Over-investment in infrastructure is the real reason Australians are paying way too much for their electricity. Picture: Aaron Francis Source: The Australian
IN late November, summer began early for Victorians and South Australians. As temperatures soared past 35C in Adelaide and flirted with 40C in Melbourne, sweltering residents took refuge in the comfort of their air-conditioned homes.
On November 29, thousands of kilometres away on the central coast of NSW, one of the state's energy generators, Delta Electricity, switched on its flagship gas-fired power plant to absorb some of the surging national demand.
Between 1995 and 1998, Australia's state-based electricity markets merged (except for Western Australia's, which is too far away) into the National Electricity Market, the world's biggest interconnected power system, covering a distance of 4500km. Tasmania is a net energy exporter, while NSW is typically an importer.
Nearly 40m high, the equivalent to four jumbo jet engines huddled alongside each other, Delta Electricity's $500 million gas-fired power station at Colongra is only turned on a few days a year, when daily demand surges past about 12,000 megawatts.
"The power station is up and running within half an hour," says Delta chief executive Greg Everett, "whereas our coal power stations can take a day to warm up and are also much more expensive to build or buy."
"Gas-fired power stations are the Linda Evangelistas of power supply," says Matthew Warren, CEO of the Energy Supply Association, referring to the supermodel's famous quip she only got out of bed for $10,000 a day.
Coal cheaply supplies almost 80 per cent of Australia's electricity needs, but the 12 per cent sourced from about 25 gas-power stations, mainly to satisfy "peak demand" on hot days, massively increases the capital costs of Australia's electricity network.
Sydney and Melbourne electricity prices have tripled since 1998, reversing more than four decades of real price falls. Since 2008, retail energy prices in Sydney, Melbourne and Brisbane have surged between 10 and 20 per cent a year, so much so that total demand has started to wane.
"Electricity consumption grew about 3.5 per cent a year since World War II, but very recently has started to fall," says Tim Reardon, executive director of the National Generators Forum.
But maximum demand on very cold or hot days has still been growing, thanks to our growing battery of 8.5 million airconditioners, prompting huge investments to upgrade the energy grid.
"Around 25 per cent of the electricity network is built to run on only those handful of days a year when demand peaks, leaving billions of dollars of plant and equipment sitting idle for most of the time," Warren says.
The growing costs of keeping comfortable on a handful of days a year has pushed up average costs throughout the year.
Cheap energy had long been one of Australia's comparative advantages, underpinning our fledgling manufacturers. "Sydney is a geological freak," says Warren, "surrounded by copious volumes of coal in the north and south."
But the ultimate cost of electricity has decoupled from the price of coal, thanks to a perfect storm of rising "peak demand", obsolescent infrastructure, a dubiously effective raft of "green schemes" and a flawed regulatory system that has encouraged unnecessary investment.
Government rules ensuring households are left entirely in the dark about the huge variation in the cost of supplying power, including at peak times, have made the situation worse. Customers face no incentive to be careful with electricity consumption, resulting in much higher prices for everyone all year round.
The standard wholesale prices of electricity are about $30 to $60 per mega watt hour, but on very cold and hot days the price can rocket beyond $12,500 Mw/H.
Power consumption, and the wholesale electricity price, surge in the morning at about 8am and then again at about 7.30pm.
"If prices bore a closer relationship with real costs a factory might shut down on a 40C day, or a middle-class family might choose to turn the pool filter off," says Warren.
"Households without airconditioners pay an implicit subsidy of $330 each year for upgrades to networks and generators to ensure electricity can get through in times of high demand," he adds.
At the same time as peak demand has been rising, the ageing grid of power lines and substations is being upgraded. The bulk of electricity generators and supporting grid were built during the 1960s and 70s with lifespans no longer than about 50 years. More than half the increase in power costs since 2007 is a direct result of extra investment in electricity networks.
Improved reliability standards have sped up the refurbishment. A major blackout in Sydney in 2004 prompted state governments to ratchet up reliability standards.
If households realised the ultimate cost, they might have complained less about blackouts.
David Leith, a utilities analyst at UBS, says "the NSW government's decision to make Sydney an N-2 city rather than a N-1 city, meaning at any given time two rather than one major lines could be down without triggering major disruptions, pushed up investment costs by 25 per cent".
Flawed regulatory arrangements have encouraged excessive investment, lumping consumers with higher bills than they should otherwise be paying.
Since the Australian Energy Regulator became the national body responsible for setting the maximum prices energy networks could charge in 2009, the pace of price increases has accelerated dramatically.
Unlike electricity retailers or electricity generators, electricity networks are natural monopolies, resulting in government regulation of their charges.
Every five years the AER sets a price trajectory for the electricity grids across Australia's states, except those in Western Australia. The regulatory price caps of the networks are set according to the value of their assets, so they have an incentive to "gold-plate" their networks to ensure higher returns, unless regulators have the power to penalise them for over-investing.
The value of the regulated asset base of NSW networks has risen from $10 billion to $30bn since 2005. In the decade from 2001, Queensland's transformer capacity grew by 130 per cent, more than it had in the 23 years prior.
By 2015, NSW networks will have a regulated asset base per customer that is more than five times greater than electricity networks in Britain, where regulators have had far greater powers to penalise firms for excessive investments and to force them to conform to efficiency benchmarks. Permitted rates of return on investments for networks in Britain are about 3 percentage points lower than in Australia in 2010, according to a recent study.
"In Australia, whatever networks spent would be included as a valid capital expense, forcing up costs in the next regulatory period," Phil Manners, an economist at the Centre for International Economics in Sydney, says.
The chairman of the AER, Andrew Reeves, concedes the rules had been too generous to the electricity networks, permitting rates of return on investment of about 9 per cent.
A new set of rules, which have effect from 2014, are likely to limit future prices increases, he says. "If we find that any of the expenditure was unnecessary or inefficient we can refuse to add that expenditure to the network's asset base - so they won't earn a return on the investment," he adds.
Nearly 20 years after the Hilmer report recommended privatising state electricity assets, only in Victoria has the state government privatised all its electricity assets - generation, distribution and retail provision.
The Productivity Commission says "the rationale for state ownership of network electricity businesses no longer holds", pointing to the unfairly cheap borrowing costs publicly owned companies enjoy over private competitors, which in turn encourages lazy and excessive spending.
"State-owned businesses in NSW and Queensland have increased their capital expenditure to levels well above those of private firms in Victoria for a level of peak demand," said the commission recently, citing studies that suggest state-owned networks in NSW and Queensland were half as efficient as their privately owned peers in Victoria.
"State-owned businesses have had relatively large increases in regulated assets for a given increase in their network capacity," it added.
So far, renewable energy schemes and the carbon tax make up less than 20 per cent of households' ultimate energy bill, but falling consumption and rising commodity prices may increase their burden.
The Renewable Energy Target forces retail electricity providers to source energy from more expensive renewable sources, such as wind and solar energy. By 2020 electricity retailers will be required by legislation to buy 41 terawatts of energy from renewable sources.
"At the time RET was legislated, such a sum was bound to amount to around 20 per cent of total electricity consumption coming from renewable by 2020," explains Reardon, "but falling electricity consumption could mean the ultimate fraction is much larger, putting even more pressure on prices."
Cameron O'Reilly, chief executive of the Energy Retailers Association, points out that solar and wind energy are about three times as expensive to buy as electricity from coal-fired power stations.
Gas is about half as emissions-intensive as coal, but O'Reilly worries the $23 a tonne carbon tax will be ineffective because it won't provide sufficient incentive to shift from coal to gas.
"If Australian gas prices ever rise to the levels in Japan and Korea, coal will remain a more attractive fuel for electricity generation, even with a carbon tax, which would simply serve to damage the country's economic competitiveness by artificially putting up energy costs," O'Reilly says.
Reardon agrees, adding that "the carbon tax would have to be between $80 and $100 a tonne to have any substantial impact on the energy supply decisions".
Making forecasts about future energy prices is difficult, though. Warren points out current coal prices have been fixed by long-term contracts. "In 2015 lots of those contracts will need to be renegotiated at higher coal prices," he says.
Manners from CIE is critical of state-government feed-in tariffs, which force retailers to buy solar energy from customers with solar panels.
NSW's scheme, introduced by the previous Labor government, forced retailers to buy solar energy at six times the market price.
"The government has closed the scheme to new entrants, but it's still costing households around $40 a year on a typical bill," he says, pointing out the scheme effectively forced poorer households, who couldn't afford solar panels to subside the energy use of richer ones who could.
But Leith reckons solar panels will dramatically alter the energy landscape, pointing out they are fast becoming economic without any government subsidies at all.
Their installation costs have fallen 66 per cent in two years owing to technological breakthroughs in their manufacture. "Like plasma TVs a few years ago their price has plummeted," he adds, hinting they might become just as common.
"In the long run it will matter less and less what electricity providers charge for coal and gas-based electricity because solar energy will became far more plentiful and cheaper," says Leith, arguing solar panels already pay for themselves in around 10 years without any government subsidy.
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