55% 2.04%

High Scenario: Total Electricity Prices - Average Growth Rates

1991-1999 2000-2004 2005-09 2010-2015 2016-2020 2021-2030 1991-2009 2010-2030


NSW&ACT -0.50% 1.68% 5.49% 3.03% 2.53% 2.29% 1.65% 2.56%

VIC 1.31% 2.80% 3.67% 4.21% 2.33% 2.46% 2.32% 2.93%

QLD 1.75% -1.96% 8.38% 4.62% 2.88% 2.74% 2.52% 3.31%

SA 0.30% 6.06% 1.74% 3.29% 2.48% 2.05% 2.20% 2.51%

WA -0.08% 0.75% 0.91% 3.70% 2.43% 2.72% 0.40% 2.93%

TAS 2.91% 3.54% 8.38% 4.79% 3.34% 3.44% 4.51% 3.80%

NT 0.47% 1.15% 0.11% 4.24% 1.30% 1.42% 0.55% 2.20%

Low Scenario: Total Electricity Prices - Average Growth Rates

1991-1999 2000-2004 2005-09 2010-2015 2016-2020 2021-2030 1991-2009 2010-2030


NSW&ACT -0.50% 1.68% 5.49% 3.42% 4.34% 2.96% 1.65% 3.42%

VIC 1.31% 2.80% 3.67% 4.14% 3.98% 3.02% 2.32% 3.57%

QLD 1.75% -1.96% 8.38% 5.30% 4.57% 3.42% 2.52% 4.23%

SA 0.30% 6.06% 1.74% 4.11% 3.82% 2.65% 2.20% 3.34%

WA -0.08% 0.75% 0.91% 4.53% 4.70% 3.49% 0.40% 4.07%

TAS 2.91% 3.54% 8.38% 4.18% 6.55% 3.97% 4.51% 4.65%

NT 0.47% 1.15% 0.11% 2.99% 1.33% 1.27% 0.55% 1.78%

Source: ABS 6401.0 and KPMG Econtech Forecasts.

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Table 2: Gas Prices Average Growth Rates History and Forecast

Medium Scenario: Gas Prices- Average Growth Rates

1991-1999 2000-2004 2005-09 2010-2015 2016-2020 2021-2030 1991-2009 2010-2030


NSW&ACT 3.17% 7.43% 4.43% 3.70% 4.63% 3.47% 4.62% 3.81%

VIC 2.84% 4.17% 5.69% 3.58% 3.18% 3.10% 3.94% 3.25%

QLD 1.53% 4.86% 9.75% 2.71% 4.07% 3.23% 4.57% 3.28%

SA 2.96% 6.42% 6.31% 3.07% 4.18% 3.24% 4.76% 3.42%

WA 1.43% 4.73% 6.83% 1.30% 2.52% 1.56% 3.72% 1.71%

TAS 1.50% 7.02% 5.82% 2.71% 3.82% 2.40% 4.09% 2.83%

NT 3.80% 5.50% 6.86% 4.67% 4.61% 3.97% 5.06% 4.32%

High Scenario: Gas Prices - Average Growth Rates

1991-1999 2000-2004 2005-09 2010-2015 2016-2020 2021-2030 1991-2009 2010-2030


NSW&ACT 3.17% 7.43% 4.43% 2.46% 3.32% 2.68% 4.62% 2.77%

VIC 2.84% 4.17% 5.69% 3.35% 2.54% 2.70% 3.94% 2.85%

QLD 1.53% 4.86% 9.75% 1.40% 1.87% 1.84% 4.57% 1.72%

SA 2.96% 6.42% 6.31% 2.19% 3.11% 2.52% 4.76% 2.57%

WA 1.43% 4.73% 6.83% 0.90% 2.24% 1.30% 3.72% 1.41%

TAS 1.50% 7.02% 5.82% 1.43% 3.24% 2.02% 4.09% 2.14%

NT 3.80% 5.50% 6.86% 2.55% 2.87% 2.69% 5.06% 2.69%

Low Scenario: Gas Prices - Average Growth Rates

1991-1999 2000-2004 2005-09 2010-2015 2016-2020 2021-2030 1991-2009 2010-2030


NSW&ACT 3.17% 7.43% 4.43% 4.32% 6.23% 3.82% 4.62% 4.54%

VIC 2.84% 4.17% 5.69% 3.63% 3.83% 3.34% 3.94% 3.54%

QLD 1.53% 4.86% 9.75% 3.28% 6.52% 4.11% 4.57% 4.45%

SA 2.96% 6.42% 6.31% 3.59% 5.15% 3.79% 4.76% 4.06%

WA 1.43% 4.73% 6.83% 1.36% 2.95% 1.76% 3.72% 1.93%

TAS 1.50% 7.02% 5.82% 3.49% 4.40% 2.71% 4.09% 3.34%

NT 3.80% 5.50% 6.86% 5.35% 6.24% 4.48% 5.06% 5.15%

Source: ABS 6401.0 and KPMG Econtech Forecasts.

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Table 3: Electricity Demand Average Growth Rates History and Forecast

Medium Scenario: Electricity Demand - Average Growth Rates

1990-1999 2000-2004 2005-09 2010-2015 2016-2020 2021-2030 1990-2009 2010-2030


NSW&ACT 3.00% 1.94% 1.90% 1.91% 2.27% 1.82% 2.46% 1.95%

VIC 1.91% 3.10% 3.98% 1.92% 2.28% 1.78% 2.72% 1.94%

QLD 5.32% 3.80% 1.94% 2.40% 1.79% 1.63% 4.09% 1.89%

SA 3.34% 1.71% 2.74% 2.82% 2.79% 2.17% 2.78% 2.50%

WA 5.47% 2.70% 3.07% -0.12% 1.69% 1.09% 4.18% 0.89%

TAS 1.10% 2.18% 3.60% 2.12% 2.46% 1.74% 1.99% 2.02%

NT 4.66% 3.64% 4.76% 0.24% 1.62% 1.54% 4.43% 1.19%

High Scenario: Electricity Demand - Average Growth Rates

1990-1999 2000-2004 2005-09 2010-2015 2016-2020 2021-2030 1990-2009 2010-2030


NSW&ACT 3.00% 1.94% 1.90% 1.93% 2.40% 2.21% 2.46% 2.18%

VIC 1.91% 3.10% 3.98% 2.01% 2.77% 2.36% 2.72% 2.36%

QLD 5.32% 3.80% 1.94% 2.51% 2.12% 2.05% 4.09% 2.20%

SA 3.34% 1.71% 2.74% 2.98% 3.43% 2.93% 2.78% 3.06%

WA 5.47% 2.70% 3.07% 0.21% 1.89% 1.53% 4.18% 1.24%

TAS 1.10% 2.18% 3.60% 2.16% 2.77% 2.23% 1.99% 2.34%

NT 4.66% 3.64% 4.76% 0.72% 1.81% 1.82% 4.43% 1.50%

Low Scenario: Electricity Demand - Average Growth Rates

1990-1999 2000-2004 2005-09 2010-2015 2016-2020 2021-2030 1990-2009 2010-2030


NSW&ACT 3.00% 1.94% 1.90% 1.86% 1.93% 1.47% 2.46% 1.69%

VIC 1.91% 3.10% 3.98% 1.70% 1.31% 1.40% 2.72% 1.46%

QLD 5.32% 3.80% 1.94% 2.30% 1.26% 1.33% 4.09% 1.59%

SA 3.34% 1.71% 2.74% 2.44% 1.83% 1.60% 2.78% 1.90%

WA 5.47% 2.70% 3.07% -0.30% 1.01% 0.88% 4.18% 0.57%

TAS 1.10% 2.18% 3.60% 1.80% 1.77% 1.44% 1.99% 1.62%

NT 4.66% 3.64% 4.76% -0.11% 1.29% 1.38% 4.43% 0.93%

Source: ABARE Australian Energy Consumptions Data and KPMG Econtech Forecasts.

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Table 4: Gas Demand Average Growth Rates History and Forecast

Medium Scenario: Gas Demand - Average Growth Rates

1990-1999 2000-2004 2005-09 2010-2015 2016-2020 2021-2030 1990-2009 2010-2030


NSW&ACT 4.01% 1.08% -1.70% 1.77% 2.30% 1.70% 1.85% 1.86%

VIC 0.00% 3.11% 1.26% 2.69% 2.37% 1.44% 1.09% 2.02%

QLD 13.10% 9.91% 8.47% 10.11% 8.48% 7.26% 11.15% 8.37%

SA 1.08% 1.62% 4.09% 2.00% 1.39% 1.28% 1.97% 1.51%

WA 7.43% 4.26% 6.99% 2.86% 2.64% 3.16% 6.53% 2.95%

TAS - - 15.58% 5.10% 3.26% 2.42% 15.58% 3.39%

NT 5.66% 3.02% 13.15% 6.60% 4.45% 4.55% 7.19% 5.11%

High Scenario: Gas Demand - Average Growth Rates

1990-1999 2000-2004 2005-09 2010-2015 2016-2020 2021-2030 1990-2009 2010-2030


NSW&ACT 4.01% 1.08% -1.70% 1.80% 2.54% 2.20% 1.85% 2.17%

VIC 0.00% 3.11% 1.26% 2.50% 2.49% 1.77% 1.09% 2.15%

QLD 13.10% 9.91% 8.47% 9.90% 8.78% 7.70% 11.15% 8.58%

SA 1.08% 1.62% 4.11% 2.04% 1.94% 1.85% 1.97% 1.93%

WA 7.43% 4.26% 6.99% 3.31% 3.14% 3.81% 6.53% 3.51%

TAS - - 15.58% 5.40% 3.88% 3.28% 15.58% 4.03%

NT 5.66% 3.02% 13.15% 7.14% 5.28% 5.38% 7.19% 5.86%

Low Scenario: Gas Demand - Average Growth Rates1990-1999 2000-2004 2005-09 2010-2015 2016-2020 2021-2030 1990-2009 2010-2030


NSW&ACT 4.01% 1.08% -1.70% 1.73% 1.76% 1.22% 1.85% 1.50%

VIC 0.00% 3.11% 1.26% 2.86% 1.90% 1.15% 1.09% 1.81%

QLD 13.10% 9.91% 8.47% 10.27% 8.01% 6.90% 11.15% 8.13%

SA 1.08% 1.62% 4.11% 1.20% 1.07% 1.07% 1.97% 1.11%

WA 7.43% 4.26% 6.99% 2.88% 0.71% 3.18% 6.53% 2.51%

TAS - - 15.58% 4.67% 2.00% 1.89% 15.58% 2.71%

NT 5.66% 3.02% 13.15% 6.06% 3.05% 4.45% 7.19% 4.58%

Source: ABARE Australian Energy Consumptions Data and KPMG Econtech Forecasts.

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1 IntroductionIn early 2009, KPMG was engaged by the then National Electricity Market ManagementCompany (NEMMCO) (now the Australian Energy Market Operator (AEMO)) to provideenergy policy analysis, economic scenarios and forecasts, and electricity market inputs for the

National Electricity Market (NEM) regions. This data was to support the production of energyand demand projections to inform its 2009 Electricity Statement of Opportunities (ESOO).

In late 2009, AEMO then engaged KPMG Econtech to update the key economic and energydemand forecasts used for the production of the 2009 ESOO. These updated economic andenergy demand forecasts were used as inputs into the Energy White Paper (EWP) which iscurrently being prepared by the Department of Resources, Energy and Tourism (DRET). The

updated forecasts covered the NEM regions, Western Australia and the Northern Territory.Following from our 2009 work, AEMO has now engaged KPMG to provide three staged reportsto inform its 2010 ESOO, relating to:

key known and possible energy policies and high level calibration of their impliedquantitative impacts (Stage 1 Report);

economic scenarios (medium, high and low) and electricity and gas market outcomes for theNEM regions and Western Australia and the Northern Territory (Stage 2 Report); and

semi-scheduled, non-scheduled and exempted generation, on a state/territory basis, byclassification as renewable or non-renewable and by specific fuel source (Stage 3 Report).

This report is the Stage 2 Report and it is intended to support the production of energy anddemand projections for the 2010 ESOO. The key difference between the 2009 and 2010 reportsrelate to the main scenario drivers. In the 2009 report, the main scenario drivers were developedwith reference to the Stage 1 Report. For the 2010 report, the main scenario drivers are to alignwith the scenarios developed for the EWP. Another difference is that in the 2009 report, onlythe total electricity demand for each NEM region was forecast, but for the 2010 report, fifteensectoral electricity and gas demand forecasts for each state are provided. As a result, theforecasts presented in this report cover an expanded number of variables and regions thanincluded in the 2009 report.

This report will provide economic forecasts for the next 20 Australian financial years for thefollowing three core scenarios:

MMA Scenario 1 - fast economic and population growth with an initial target to reduceemissions by 25 per cent from 2000 levels by 20204.

MMA Scenario 3 - medium economic and population growth with an initial target to reduceemissions by 15 per cent from 2000 levels by 20205.

4According to the Treasury climate change mitigation policy modelling released in October 2008, the 25 per centreduction scheme is referred to as Garnaut-25. This scenario assumes an optimal international emissions tradingscheme, covering all emission sources and all economies. Australias emission reduction targets in Garnaut-25 are 25per cent below 2000 levels by 2020 and 90 per cent below by 2050 for stabilisation at 450ppm. In this report, the 25per cent reduction scheme in MMAs report is referred to as CPRS-25.

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MMA Scenario 5 - slow economic and population growth with an initial target to reduceemissions by 5 per cent from 2000 levels by 20206.

The specific economic variables required consist of standard output from KPMG Econtechsmacro-CGE model, MM2 as well as certain customised variables, defined below. Somesectoral outputs will be generated from MM2 satellite models, while all energy market relatedvariables (demand and prices) will be generated from customised econometric models. Allforecasts denoted in dollar values are reported in real terms, with a base year of 2006/07.

The complete list of variables presented in this report is provided in Appendix A.

1.1 Structure of this reportThis report is structured into the following sections:

Section 2 summarises the economic outlook and provides a description of the assumptionsunderlying the medium, high and low scenarios;

Section 3 outlines the data sources and forecasting methodology; and

Section 4 provides forecast results for national and state macroeconomic variables.

Section 5 presents preliminary results for energy market variables.

This report also includes a number of appendices.

Appendix A presents a complete list of variables forecast as part of this engagement.

Appendix B to V details the customised forecasting model.

Appendix W Electronic Appendix all data tables that underpin the forecasts contained inthis report are contained in an electronic Appendix.

Appendix X provides further details on MM600+, the model used to estimate the impact ofthe CPRS.

5According to the Treasury climate change mitigation policy modelling released in October 2008, the 15 per centreduction scheme is referred to as CPRS-15. This scenario assumes a more realistic multi-stage global framework.Australias long term emission reduction target is 60 per cent below 2000 levels by 2050, while the medium-termtarget is 15 per cent below 2000 levels by 2020 with a long-term stabilisation target at 510ppm.6According to the Treasury climate change mitigation policy modelling released in October 2008, the 5 per centreduction scheme is referred to as CPRS-5. The assumptions relating to a global emission trading scheme are thesame as in CPRS-15, and it also assumes the same long-term emission reduction target for Australia, 60 per centbelow 2000 levels by 2050. However, CPRS-5 assumes a slower start to global emission reductions and stabilisationat 550ppm with Australias medium-term target of 5 per cent below 2000 levels by 2020.

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2 Economic Summary, Risks and Scenarios2.1 International Outlook

In late 2008, the global economy entered a period of severe financial instability. Spurred on bythe collapse of the US sub prime mortgage market, banks, financial institutions and othertrading based operations around the world incurred massive losses associated with thedevaluation of mortgage backed securities and other forms of hybrid debt instruments. Theresulting impact on the real economy was no less intense; following the collapse of severalmajor financial institutions in the US and UK, credit markets around the world seized up,making it difficult for businesses to access the necessary finance to undertake normal business

operations. Equity markets were likewise devastated, with share prices around the worldplummeting in line with extreme investor risk aversion and market pessimism.

Financial institutions remained unwilling or unable to lend to each other and to other businessesthroughout the majority of 2009. As a result, the world economy contracted for the first time inthe post-war period. Whilst developed nations were the hardest hit, weaker consumption in theUS, UK and Euro zone did flow through to impact on export demand for the developing world.The overall impact was an estimated contraction of 0.8 per cent in global GDP

7.

Since late 2009, the global economy has begun to exhibit signs of a recovery. Economicconditions have improved somewhat more rapidly than expected, leading the IMF to revise itsgrowth forecasts up to 3.9 per cent for 2010. The speed of recovery will likely vary

considerably across different nations due to the uneven distribution of economic conditions,policies and shocks experienced. Growth will be driven primarily by resurgent activity indeveloping countries, with Asian economies in particular exhibiting strong growth. Developednations on the other hand are likely to experience more sluggish growth rates (see Chart 2.1).

Economic growth expectations for the developing world are very optimistic on average. Centraland Eastern European countries have seen promising growth in the last quarter of 2009, whilstLatin American countries have also shown signs of accelerating growth. The Chinese economyis back on a rapid growth path, after a temporary slow down during the financial turmoil.Chinese GDP growth was very high at an annualised rate of 10.7 per cent in the last quarter of2009, with fiscal stimulus policies being a key contributor to Chinas economic performance.

Net exports on the other hand contributed negatively to GDP growth in 2009. The IMF

forecasts Chinas growth to be 10 per cent in 2010.

The outlook for the developed world on the other hand is more mixed. The economies of boththe US and the UK did expand in the last quarter of 2009, but a large measure of activity can beattributed to fiscal stimulus measures. This has led many commentators to question whether thefundamentals for these economies have actually improved substantially since mid 2009, andwhether or not such growth can be sustained over the next year. For example, recent economicdata shows that the US economy expanded strongly in the last quarter of 2009, at an annualisedrate of 5.7 per cent. Whilst this is a marked improvement over previous quarters, a large

proportion of this growth can be attributed to a slowing in inventory draw downs and the impactof the cash-for-clunkers program. That said, the IMF has taken this result as a sign of

7IMF, January 2010, Update to World Economic Outlook.

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returning confidence in the US economy, revising their growth forecasts up to 2.7 per cent for2010.

Chart 2.1: Global GDP Growth (per cent, annual)

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

2000 2001 200 2 2003 2004 2005 2006 2007 2008 2009 2010 2011

World

Advanced Economies

Emer.& Develop. Eco.

Source: Adapted from IMF, January 2010, World Economic Outlook Update.

Growth in the UK has been less impressive; real GDP expanded by 0.1 per cent in the lastquarter of 2009. Despite marginal improvements in consumer and business confidence, growthin the UK is expected to remain sluggish as households continue to be constrained by tightcredit markets as well as high unemployment rates.

The Euro zone economy has recently been shaken by a blow-out in government budget deficits.Of particular concern is the announcement that the 2009 Greek budget deficit would come in atan estimated 12.7 per cent of GDP, well above the EU target of 3 per cent. This event has cast aspotlight on the tenuous budget positions of other EU member countries (Spain, Portugal andItaly) and raised concerns that planned fiscal stimulus measures may be rolled back to rein ingovernment spending. The situation currently remains unresolved and has created significantuncertainty in European equity markets, and to a lesser extent, the US. This situation has the

potential to have further negative impacts on global confidence if the European Central Bankdoes not extend financial support, and Greece is forced to appeal to the IMF for funding.

At the same time, the latest report from the European Central Bank shows that household andbusiness confidence remain significantly below their long-term averages. Continuing tightnessin the credit market will also discourage investment, and fears of rising unemployment will limithousehold consumption. Consequently, growth prospects for the EU area remain pessimistic,with France being the only large economy showing any real signs of growth.

Various indicators suggest that conditions improved in the Japanese economy in the last quarterof 2009. However, the countrys Cabinet Office revised third quarter real GDP growthdownwards from 1.2 per cent to 0.3 per cent. Even though consumer confidence does notappear to be recovering, spending on durable goods appears to be steady, and industrial

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production has increased for several periods. Despite an expected slow recovery in domesticdemand, Japanese growth will be aided by strengthening export demand from recovering SouthEast Asian economies. IMF forecasts for GDP growth in Japan remain stable at 1.7 per cent for2010.

On balance, recovering industrial production in developing countries should underpin animproved performance in 2010. Although growth in developed economies will remain weak in2010, recent developments suggest they are on much firmer ground than they were in 2009.Provided that no Euro zone members default on government debt, a full-fledged global recoveryshould begin in 2011.

2.2 National OutlookThe Australian economy has continued to surprise over the last few quarters, exceeding theexpectations of both markets and policy makers. A comparatively rapid recovery in thedomestic economy can be attributed to a range of factors, including the strong performance ofAsian trading partners, resilient consumer spending, the relative health with which theAustralian banking sector entered the financial crisis and a sooner than expected recovery indwelling investment. With global economic conditions continuing to improve, and domestic

business and consumer sentiment bouncing back to pre-crisis levels, overall economic growthshould pick up in 2009/10. A full-fledged recovery is expected in 2010/11 as the economygathers pace in late 2010.

One of the key drivers of growth will be the dwelling construction sector, which has recentlybeen coaxed into a recovery by combined effect of the First Home Owners Boost (FHOB) andextremely low interest rates. Strong underlying demand for housing will drive a continuedexpansion in dwelling investment, despite prospective interest rate rises and the discontinuationof the FHOB as of the end of December 2009. Higher export volumes will also contribute

positively to GDP growth, as an expansion in Chinese industrial production translates intoincreased demand for bulk commodities.

Recent statistics suggest the labour market has been far more resilient than initially expected.Employment, whilst stagnant in 2009, did not experience any substantial falls that wouldusually be associated with an economic downturn. Rather than laying off workers, many firms

opted to reduce hours so as to avoid redundancies. Consequently, the unemployment rateappears to have topped out at 5.8 per cent in October 2009. Going forward, unemploymentshould gradually ease over 2010, although employment growth is expected to be slow in theshort run as firms prefer to increase hours worked as opposed to hiring new workers.

Following an alleviation of inflationary pressures, in the wake of reduced domestic demand andexternal price pressures, the RBA cut interests rates to a record low of 3 per cent in April 2009.The bank maintained this rate throughout the majority of 2009, although has since raised theinterest rate back to 4.0 per cent. With a return to normal growth within the domestic economy,it is highly likely that rates will be brought back to a neutral level by the end of 2010.

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2.3 Scenario DevelopmentThe Energy White Paper prepared by DRET is concerned with long-term planning for theenergy sector under extreme change and uncertainty. The uncertain nature of developments inthe energy sector is managed by AEMO/DRET through the construction of alternative futurescenarios, each of which should be accepted as being possible but not necessarily likely. Fromthis point of view, the high and low scenarios developed in this report represent extreme casesrather than expected outcomes that could be interpreted as a confidence interval or sensitivityanalysis around a baseline.

To assist with the management of the uncertain nature of developments in the energy sector,DRET and AEMO commissioned MMA to develop five scenarios describing the potential state

of the Australian stationary energy sector in 2030. The five scenarios

8

are distinguished fromeach other through the following six dimensions:

Economic growth;

Population growth;

Carbon policy;

Centralised supply-side response;

Decentralised supply response; and

Demand-side response.

The first three dimensions have economy-wide implications, while the last three dimensions aremore specific to the energy sector. For this report we have developed three scenarios (medium,high and low) that are distinguished through economy-wide dimensions rather than electricitysector specific dimensions. The three scenarios developed by KPMG Econtech aredistinguished from each other in terms of the following three broad factors:

the strength of global and economic growth;

the strength of population growth; and

the assumed emission targets to be included in the Carbon Pollution Reduction Scheme(CPRS).

The CPRS assumptions, and indeed all of the assumptions underlying the scenarios, have beendeveloped based on requirements from AEMO that they are consistent with the scenariosdeveloped in the 2009 MMA report. Given these requirements, our medium, high and lowscenarios have been developed to align with MMA scenarios 3, 1 and 5 respectively. Table 2.1

provides a brief description of each scenario in terms of the three broad factors.

8MMA has further differentiated the five scenarios by introducing 2 CPRS targets under each scenario.

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The medium scenario assumes an emissions reduction target of 15 per cent by 2020 (meaning areduction in emissions of 15 per cent below 2000 levels). This scenario, referred to as CPRS-15in the MMA report, is based on an assumption of a realistic multi-stage global framework ofmoderate emissions reductions. The Treasury estimates that if the CPRS were to be introducedin 2010/11, the nominal carbon permit price would be $32/t CO2e.

9 Based on the governments

amendments to the CPRS, announced 4 May 2009, a carbon price will be fixed at $10/t CO2 in2011-12 and a full scale CPRS has now been postponed to 2012/13. As such, the estimatedcarbon price has been inflated forward at a rate of 3.5 per cent per year, resulting in a carbon

price of $34.3/t CO2e in 2012/13. We have assumed that a transitionary scheme would be putin place, so the carbon price begins at $10/t CO2e in 2010/11, before being raised to $34.3/tCO2e in 2012/13.

The high scenario assumes an emissions reduction target of 25 per cent by 2020. This scenario(CPRS-25) is based on an assumption of strong international involvement in an emissionstrading scheme, covering all emissions sources and all economies. Again, the carbon price isassumed to start at $10/t CO2e in 2010/11 before being raised to $51.4/t CO2e in 2012/13. Theestimated carbon price is based on Treasurys estimated price of $48/t CO2e in 2010/11,inflated by 3.5 per cent per year.

The low scenario assumes an emissions reduction target of 5 per cent by 2020. This scenario(CPRS-5) is based on an assumption of lower international involvement in an emissions tradingscheme, with a slow start to emissions reductions in both Australia and abroad. Again, thecarbon price is assumed to start at $10/t CO2e in 2010/11 before being raised to $24.6/t CO2e in

2012/13. The estimated carbon price is based on Treasurys estimated price of $23/t CO2e in2010/11, inflated by 3.5 per cent per year.

Under each scenario, the carbon price is assumed to grow by a real rate of 4 per cent per annumfrom 2012/13 onwards. This 4 per cent real growth rate reflects the fact that carbon permits arefinancial assets and are bankable over time. It is based on a 2 per cent annual return and 2 percent risk premium.

It is also important to note that the economic impacts may not be driven by the emissions target.The CPRS allows for the imports of permits from overseas, provided there is globalinvolvement in an emissions trading scheme. This means that the price of carbon in Australia iseffectively determined on the global market. For example, if the price of carbon in Australia is

higher than the price of carbon overseas, emitters will purchase permits on the global marketand not the Australian market. This will place downward pressure on the price of carbon inAustralia until parity is achieved between the Australian price and the global price.

We note that the overall impacts of the CPRS assumptions on the macro variables are limited;however, the utility sector outcomes are sensitive to the choice of CPRS assumptions.

2.3.3 Global Economic Outlook and Productivity GrowthDevelopments in the global economy have a strong impact on Australias growth prospects. Asa resource based economy, external demand for commodities has a direct and significant impact

9Treasury (2008), Australias Low Pollution Future: The Economics of Climate Change Mitigation Summary.

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on Australian export earnings. The availability of credit from international sources dictates thecost of funding within the Australian financial sector. Accordingly, assumptions governing thespeed of recovery from the Global Financial Crisis (GFC) are a key determinant of domesticeconomic growth over the short to medium term.

The GFC has lead to a substantial re-pricing of risk. Investors are currently requiring higherrisk premiums for both debt and equity, and financial institutions have become far more riskaverse in regards to financing businesses. The main sources of uncertainty surrounding thecrisis are the extent to which risk premiums remain elevated and the length of time it takes forreal economic activity to recover. Our scenarios have been developed to incorporate a range ofassumptions regarding credit availability, risk premiums and ultimately, global growth.

The medium scenario assumes a recovery in global growth to a moderate level by 2010/11.Under this scenario, a moderation in credit risk premiums and increased capital liquidityunderpin emerging growth of 1.15 per cent in 2009/10, picking up to a rate of 3.24 per centfrom 2010/11 onwards. This assumption is broadly in line with current IMF forecasts of 3.9 percent global growth in 2010. Renewed economic activity flows through to increased demand forcommodities; the assumed impact is for rural and non-rural commodity prices (based on theRBA index of rural and non-rural commodities) to appreciate by 5.5 per cent in 2010/11.Commodity prices are assumed to grow at an annual rate of 2 per cent from 2010/11 onwards, astandard balanced-growth modelling assumption.

The high scenario assumes a strong global recovery from the GFC, led by rapid growth in China

and India. Global growth is assumed to reach a rate of 5.1 per cent by 2010/11, continuing overthe forecast period. Under this scenario, growth will be aided by lower credit risk premiums(below the medium scenario risk premium) and increased capital liquidity. Strong demand fromdeveloping economies will support a rapid appreciation in commodity prices, with rural andnon-rural commodity prices appreciating by 9.5 per cent in 2010/11. Commodity price growthwill moderate to 2 per cent per annum from 2010/11 onwards.

Conversely, the low scenario assumes a slow global recovery from the GFC, with continuedweakness in OECD economies and a slower start to industrial production in developingeconomies. Global growth is assumed to reach a rate of 2.1 per cent by 2010/11, continuingover the forecast period. Under this scenario, growth will be inhibited by continued tightness incredit markets. Lingering risk aversion will see credit risk premiums remain at high levels

(above the medium scenario risk premium) and low levels of capital liquidity. Weaker demandfor commodities will mean prices appreciate by a lower rate of 3.4 per cent in 2010/11.Commodity price growth will moderate to 2 per cent per annum from 2010/11 onwards.

In addition to external drivers of growth, the scenarios incorporate assumptions of domesticproductivity growth. The inclusion of productivity assumptions manages for the uncertaintyassociated with future technological innovations and labour force skill development.

The medium scenario assumes that technological innovation supports productivity growth of 1.5per cent per annum over the forecast period. This value was chosen in accordance withhistorical rates, as well estimates used by the Productivity Commission and within the Federal

budget papers. We note that the rate of 1.5 per cent is in accordance with the rate used by

Treasury in the 2009-10 budget papers, but below the 30-year historical average of 1.6 per cent

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that is assumed by the Treasury in the 2010 Intergenerational Report. This arguablyconservative estimate of productivity growth reflects a continuation of the status quo;

productivity growth in Australia has slowed to an average of 1.4 per cent per annum over thelast decade compared to an average of above 2.0 per cent for the 1990s.10 This deceleration can

be linked to a number of factors including capacity constraints in the Australian economy andshocks that have affected specific industries (i.e. drought impacted on agriculture productivityand fast output expansion in mining meant productivity was sacrificed to achieve short termcapacity growth).11 As such, a 1.5 per cent rate assumes a slight improvement in productivitygrowth over the last ten years, reflecting an abeyance of industry specific shocks, but alsomanages for productivity constraints due to a saturation of technological progress.

The high scenario assumes a fast rate of productivity growth, at 1.75 per cent per annum over

the forecast period. This scenario simulates a situation in which productivity growth outpacesthe growth seen in recent years, and returns towards its long run (40 year) historical average. Of1.75 per cent. This scenario represents a situation in which policy reforms, such as reducedindustry assistance, regulatory reform and strong investment in Research and Development

promote productivity growth. The low scenario on the other hand assumes a slower rate ofproductivity growth, at 1.25 per cent per annum over the forecast period. This simulates asituation in which productivity growth continues to moderate from the long run average, as aresult of weaker policy initiatives, slower human capital investment and a continuation ofcapacity constraints in the Australian economy.

10Treasury (2010), Intergenerational Report.11Banks, G. (2009), Back to the Future: Restoring Australias Productivity Growth, Presentation made to theMelbourne Institute/AustralianEconomic and Social Outlook Conference, 5 November 2009, availablewww.melbourneinstitute.com.

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3 Modelling Methodology, Data Sources and Estimation3.1 Data Sources

3.1.1 Energy Sector DataHistorical data for electricity and gas demand is based on ABARE Australian energyconsumption data

12. Electricity prices for residential, non-residential and the total market up to

2002/03 are based on the ESAA publications. For the remaining historical period, historicalannual AEMO spot prices for New South Wales, Victoria, Queensland are used to estimate therelevant retail prices, while prices for Western Australia and the Northern Territory are based on

the Western Australia historical average growth rates. AEMO directly provided all of historicaldata for electricity prices in South Australia. The gas price series are based on thecorresponding components of the Consumer Price Index (ABS Catalogue No. 6401.0). For theresidential electricity price forecasting models, ABS CPI indices have been used; this isconsistent w

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