One piddling light and the plunging cost of electricity

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Just how much would it cost electricity generators if I reduced my electricity consumption by turning off just one light?

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Just how much would it cost electricity generators if I reduced my electricity consumption by turning off just one light? You would think the answer is half of bugger all, and you’d be almost right.

In an attempt to be a bit more precise, let’s quantify exactly what “half of bugger all” amounts to. Assume that the light I stop using is a 75 watt globe and that I was only using it for about 3 hours a day. So turning it off reduces my average electricity consumption by about 10 watts and saves me about 85 kilowatt-hours over the year.

With my generator expecting to get about 5 cents for every kilowatt hour traded on the wholesale market, the lost income due to my action is a touch over 4 dollars for the year. So “half of bugger all” comes in at about 1 cent each day. It means even less to the generator’s bottom line, because it no longer has to cover the cost of making the electricity that I no longer want.

So you wouldn’t expect the generator to give two hoots about my action. But there are reasons why the generators might be concerned, and they are all about multipliers.

Firstly, demand reduction has a significant multiplier on generator income. Not only does my not using electricity cost the generator a lost sale, it also reduces the price of all other sales on the wholesale market. And in theory, that directly impacts the generator’s profit, since that is on electricity that still has to be delivered.

In reducing my demand, I effectively create an oversupply in the market. And, as with any efficient market, prices respond with a signal to reduce supply. In fact recent market trends show that in addition to reducing the revenue in electricity sold by about $4, my turning off one 75 watt globe reduces the revenues of all other electricity sold by more than $10 across the year. So the net impost on the generator’s revenue is more than $14, most of which is profit.

Still not too much of a worry, unless of course I am not alone. Multiply my action by 7 million, or about 1 in every 3 Australians, and generator revenue would be down more than 100 million dollars on a net reduction in demand of 65 megawatts. That is about 1% of expected annual wholesale market bottom line, but a much higher percentage of generation profits. Multiply that again by a factor of 10, and we are talking of losses in the billions, and a potential bankrupting of some leading industry players.

And it is already happening.

Over the last few years, demand for electricity traded on the National Electricity Market – or NEM – has collapsed by over 900 megawatts and over twice that on forward projections. And wholesale electricity prices on the NEM have plummeted to record lows, down some 40% on just a few years ago.

Until early 2009 the demand for electricity traded on the market grew fairly consistently at around 2% each year. Although there was some slackening in demand before 2009, most industry analysts put it down to the GFC and thought it inevitable we would need another gigawatt or thereabouts of supply to meet 2012 demand.

 

 

Mean demand traded on the mainland NEM by financial year in gigawatts (GW). Left panel shows total demand, and right panel shows demand deficit relative to 2000-2009 trend growth of 1.9% per annum. Mean demand has fallen at an average rate of 1.4% per annum over the last three years, but is down around 10% on 2009 forward projections. Tasmanian demand is excluded as it only joined the NEM in 2005.data sourced from AEMO – image by Mike Sandiford
Click to enlarge

 

 

That is the equivalent of one big new coal-fired power station, about 3 gigawatts of installed wind power capacity or 6 gigawatts of PV.

But instead, in 2009/10 demand actually fell in real terms by 140 megawatts, fell again in 2010/11 by 290 megawatts and again in the last 12 months by 500 megawatts. Compared to 2009, demand is now down by about 930 megawatts, or almost 4%. Compared to the forward projections of just three years ago demand is down by about 2.2 gigawatts or 10%. That is the equivalent of two big power stations we thought we would need, but no longer do.

And since 2010, wholesale prices have collapsed. The average price in the last financial year was a touch under $30 per megawatt hour. That is the lowest average annual price recorded on the market since 1999 and is about 40% lower than the long-term average of around $47, adjusted to 2012 dollar terms. Market revenue was down almost $3.5 billion on the yearly average of $9 billion in adjusted terms, and more than $5 billion on forward growth projections.

 

 

Mainland NEM average volume weighted prices for financial years in dollars per megawatt-hour. Right panel shows prices adjusted to 2012 dollar terms. Blue line shows the average adjusted prices, to 2010, factoring out the anomalous high price years ending 2011, 2007 and 2008, when extraneous factors, such as drought conditions, impacted supply.data sourced from AEMO – image by Mike Sandiford
Click to enlarge

 

 

These figures give a direct measure of how the electricity market values demand reduction in terms of its impact on wholesale prices or, in other words, the price signal of oversupply. In fact the market is valuing a demand reduction of 1 watt on the forward projection at about $1.40 over the year. That compares to the expected wholesale value for 1 watt-year of electricity of 44 cents.

 

 

Mainland NEM traded revenues for financial years in dollar terms adjusted to 2012. Left panel shows total adjusted revenues. Right panel shows the revenues in terms of deficits with respect to the expected revenues assuming the long term average price of $47 per megawatt hour for the actual demand – see also the blue line on the left.data sourced from AEMO – image by Mike Sandiford
Click to enlarge

 

 

And so we get an estimate of our multiplier, of 140/44 or 3.2. Factoring in some other price effects such as the prevailing la Niña weather cycle, and a more conservative estimate of the price signal multiplier is probably a bit lower at around 2.5.

That is a very strong price signal, and testifies to the effectiveness of an efficient market. It may explain why generators are less than enamoured by schemes, such as energy efficiency and distributed PV, that take market share away from their business.

Of course, in the face of plummeting wholesale prices, consumers should be asking if they are seeing any of the benefit. Near record increases in retail prices would seem to suggest not and raise a raft of questions such as what exactly is the function of the wholesale market?

Mike Sandiford is director, Melbourne Energy Institute at University of Melbourne. This article was originally published on The Conversation. Reproduced with permission.

 

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7 Comments
  1. Warwick 7 years ago

    Caution needs to be exercised analysing spot prices and it seems that the years of 2007, 2008 and 2011 did not fit the “model” so they were excluded. To do a meaningful analysis means examining contract prices not spot prices as the great majority of electricity that retailers sell is contracted. As an example the Australian Energy Regulator does weekly reviews of spot AND contract prices in the NEM.
    This can be found at http://www.aer.gov.au/node/451.

    If one truly believes that retail energy prices are directly related to spot prices, then you should watch your 2012-13 energy bill to triple as current spot prices are averaging between $70 to $90/MWh across the states.

    It might be easy and convenient to suggest that the retailers are making supernormal profits by using spot prices but contracts are what is relevant. i.e. on the 13th July 2011, the 2011-12 prices were $32.40 in QLD, $38.04 in NSW, $33.25 in Victoria and $39.88 in SA…but yesterday, the prices for the 2012-13 FY were $58.45 in QLD, $62.57 in NSW, $60.66 in Victoria and $64.07 in SA. What this means is that wholesale prices have actually gone up not down.

    • Adam 7 years ago

      But if I’m negotiating an off-take agreement, it’ll take into account the wholesale market (and predictions for it), and therefore be “somewhat” representative of market trends. Granted the signals aren’t as clear as reading straight off the NEM spot price but they are correlated though right?

      Otherwise, I’ll just buy straight off the spot market.

      I don’t understand how the NEM incorporates contracts. Do the utilities bid on the market using generators for which they have contracts and then settle the contract agreed revenue later? Or are contracted generators non-scheduled and just generate what the contract owners tell them (and AEMO settles the demand balance within the NEM)?

      You don’t have a link on that per chance?

      • Warwick 7 years ago

        Adam,

        AEMO has a brief introduction on how the market works (http://www.aemo.com.au/en/About-AEMO/~/media/Files/Other/corporate/0000-0262%20pdf.ashx). I suggest page 20 is a good read for the basics of contracts.

        As an indication of true wholesale prices have a look at the following website (http://d-cyphatrade.com.au/) which lists ASX contract prices for electricity.

        The NEM is a gross energy only pool market where all the energy consumed by market customers or retailers is paid to the pool every week and generators receive their funds the same day too. The critical thing is that payments such as swaps or caps occur that same day. i.e. spot prices might be high but the generators will be paying most if not all of that “profit” back to a retailer.

        It’s tempting to think spot prices are low, “why can’t I pay that price?” The problem is the potential cost for when the price does hit many $1,000’s/MWh. This has likely lead to the demise of a few small industry players. Additionally, the retailers will all have strict risk management policies that prescribe appropriate hedging levels and often that will be within the constraints of the IAS39 accounting standard that they must be hedged within 80% to 120% of expected load.

        What doesn’t seem to be well understood is that the standard contracts of swaps and caps are financial contracts and pay out relative to the difference between contract and spot prices. this means that when prices are low, generators get paid the difference between the contract price and the spot price. In effect, they receive a capacity payment for when prices are low in exchange for retailer’s insurance when prices are high. i.e. potential high spot prices (which can bankrupt a retailer) incentivise retailers to contract. As a result, capacity payments are unnecessary for generators.

        At a most basic level, the customer pricing is a combination of the peak and off peak contracts available plus sufficient margin to cover the additional costs of being over and under hedged. This will be significantly more than average spot prices…

        • Adam 7 years ago

          That’s great mate. Thanks.

          Had a good read – as expected I have many more questions! Although, perhaps I’ll go educate myself…

          One though: are there any countries in the world that have tried to sell to consumers straight off an electricity market (with smartmeters or something)? Or studies into such a scenario…

          it’d be interesting to see the demand side management and whether the instability in pricing could be tolerable – even efficient!

          Thanks.

        • Tim 7 years ago

          So theoretically, if you were a retailer that sold electricity exclusively to customers who had low demand during times of the day when spot prices are normally high, you could indeed buy most electricity at the low spot price?

          I’m thinking businesses with solar PV, energy storage and other demand reduction strategies…

  2. Adam 7 years ago

    Also, I note you’ve made this or similar comment a few times on Renew’s spot market analysis (and reducing demand theory).

    It’d be good if one of the contributors could respond to it I think.

    My understanding is that industry does view demand as coming down – whether it’s based on the presented analysis or not.

  3. peterdub 7 years ago

    An interesting point,
    but I don’t think the Light Bulb is a good example
    (which incidentally is also one reason why the incandescent ban in Australia makes particlarly little sense…)

    That is, assuming over-supply from turning off a light bulb: As electricity already IS over supplied at night, hence the lower price. So, taking Aussie coal, much burned that noone uses (turning down plants at night has problems, as referenced via the below link)
    Most lighting is used after peak general demand 5-7pm (UK data, also supplied via the link – no doubt later still in “sunny Australia”)
    See “The Deception behind the Arguments used to ban Light Bulbs and other Products” as via http://tonn.ie Left Side
    (cant put the direct longer link here or comment gets blocked)

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