We are seeing an unprecedented rise in electricity prices across the board, with the impact being felt acutely across the business community.
At the same time we are at the early stages of a fundamental transformation of the electricity sector and on the cusp of a very rapid transition towards new technologies.
What have been the main drivers of rising electricity prices?
There are four underlying causes...
1. Wholesale Gas Prices
In the short-term, the biggest cause of high electricity prices is the cost of gas, which is increasingly setting the prices in the wholesale electricity market.
Gas and electricity markets are closely connected.
In the wholesale electricity market, generators bid the quantity of electricity they are willing to supply and the price they want to receive in an auction process. Generators are dispatched in price from lowest to highest up to the level where supply requirements are met. The most expensive marginal generator sets the clearing price that is paid to all generators dispatched. The economics of gas-fired generators are being challenged by rising gas prices and tightening of supply, which then increases the spot price for the wholesale electricity market.
In the past decade, the east coast gas market has fundamentally changed with three QLD LNG projects having significant impact on the domestic gas market. These LNG projects have entered into long-term LNG export agreements, with strict gas supply delivery requirements. However, some of these projects have experienced difficulties in extracting sufficient gas reserves.
With rising international gas prices and simultaneous domestic restrictions on CSG exploration, significant volumes of gas originally intended for the domestic market are being exported.
As a result, it is becoming increasingly difficult and more expensive for gas-fired generators to secure firm gas supply contracts.
The rising cost of input costs for gas-fired generators is being translated in higher wholesale electricity spot prices, which then flow on to higher retail prices.
The Federal Government has introduced measures, effective 1 July 2017, to impose export restrictions on gas to reduce domestic gas supply shortages, which will apply downward pressure on gas and electricity prices.
2. Transmission and Distributions Charges
Large demand forecasting errors have contributed to a number of problems in the NEM.
Previously, electricity demand increased with population and economic growth. From the late 2000’s, demand has moderated and then declined. Electricity forecasters did not realise immediately that this was a structural change and that consumer patterns have shifted permanently with the arrival of new technologies.
Increased penetration of roof-top solar panels, changing industrial consumption and energy efficiency initiatives have contributed to a structural reduction of actual demand.
As a result, there has been a significant degree of over-investment in recent transmission and distribution network infrastructure, with consumers bearing the cost of these investments through substantial transmission and distribution charges.
The Federal Government has announced on 20th June 2017 that it will address these through strengthening the hand of the Australian Energy Regulator and limiting the ease of appeal, in line with the Finkel Review recommendations.
3. Performance and Transparency
Effective competition is a key driver of productive, efficient and innovative markets. There have been some suggestions made during the submission process to the Finkel Review, that the electricity retail market is not offering the same value to consumers as other markets, and in particular in comparison to other electricity markets overseas.
A number of reviews and inquiries, including the Australian Competition and Consumer Commission, are currently considering issues related to the effectiveness of the electricity retail competition. Increased competitiveness in markets reduces the likelihood of above equilibrium pricing.
4. Investor Uncertainty
The above reasons (1-3) are all short-term factors applying upward pressure on electricity pricing.
But for the long-term, the more fundamental, underlying reason for rising prices in the wholesale market, especially in the price of forward contracts, is investor uncertainty. That uncertainty revolves around current and future emissions reduction policies.
In the long-term, resolving the uncertainty will out downward pressure on prices by bringing new generation online. Increasing overall supply in the market will reduce prices at each point on the supply curve.
The electricity sector acknowledges the role it will play in Australia’s national emission reduction efforts. The overwhelming view from stakeholders, especially from within the electricity sector, was the need for a credible and enduring emissions reduction mechanism.
The uncertainty and changing directions of emissions reduction policy for the electricity sector has compromised the willingness for market participants to make investments in the NEM – this is the case for all participants, including renewables, gas and coal generation.
For a sector characterised by very high-cost and long-lived assets, policy transparency, credibility and durability are key.
Without investment in new generation, the reliability of the NEM will be compromised.
Long term emissions reduction trajectory for the electricity sector, notice of closure requirements for large generators and an emission reduction mechanism to provide policy stability and certainty will drive new investment. Investment in new generation increases supply and provides downward pressure on long-term electricity pricing.
The information above has been sourced from the Independent Review into the Future Security of the National Electricity Market, June 2017 (Finkel Review)