Australia saddled with a Taj Mahal power network

The Prime Minister delivered a landmark speech yesterday on the need for changes to Australia’s energy markets, particularly the way that electricity networks (poles and wires) are managed. This speech will significantly raise the profile of this debate, but to energy insiders this speech isn’t a surprise, it’s long overdue.

No doubt there will be a political fight in shifting anger about rising energy prices from the carbon
tax (the Australian Government) to the energy market (the states). However, the Prime Minister has
raised issues that are very real and she’s not the first person to raise them. On June 13, Greg Hunt,
the federal Shadow Minister on Climate Action, Environment and Heritage, set out a three point
plan for reducing energy prices that included a specific change to the energy markets.

There is something very wrong with the National Electricity Market. The price of wholesale
electricity is going down, but people’s bills are going up, increasing by over 50 per cent over four
years. The carbon price only accounts for 6 per cent of the average electricity bill, and other ‘green’
schemes are less than 7 per cent of bills and actually lower wholesale prices. In contrast, network
costs (‘poles and wires’) account for 43 per cent of the average bill and are rising rapidly – in 2010
Ross Garnaut estimated that 68 per cent of price rises by then were due to network costs.

Why are network costs going up so fast? Put simply, the network companies are spending $45 billion
to ‘augment’ the network over 5 years, and those costs are passed on to electricity consumers. There
is no doubt that some of this expenditure is essential. New suburbs need to be connected and some
old infrastructure needs to be replaced. However, while its convenient for network companies to
blame aging infrastructure, it’s a scapegoat for a much broader range of spending, and probably only
accounts for 20 per cent of expenditure.

There are two main factors driving network expenditure. Firstly, the network companies are paid
based on the amount of infrastructure that they build. Unsurprisingly, this gives them an incentive to
spend as much on infrastructure as they can justify. Secondly, rising peak demand, the demand on a
couple of hot days a year, gives networks the cover that they need to keep building.

The scale of the peak problem can’t be exaggerated. While average demand is falling, peak demand
is still rising and grew 30 percent between 1999 and 2010, from 26 GW to 34 GW. This growing gulf
between peak and average demand is a serious problem. As the Prime Minister said, “One sixth of
our national electricity networks – $11 billion in infrastructure – caters for peak events that last for
barely four days per year”. In other words, consumers are saddled with the costs of a ‘Taj Mahal’
energy market that’s plated with gold and marble that we just don’t need.

Peak demand also affects the second and third largest components of electricity bills – wholesale
energy (30 per cent of prices) and retail costs and margins (14 per cent of prices). Wholesale prices
have been falling, in part because renewable energy and reduced electricity demand have been suppressing wholesale prices. However, rising peak demand means that wholesale prices during peak periods are substantially higher than average prices. Furthermore, retailers need to expend significant sums on hedging to deal with peak demand periods that last just a few hours a year.

Recent work suggests that around 10 to 25 percent of total energy bills are currently due to peaks
that last just 0.5 per cent of the year. Peak is the main reason that energy prices are rising, and the
problem could get worse. The Draft Energy White Paper projects that $240 billion of investment in
infrastructure will be needed by 2030, and much of this to meet projections of peak demand. As
the cost of this infrastructure will need to be divided between fewer units of energy consumed, this
would massively increase the cost of electricity.

Unless something is done now Australia will be crippled by the burden of sky rocketing prices that
will reduce industry competitiveness and create unnecessary financial hardship for households.

The reasons for this rapid growth in peak are well understood. Australia does not have a more
serious peak demand problem than other high-income countries because of weather patterns or
declining costs of air-conditioning units. Other countries face these issues. Australia has a serious
peak demand problem because we don’t have a system for managing peak demand.

The vast majority of consumers pay only a fraction of supply costs during critical peaks and,
unsurprisingly, this has lead to overconsumption during critical peak periods. However, while time-
of-use pricing offers one route to unlock demand-response, it will be challenging to introduce
widespread time-of-use pricing in the next one or two decades due to practical issues and public
concerns. Even with time-of-use pricing, consumers are time and information poor and will find it
hard to manage their peak energy use without support.

However, some basic changes to the energy market would create real incentives for energy users
and experts to help consumers reduce peak demand. Put simply, its generally much, much cheaper
to reduce peak demand for a few hours a year than to build very expensive infrastructure to meet
that peak demand.

Firstly, we should pay energy users or experts when they cut demand during periods of peak
demand (e.g. ramping down cold stores for short periods) by letting them sell ‘demand reduction’
into the wholesale electricity market. This kind of system has been in place for years in the US, New
Zealand and Western Australia. In Western Australia, where there’s a separate energy market, more
than 500 companies, including mines and other site, get paid to reduce demand during peak periods,
and this is reducing energy prices. This was the recommendation that Greg Hunt made on 13 June,
and it’s a very sensible, long overdue change.

Secondly, we should reward and regulate network companies to serve customers needs, not build
infrastructure we don’t need. Networks should help consumers reduce demand during peak periods
when it’s cheaper than building infrastructure. While getting the incentives right will partly solve
this problem, there will still be issues like gaps in skills that mean that we still need to regulate them
to take action. The Council believes that it is critical to set targets for network companies to reduce
their costs by reducing peak demand. It’s also critical that third parties should be able to compete
with networks to deliver this service, to ensure that its cost-effective.

Finally, we need to set up a National Energy Saving Initiative (ESI) to help households and businesses
manage rising energy costs. Recent estimates suggest than an ESI could save households $90-$300
per year by 2020 and medium-sized businesses $10,000-$23,700 per year.

These programs need to be designed properly, but they are absolutely essential to keeping energy
affordable in Australia.

Rob Murray-Leach is CEO of the Energy Efficiency Council, the peak body for energy efficiency, demand-management and cogeneration