A senate inquiry is pending into the long-flawed system delivering rising electricity prices. By Martin McKenzie-Murray.

The power of the electricty market

This month, the federal parliament agreed to a senate inquiry into rising electricity prices after Greens leader Christine Milne introduced a motion. Obliged to report next March, the inquiry’s terms of reference are specific: to assess how much network monopolies are cynically overinvesting in assets and driving up retail prices.

The inquiry was boosted by whistleblower Cally Wilson, an analyst at the Queensland state-owned company Energex, who recently alleged the company engaged in “data manipulation” to drive up its capital costs, and so extract more money from consumers.

But the debate about electricity prices is enmeshed in the serial laments of our political leaders about cost-of-living increases. During last year’s federal election campaign, Rudd and Abbott repeated the line: families are doing it tough. Rudd qualified his statements the least, saying in one press conference that all “families were feeling the cost-of-living pressure”. These remarks were made despite average wages growing more than inflation, a ratio helped by falls in the average price of food and petrol.

But Tony Abbott was right about one thing: electricity. Prices had been increasing rapidly. From 1980, the average cost of electricity rose almost in sync with the consumer price index (CPI). If you study the graph of Australian Bureau of Statistics data, the two lines are virtually braided until, that is, 2006 when electricity prices separate dramatically from the CPI line and soar skywards. Since then, the average household’s power bill has increased 85 per cent in actual terms – 60 per cent in real terms. What’s remarkable is that these increases in price have coincided with a decrease in demand. Abbott insisted the carbon tax was to blame. “We’re definitely paying too much for electricity,” Tony Wood says. Wood is the Grattan Institute’s energy program director and a former government adviser. “There’s no doubt that reform is needed. But the impact of the carbon tax was overstated.”

1 . How power use has dropped

It has never happened before. Nor, it seems, did anyone think it possible. For half a decade now, our electricity use has declined. Before that, conventional wisdom held that demand for electricity in a growing economy was inelastic. The numbers seemed to bear that out: between 1961 and 2002 there was not a single year in which electricity use declined. But behold: elasticity. Since 2009, power use has fallen 4.5 per cent in Australia’s largest market – the National Electricity Market, an intricate, sprawling network of poles and wires covering the eastern states, South Australia and Tasmania.

The reasons for this decline are numerous. Stricter building requirements have helped. More and more homes are being built with double-glazing, robust seals, insulation and eaves. And the appliances that fill those homes are becoming far more energy efficient, too. Not long ago, plasma television screens flooded the market. With three million sets sold in Australia each year, most would have been of this kind. But in 2009, the federal government introduced efficiency requirements for televisions, and plasmas were quickly overtaken by the far more efficient LCD sets.

Lighting is another significant change. According to Wood’s report, a fifth of electricity is used for lighting households globally. Within them, the old incandescent lights convert just 2 per cent of their power into light. LED lights are a magnitude more efficient. Households are also adopting smarter meters, allowing consumers to better monitor their home’s usage.

Then there was the dramatic adoption of solar panels. Driven by large government subsidies and cheaper technology, Australia went from about 8000 households using the panels in 2007 to more than a million today. Not only are households requiring less electricity from the grid, they’re supplying they’re own excess power to the larger network.

The decline in Australian manufacturing is another significant factor to driving down prices. As labour has transitioned from lower-skilled manufacturing, heavily electricity-dependent industries have narrowed their operations, or shut altogether. “Look at aluminium smelters,” Wood tells me. “There was a plant in New South Wales – Kurri Kurri – that closed two years ago. That place used a lot of energy, and all of that was removed from the market.” Kurri Kurri, in fact, was using about 2 per cent of all electricity generated in NSW.

2 . How prices has risen, regardless

But here’s the perversity: in a conventional market, falling demand would result in falling prices – oversupply would be corrected by lowering the cost for consumers. Not in the electricity market, where a major section of it is a regulated monopoly.

There are four components to the energy market. First, the generators. These are the power plants – gas, coal, etc – that produce the electricity. Then you have the transmitters and the distributors – collectively known as the networks – that supply the poles and wires, whether they be the enormous steel towers in the country, or the modest poles and wires along your street. Finally, you have the retailers. They broker the energy – essentially buying it for consumers from the network – and manage your account.

“So it’s basically a competitive market for the generation of power, and the retailing of it,” Wood says. “The wholesale price of power varies because it’s competed for. The price changes every 30 minutes on the market. But the bit in the middle – the networks – are essentially a regulated monopoly. This is because we can’t have multiple electricity networks. It’s impractical.”

And here lies the problem: because they’re a monopoly, networks are overseen by a regulator. In the National Electricity Market, that’s the Australian Energy Regulator; in Western Australia, which uses a separate network, they’re subject to the Economic Regulation Authority. The regulator determines what amount of revenue networks can earn over a set five-year period. To help determine this figure, network companies supply a business case outlining their forecast expenditure, debt and other operating costs. Which is why when demand falls, these network companies may increase their prices to recoup their losses from other customers.

Almost half our power bill comes from these network costs. “I’m not sure I like the term gold plating,” Wood says. “It suggests a level of capriciousness. Sometimes it’s expenditure, which in hindsight is unnecessary. But the way the system is at the moment is flawed, and it’s only natural for companies to try to game it.”

But it’s not only this cynicism, alleged by Cally Wilson, that drives prices upwards. As recently as 2012, the senate released its report on electricity prices. Surprisingly it stated: “Many residential and commercial electricity consumers are installing embedded generation (for example, co- and tri-generation and solar photovoltaic generation) in their homes and businesses: this has a positive impact on both electricity prices and the environment.”

While solar panels undoubtedly benefit the environment, under current conditions non-solar panel households are subsidising those with panels – and most likely they’re the households that can least afford it. “There have been two schemes that have driven the uptake of solar PV,” Wood says. “The first was a rebate scheme, and that was terminated a few years ago. The second has been a proliferation of state-based feed-in tariff schemes. These are paid for by smearing the cost of the tariff across all consumers, so those without PV subsidise those that have PV. The schemes have varied in generosity, but have all been aggressively wound back as their foolishness became apparent.

“There has been close to 2000 megawatts of solar PV installed. By contributing to an oversupply at a time of falling demand, there will have been some impact on wholesale electricity prices and that flows through to retail prices. There will have also been some reductions in emissions without an economy-wide carbon price. I would suggest that on balance this is a very expensive way to reduce greenhouse gas emissions.”

3 . Flat tariffs unfair

Crucially, there is also the question of peak demand. On average, most states will only come within 5 per cent of peak supply for less than a day each year in total. However, the network must be maintained in a way that can cope with this capacity. “Think of freeways,” Wood says. “During the middle of a weekday they might be almost empty. But they’re built in a way to accommodate peak hour.”

What this means for electricity networks is that they are paying to maintain infrastructure that is redundant for the vast majority of the year. Peak demand normally hits in summer, though in Tasmania it’s winter, and is often driven by airconditioners – the percentage of homes with them has increased substantially over the past decade. “So we have a system that’s unfair, because we’re paying a flat tariff rather than one which takes into account what we contribute to the peak demand. Those who don’t use as much power during peak moments are subsidising those who do.”

Interestingly, two states run network businesses – Queensland and NSW – but they are coming under federal pressure to privatise them. In balancing cost versus reliability for consumers, historically, state-owned networks have preferred reliability, believing that unreliable power is more detrimental to them politically than increased power bills. “How do you determine what’s the right level of reliability?” Wood says. “Some people or businesses or institutions are more dependent than others. What price are we willing to pay for 100 per cent reliability? In some states you have what might be excessive reliability, balancing that against cost.”

Wood is sceptical that the inquiry will find anything new, but is certain that things have to change. “It’s too easy to game the system at the moment, and the revenue being allowed for networks is too high – they’re not risking anything, like the generators are. It’s low risk, and so it should be low revenue.”

This article was first published in the print edition of The Saturday Paper on Oct 18, 2014 as "Balance of power".

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Martin McKenzie-Murray is the author of The Speechwriter.