Can land values fund Latrobe Valley’s energy transition?

Posted on September 9, 2016 · Posted in Blog

Latrobe Valley is home to three major coal fired power stations, and the open cut coal mines that feed them. To decarbonise the Australian economy requires a substantial transition away from this energy source to renewables.

Such a transition is expected to be disruptive to the economy of the Valley, and many argue that public investment in regeneration and renewable energy programs can help the Valley adapt and thrive. One unresolved question is whether this type of program can be “self-funded” by the economic gains to the region, by directing a share of land value gains that may arise because of improved environmental amenity towards new investments.

Evidence suggests that power plants reduce nearby home values by 3-7%[1], while renewable energy facilities such as wind turbines, have no statistically measurable effect[2]. In a transition period that would include the closure of the three main power plants in the Valley, one could reasonably expect home prices to increase by this amount, subject to sufficient alternative local industrial activity supporting employment in the area. This last point is important, because local wages and employment opportunities are another key determinant of home prices.

It may therefore be possible for a government seeking to spend money on investing in alternative energy facilities, and rehabilitating mine and power station sties, to recoup some of that spending through a charge on land value gains in the local area.

Before pursuing such an approach some estimate of the potential size land value gains is needed. This can then be compared to the costs of the investments needed to close the power stations while maintaining local industry and employment.

The simplest way to do this is to focus on residential land values, which make up the bulk of land values in urban areas, and are most affected by the negative amenity of nearby power plants. The table below shows the calculation of the total value of residential dwellings in the major towns of Latrobe Valley, and then the potential value gains from the closure of the power plants.

The first column is the 2015 median home sale price, with the next the 2011 population (a conservative estimate compared to today’s population). The third column takes the occupancy rate of 2.6 persons per dwelling from the ABS survey of housing to estimate the number of homes from the population, which is immediately multiplied by the median price in each area to get an estimate of the total value of housing in each town.

Residential Values (2015) Population (2011) Est. value @2.6 per home 3% gain 7% gain
Moe 168,000 8,751 565,449,231 16,963,477 39,581,446
Morwell 165,000 14,005 888,778,846 26,663,365 62,214,519
Traralgon East 298,000 1,864 213,643,077 6,409,292 14,955,015
Traralgon 385,000 23,834 3,529,265,385 105,877,962 247,048,577
TOTAL 48,454 5,197,136,538 155,914,096 363,799,558

Sources: Land values from Victorian Property Sales Report, Department of Transport, Planning and Local Infrastructure. Population from ABS 2011 Census. Occupancy rate from ABS 4130.0 Housing Occupancy and Costs 2013-2014.

The last two columns are estimates of the value changes that would arise in the two scenarios where the closure of the power plants resulted either a 3% or 7% increase residential home values.  The last row is the total for the area, showing that if sufficient employment opportunities are maintained in the area, the net effect on land values of simply closing the power stations and replacing the energy with renewable sources, would be between $155 – $363 million.

At a 5% capitalisation rate, an incremental land value charge that captured all these gains would generate annual revenues of $7 – $18 million from residential landowners.

There are some other points to briefly clarify about this analysis.

  1. This “back of the envelope” calculation excludes non-residential land uses, which would increase the total gains.
  2. It excludes any population changes in the past five years, as well as excluding the land value gains in land able to be converted to future residential uses.
  3. It assumes that all other factors affecting home prices are unchanged. In particular, this means that local wages are sustained because of substantial other investments occurring in the region.
  4. It ignores cyclical effects on land values that may happen during any transition period.

Lastly, if such a scheme were to be implemented, questions about the distribution of economic gains must also be addressed. In the absence of a land value capture scheme, land value gains would go to a large share of residents with a long term interest in staying in the area, which they may be able to draw on by borrowing to help their own transition and invest in their local businesses. Therefore, a land value capture mechanism is likely to crowd out some private investment that would be facilitated any increase in home prices.

Overall, this exercise gives a reasonable picture of the potential size of land value gains in the areas, which could form a part of any funding arrangement for transitional investment in the region.

[1] Davis, L. W. (2011). The effect of power plants on local housing values and rents. Review of Economics and Statistics, 93(4), 1391-1402.

[2] Lang, C., Opaluch, J. J., & Sfinarolakis, G. (2014). The windy city: Property value impacts of wind turbines in an urban setting. Energy Economics, 44, 413-421.

By Dr Cameron Murray (@rumplestatskin)