Today’s pricing announcements
Electricity prices have risen significantly over the past few years. But the good news is that many people are now talking about prices having peaked and are now potentially trending downwards.
AGL has recently announced that NSW, QLD and SA residential and SME customers will receive a decrease in their electricity prices from 1 July 2018. Victorian prices are generally reset in January rather than mid-year.
So why are electricity prices now decreasing (and why had they increased so much before now)?
At a high level, network charges represent around half of the bill with the other half being comprised of wholesale energy and retailer costs; and government scheme costs (such as the Renewable Energy Target).
Transmission and distribution networks transmit the power generated to our homes and businesses. Networks are regulated monopolies. The Australian Energy Regulator regulates the prices charged by networks. There has been a significant increase in network charges over the past ten years. These price increases have been driven by forecasts of increased peak demand; increased reliability standards; and replacement of ageing infrastructure. There are strong arguments for examining whether network asset bases may need to be reviewed in the future as more consumers install embedded generation (such as solar PV and batteries) and use of the network declines. You can read more about my thoughts on these issues in a paper I had published in Economic Papers. The Grattan Institute and Professor Paul Simshauser of Griffith University have also published papers on this topic.
Green scheme costs
Over time, there have been two factors at play in relation to green scheme costs. Firstly, the cost of technology has declined. In fact, wind is now the cheapest form of energy in Australia today when accounting for both fixed and variable costs. But, the proportion of renewable energy required in the system has continued to increase. When combined these factors have resulted in an increase in green scheme costs in 2018.
Wholesale energy costs
The other major component of the energy supply chain is the production and retailing of electricity. In the wholesale electricity market, generators bid the quantity of electricity they are willing to supply and the price they want to receive for each dispatch interval (each interval is five minutes in length). Generators are dispatched by the Australian Energy Market Operator (AEMO) in price order from lowest to highest up to the level required to match demand. All dispatched generators receive the market-clearing price in their region, which is the price of the final dispatched generator. The specific bids made by each generator are a combination of several factors including their short-run operating costs and plant technology. The suitability of different technologies for different types of demand is discussed in an earlier blog post.
The wholesale market can be very volatile. Prices can increase rapidly from around $50-100 per megawatt-hour (MWh) to $14,000 per MWh in half an hour. As a result of this price volatility, a prudent retailer will enter into forward contracts with generators to ensure their customers can be offered a stable price. Essentially, retailers and generators seek to reduce their exposure to price volatility by entering into these financial contracts.
Wholesale prices rose substantially in 2016 and 2017 due to the closure of power stations with insufficient notice for new capacity to be built. This is shown in the graph below. But markets with higher prices generally spur on new investment. And that is what has happened in the NEM. Several thousand megawatts of new capacity are under construction. In fact, AGL is developing new gas-fired infrastructure in SA and NSW, and new renewables such as the Coopers Gap and Silverton wind farms in QLD and NSW respectively. These projects alone are adding more than 1,000 MW of capacity and involve billions of dollars of investment.
As a result of this new supply continuing to come into the market, forward electricity prices have moderated and these cost reductions are the primary reason overall electricity prices are now declining.
Summary and the importance of retail competition
So in summary, electricity prices are now declining. While network costs and green schemes are either static or increasing, the decline in overall prices is due to wholesale electricity price reductions driven by new investment in gas-fired and renewable energy projects.
A final observation about energy prices is to emphasise the importance of competition. The Australian Energy Market Commission recently noted there are 22 retail electricity businesses in New South Wales and that consumers who shop around can save around 21 per cent or $309 per annum on their electricity bills. The Energy Made Easy website is a great way of comparing offers in the market. There are significant benefits available through a deregulated market.
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