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Our power prices are plunging, but only for a chosen few

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Given that our entire political debate seems to be centred around the cost of living, and much of Tony Abbott’s election plan rests on a campaign against rising electricity prices, it must come as a shock to many to learn that wholesale electricity prices are at their lowest since the introduction of the National Electricity Market more than a decade ago.

You could be excused for not noticing. The way the market works in Australia, dominated as it is by vertically integrated companies that act as oligopolies all along the value chain, low wholesale electricity prices have not been reflected in retail costs, and because there is too much money being spent on upgrades and expansion of the grid – essentially the poles and wires.

But you’d have to ask yourself, what for? Demand for electricity is falling, and it is falling fast. Not like a stock market, which lurches from one extreme to another with double-digit percentage movements, but by enough to cause all our major energy players to rethink their 20-30 year investment horizons, and for others to wonder if the NEM, as constructed, is serving a useful purpose.

Still, the graphs below, prepared by Professor Mike Sandiford from the Melbourne Energy Institute, are dramatic enough.

The first one shows the reversal in demand and prices in Victoria

Then we have NSW. Look at the fall in average wholesale prices.

And then we have Queensland.

The slump in demand is being caused by a range of factors: reduced demand by lower manufacturing output; reduced demand from efficiency measures or the response to rising electricity costs at the consumer end; mild weather in some years; and the growing impact of renewables – largely due to the massive deployment of wind energy in South Australia, and to a lesser extent the reach of solar PV.

Demand is already around 10 per cent below where it was expected to be four years ago, when energy regulators and operators assumed an average annual growth of 2.2 per cent. The industry is awaiting with interest the upcoming forecasts from AEMO, which is preparing to public its latest demand forecasts at the end of this month, with talk that several gigawatts will be lopped off the near term and medium-term forecasts for the NEM (which includes the eastern states but not WA or the MT, or Mt Isa and other areas).

Those estimates could be exacerbated with the announced closure of the Kurru Kurri smelter in NSW, and doubts about the future of other smelters in Victoria. Sandiford’s estimate is that demand in the NEM is falling by around 800MW a year.

He prepared this graph to illustrate how expectations of rising electricity demand (purple line going up) of around 2 per cent per year have been superseded by the reality of falling demand of around 1 per cent per year. Viewed like this, demand is 3 per cent below expectations per year over the last four years.

“That is several large coal-fired stations we don’t need,” Sandiford says, wondering why the federal government should be providing compensation to prevent their closure, yet spending more money to ensure others do close.  It’s not the carbon price that is threatening the business models of these generators, it’s demand reduction that is killing them because the product they are selling is no longer wanted (or needed). This much was made clear by analysts who looked in detail at AGL Energy’s purchase of Loy Yang A power station – the nation’s largest.

This helps explain why utilities such as Origin Energy, AGL Energy and TRUenergy say there is no case for new baseload before 2020. Apart from needs in Queensland, where a new coal mining province is hungry for power, it may be longer than that. The 20 per cent renewables target is also reducing the need for new fossil fuel generation – which is why some, such as Origin Energy, are looking for the RET to be diluted, or adjusted to reflect a percentage of actual demand, rather than a set gigawatt hour target (41,000GWh by 2020). That debate may well intensify when AEMO releases its final projections.

One of the great deficiencies of the NEM is that it is focused only on delivering the energy with the cheapest short-term marginal cost of production. The NEM is ill-suited to recognise the benefits of energy storage, distributed generation, or even the benefits of energy efficiency. As demonstrated by revelations in The Guardian this week – about a utility-inspired push by the UK government to dilute renewable energy, energy efficiency and carbon abatement targets – utilities are finding it hard to move from a world where the overriding motive is simply to sell more electrons.

The NEM also appears ill-suited to the day when renewables take on a greater share of the market – and where the common notions of baseload and peak-load generation (which the NEM is designed to enshrine) are blurred by new concepts of dispatchable and non-dispatchable energy. This is particularly important as renewable technologies such as solar thermal are developed with storage.

Sandiford suggests that it is time to develop a new market design. The NEM has already been criticised for failing to cope with environmental factors, and the growing merit order effect means that it will be poorly equipped to deal with the growing penetration of renewables.

“None of this is being passed through to the customers,” Sandiford says. “And it is not encouraging the adaptation of the energy sector (to low-carbon technologies). So you would have to ask yourself, what is the point of the market? Is it just a charade?” As it happens, Sandiford’s team is about to embark on a project to analyse other market designs and formulas. Their conclusions should be interesting.

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  • http://www.arkx.com Tim Buckley

    An excellent and timely review from Professor Sandiford. Lower economic growth, increased energy efficiency and the logical consequence of elasticity of demand with respect to rising retail prices are all key factors here. Combined with the Merit Order Effect (under the existing rules), the current electricity model for Australia is definitely in need of an overhaul. With AEMO finally realising the rapidly rising potential of distributed solar and distributed power storage, the big picture must be addressed before Australia undertakes the looming $30-40 billion national electricity grid system upgrade. Average electricity prices in Australia will not continue to rise in the long term – the consumer can’t afford it, but more tellingly, massive renewable energy DEFLATION precludes this. Tim Buckley, Arkx Investment Management

  • Warwick

    To really complete this analysis, it needs to include wholesale contract prices as this is far more important in determining the revenue of a generator. This information can be sourced through the ASX or others. It is misleading to assume that conventional generators earn their revenue at spot prices, that retailers purchase at spot or ignore the revenue that renewable generators earn through RECs or FiT’s. When this is complete, meaningful conclusions can be made but until then many of the conclusions about market structure are a little premature…

    • Evcricket

      Is this information really available through ASIX? In my experience no one is prepared to talk about their contract prices as this is commercial in confidence.

      • Warwick Forster

        It’s the ASX, not ASIX…also refer to dcyphatrade.com.au The daily cleared futures prices for all NEM states except Tasmania (no contract exists) are available. On a given day, both OTC and futures prices are indicative of hedging costs for retailers and generators. You won’t know who signs what deals, but it is where the market is priced. The analysis is meaningless without this kind of analysis. A baseload generator may earn as much as half its revenue through contracts.

        • Giles Parkinson

          Warwick. Lots of companies do lots of hedging in lots of different markets, it doesn’t mean that they don’t lose money or gain money when those markets go up and down. Or even that their hedging strategies are cleverly structured. Even AGL said Loy Yang A’s future was unsustainable in previous structure. Not sure they would be saying that – or would have had the opportunity to buy the asset at such a knock down price – if demand and wholesale prices were moving up as everyone had predicted.

  • http://australiancarbonprice.blogspot.com.au/ Graham Lovell

    There are two major items not taken into account in this article:
    1. Electricity from wind lowers the generator cost of power, but it requires a subsidy that increases the consumer cost. e.g. Generators may pay $30 MWh, but with large scale RECs of say, $40, that increases the end user cost to $70 MWh, plus the cost of distribution.
    2. Small scale RECs have to be paid by the electricity retailers. This also increases the cost of electricity to the end user.

    Since these factors were not mentioned, it nullifies the thrust of the article, which was that we are being screwed by electricity companies. As Giles complains, the electricity sector, “dominated as it is by vertically integrated companies that act as oligopolies all along the value chain.” He fails to point out that the NEM is designed to push electricity down to the lowest price, which is actually reflected in the graphs he cites.

    Certainly, lower economic activity will reduce electricity demand. The 0.6% supplied from Solar PV is hardly a major factor – it is a tiny blib on the radar. We do not know what will happen to electricity demand if, and when, the economy recovers.

    Electricity demand will go down further as aluminium refiners leave our shores and go elsewhere. Of course, the renewable chorus says that has not got anything to do with the carbon price, in defiance of any reasonable analysis.

    Like Giles, I wish we could have a more sensible discussion on these matters, but his boosterism for his cause hardly helps.

    • Evcricket

      Come on Graham –
      “Electricity demand will go down further as aluminium refiners leave our shores and go elsewhere. Of course, the renewable chorus says that has not got anything to do with the carbon price, in defiance of any reasonable analysis.”

      Both the Aluminium sector peak body and the Kurri-Kurri owners have declared publicly that the -future- carbon price is not a factor for their closing, but their outdated equipment and processes and higher wage prices in Australia are.

      More reading required in future mate.

      • http://australiancarbonprice.blogspot.com.au/ Graham Lovell

        You can believe that the carbon price had no impact if you want to. The fact is that the company knew that one of the input prices was expected to keep on increasing.

        Of course higher electricity prices in the future were part of its cost equation. It would have been taken into account by the operator, even if they were not the primary cause for the closure.

        The point of a carbon price is to put the squeeze on higher carbon methods of production. I believe that all aluminium production will go to hydro, eventually, as carbon prices are implemented around the world. The aluminium industry have virtually conceded as much.

        • WinstonSmith

          Graham has missed the point here. The carbon price is to ensure that the cost of the carbon externality is paid for by generators using fossil fuels. That it puts an additional impost in high carbon emissions energy sources is to discourage their long term use. That they have had a free carried interest by not paying for externalities has been an effective government subsidy for them.

          Lets face it at over 40 years old, Kurri Kurri is well past its use by date and there are definitely better places to smelt alumina at better prices, regardless of a carbon price impact.

  • http://www.smartbuildingservices.com.au Robert Stewart

    Giles is right on the money here. Why does the NEM exist at all?

    As a sub-metering company specialising in embedded networks, we go to tender in the market for our customers. In a soft market as we have today we are able to get pricing of >4.5 cents/kWh PLUS network charges.(say >8 cents per/kWh.) Certainly less than a total of 13 cents/kWh, which is well less than the 23+ cents per kWh being charged as a domestic tariff in QLD.
    I beleive the retailers have had it too good for too long. Domestic consumers should be getting really upset about this situation.
    Metering costs over the 15 year predicted life of smart-meters (this is the figure the providers use) would be less than $20/annum. Sneaker net (manual meter reading) costs less than $12/annum and Automatic meter reading leass than $30/annum. (assuming AMI rollouts using mesh radio of some sort)
    Why the huge disparity?
    Why hasn’t the various state governments done something about this?
    Why are larger energy users (Large Commercial & Industrial customers) getting a better deal than the average domestic consumer? Doesn’t this fly in the face of what should be happening?

    • http://australiancarbonprice.blogspot.com.au/ Graham Lovell

      Most advanced countries use a electricity market like ours, so I am interested in your model that drops the NEM from the system. For example, how does your model cope with peak demand on the system, with instanteous responses to spikes in demand?

      BTW: What does a “a sub-metering company specialising in embedded networks” actually do? Do you buy electricity directly from the generators, by-passing the NEM? Do you commit to buying a fixed amount of electricity per hour, or are there any other constraints on your pricing?

      • Giles Parkinson

        Which is why it is going to be interesting to see what happens in Germany, where the merit order effect is having the greatest impact, and where they met late last month to see if there is a better alternative. They are looking at capacity payments as one possibility to keep gas plants open, the UK is looking for contracts for difference as a means of encouraging offshore wind and nuclear.