Electricity: The true cost

Electricity: The true cost
October 2012

Australians have long enjoyed cheap electricity, but in recent years, costs have shot up – in NSW alone prices have risen by about 85% since 2008 – and consumption has gone through the roof. Why?

Residential electricity prices are likely to nearly double in the coming years.

Australians have long enjoyed ridiculously cheap electricity. A study conducted by the New Zealand government in 2009 found our residential electricity bills were ranked second lowest in the world, while Australian Bureau of Statistics figures from 2008 show that Australians spent just 2.4% of household income on their electricity bills. But in recent years, costs have shot up – in NSW alone prices have risen by about 85% since 2008 – and consumption has gone through the roof. Why?

The cost of electricity can be broken down into a number of distinct elements, ranging from power generation to distribution networks to government schemes and taxes. It is every part of the electrical production chain that is contributing to the price rises; there is no one sole cause.

Clues can be found in a paper published by Paul Simshauser, Chief Economist at AGL, and fellow authors Tim Nelson and Thao Doan in the Electricity Journal. The paper examines typical electricity bills from Sydney and Brisbane in 2008. The most expensive part of electricity – around 43% – was generation, which includes fuel and the costs associated with building and maintaining power stations. Transportation charges, such as transmission, distribution and metering (the poles and wires network) accounted for 36%, while retail costs represented around 12%. The cost of renewable energy schemes and taxes made up the rest.

But what will be most worrying for consumers and politicians is that Simshauser is predicting residential electricity prices are likely to nearly double in the coming years due to what could be seen as conditions for a perfect electrical storm: rapidly rising peak demand and cost rises across every element of the electricity production chain.

The rising demand has come about because of what Simshauser calls the “Boomerang Paradox”. These are good times in Australia, and in some ways energy could be considered the new status symbol. Rising affluence means people have bigger homes and more electrical goods to plug in. Take the example of Brisbane – in just 12 years, the number of households with air conditioners has risen to 75%; a third of homes now have two air conditioners or more.

With electricity use rising at peak times and consumers expecting perfectly reliable supply, aging infrastructure has to be able to carry a bigger peak load, and augmentation costs money. The result is more expensive electricity, which the poorest people in Australia will struggle to afford. “The paradox here is of course that rising wealth has actually caused the preconditions for fuel poverty,” remarks Simshauser.

By looking at costs in 2008 and forecasting for 2015 in NSW and QLD, Simshauser shows a raft of drivers for the likely doubling of energy bills. Australia’s historically low electricity prices have been largely due to the low cost of coal, gas and oil, which has been sold domestically at cheap prices. There is strong potential for raw energy prices to rise well above the traditional rate of being sold at a margin just above what it costs to get it out of the ground.

The switch from coal to gas has also contributed to price rises, as has the cost of building a new power plant, which has doubled between 2000 and 2008. The post-financial crisis has also impacted on the cost of finance, while there has been an explosion in the amount being spent on networks, an issue which recently came under the scrutiny of the Australian Energy Markets Commission (AEMC).

The AEMC has recently published a set of proposed rule changes in relation to how much companies that own the distribution networks are allowed to charge consumers. The changes are about ensuring that companies and investors get a fair return but that consumers don’t pay any more than is necessary. The changes aim to remove some of the volatility and uncertainty from the regulatory process, which would be in the long-term interests of electricity providers and consumers alike.

One of the focal points of the AEMC’s analysis was the return on capital that is charged by transmission and distribution networks. The rules allow these businesses to charge prices that reflect a fair return on the substantial amount of capital that is required to operate an electricity network. Just what represents a “fair” return is a source of perennial debate that requires sophisticated analysis of market data.

Professor Stephen Gray and Dr Jason Hall from UQ Business School are well known for their work in this area with a number of network companies, regulatory agencies and courts. Most recently they were the key advisors to the AEMC on cost of capital issues. Whereas the current rules have had the effect of limiting what can be looked at when determining a fair return, the AEMC’s draft rule changes are designed to produce more robust estimates by ensuring that all relevant evidence is considered in a holistic manner. There are also some more technical amendments that are designed to further decrease the volatility of price changes.

AEMC Chairman, John Pierce, said in a statement there was “no one single cause” for the rising costs of providing electricity and gas network infrastructure. “The revenues required by these network service providers are impacted by the external environment ,such as electricity demand, the cost of capital and the reliability standards expected by the community.”

Going green will cost money, too, as we move away from low-cost coal to lower-CO2 emitting gas and introduce the carbon tax. The $23 per tonne carbon price will be passed on to consumers, which the government hopes will provide an incentive for households to save energy. At this stage, UQ Business School research predicts household electricity bills will be impacted by the carbon tax to varying degrees – depending on which state people are living in – but on average they will rise about 8.9%.

But while there are grumbles about the cost of going green, it is actually proving a cheaper way to enhance aging energy infrastructure, says Martin Rushe, a corporate advisor and investor who specialises in energy and technology.

“There are good returns coming from strategically placed generating assets which take advantage of the sorry state of the transmission network,” he says.

“This kind of ‘distributed generation’ is going to be a big market. Rather than generating centrally and long-lining power to a community, distributed generation locates the generating asset closer to the load. In some cases it can save the network from upgrading their transmission lines. This kind of ‘grid augmentation’ is perfect for solar PV, cogen and trigen.”

He says, with the rising costs of delivered electricity and the falling costs of low carbon technologies, particularly solar photovoltaic (PV), investments are now working on a stand-alone basis, without government incentives. He has observed a resurgence in assets that will be built over the 2013 to 2014 period. “There is going to be a lot of commercial and industrial scale solar PV and tri-generation being built,” he says.

“Nobody is going to build new coal generation because it can’t get funded – there is too much carbon uncertainty,” he says. “Ultimately, as we decommission coal, we’ll see a shift through gas and toward smarter renewables.”


If you would like to learn more about the research in this article, then take a look at:
“The Boomerang Paradox, Part II: Policy Prescriptions for Reducing Fuel Poverty in Australia”, The Electricity Journal, 2011