Energy prices: What’s going on?

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Businesses and households across eastern and southern Australia are starting to see a new wave of energy cost increases. These will be painful for many, and a serious blow to the competitiveness of some trade-exposed industries. Many want to know: what’s happening? Why is it happening? And what can we do about it?

Here, in the first of a series of three Blog posts, we address part one of the equation: What’s happening?

Energy cost increases

  • Wholesale electricity prices are rising to around $0.06-0.07 per kilowatt hour in eastern Australia and $0.10 per kWh in SA, levels last seen during the carbon tax or the Millennium Drought. Previously they were around $0.04 in NSW and Victoria, and somewhat more in SA and Queensland.
  • Gas prices are rising to $8-10 per gigajoule, from a $3-4 historical average.
  • These increases have different impacts on the bills of different kinds of energy user.

Costs are rising for both electricity and gas.  This has taken several forms and operates across more than one timescale.

Wholesale electricity is sold by generators to retailers in a spot market where prices shift every 30 minutes. The Essential Services Commission of Victoria recently calculated that in 2015-16, average spot prices in the Victorian region of the National Electricity Market (NEM) rose by 50 per cent to $0.046 per kilowatt hour (kWh). Retailers are very likely to recover those higher prices from their customers, though some may face limits through competitive pressure where they have not anticipated the spot market adequately when contracting with customers.

To control their risks in the spot market, retailers also buy and trade futures contracts for electricity. Over the past year, contract prices for delivery in 2017 have risen by around $0.02-0.025 per kWh in every region of the market. Those future expectations closely shape the prices retailers are willing to offer in retail contracts.

The chart below shows historical wholesale electricity prices as collated by the Australian Electricity Regulator, and adds on current wholesale futures prices as reported by the ASX. The rises take the market back to prices comparable to the period of the carbon tax or the worst phase of the Millennium Drought, when limited access to cooling water constrained output from several major generators.

chart1

A small proportion of gas is sold through transparent spot markets. The Essential Services Commission of Victoria recently calculated that wholesale spot gas prices averaged $5 a gigajoule (GJ) in Victoria in 2015-16, an increase of 64 per cent.

Wholesale gas is mostly sold through opaque long-term contracts. Anecdotal evidence suggests that prices in such contracts have been rising significantly and that contracts are harder to get – and multiple competitive offers even harder. Member businesses seeking new gas contracts have reported prices of $8-10 a gigajoule, though there is significant variation. Suppliers now almost always insist on “100% take or pay” clauses, requiring customers to pay for all the gas in the contract whether they require it or not.

These absolute increases in the wholesale prices of electricity and gas translate to different percentage increases in customers’ bills because energy users differ widely in the retail prices they pay and the ways they use energy:

  • Households tend to pay all-in electricity prices of around $0.26-0.30 per kWh at retail, including costs for transmission, distribution, wholesale energy, State and Federal energy policies, and retail costs and margins. A $0.02 increase in the wholesale electricity component would mean about a 7 per cent retail price increase for such a household.
  • Household gas prices vary widely by region, retailer and offer, but many may pay around $22 per GJ at retail, including network, wholesale and retail costs. A $3 increase in the wholesale gas price would mean a 14 per cent retail price increase for such a household.
  • Businesses vary from small operations with a low energy intensity who pay prices similar to households, all the way through to enormous energy-intensive industrial facilities for whom network costs are much smaller. Larger customers are also more likely to have longer-term energy contracts, and may see price increases later.
    • For a larger electricity user paying the equivalent of $0.15 per kWh currently, a $0.02 increase in the wholesale electricity price would mean a 13 per cent retail price increase.
    • For a larger gas user paying the equivalent of $10 per GJ currently, a $3 increase in the wholesale gas price would mean a 30 per cent retail price increase.

Businesses that are larger users are thus likely to be more intensely affected by wholesale price increases, which represent a bigger shock to their cost structure than for smaller businesses and households. Energy is a relatively minor expense for many businesses compared to labor, rent or other input costs.

In Ai Group’s 2012 Energy shock survey, nearly half of all respondents spent less than 1 per cent of their income on all forms of energy combined (electricity, gas, liquid fuels) and another third spent between 1 per cent and 2 per cent. However, for energy intensive sectors like metals production, basic chemicals, cement, glass, dairy processing and many more, energy costs matter a great deal. Manufacturers also tend to be heavily exposed to international trade, limiting the willingness of their customers to accept the pass-through of production cost increases.

Watch this space tomorrow for the second post in our Energy Prices Blog series: Why is this happening?

What has been your recent experience with energy costs in your business? Have you had to make significant adjustments to budget for increased costs moving forward? Please share your thoughts and experiences by leaving a comment below.

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Tennant Reed
Tennant is Principal National Adviser – Public Policy at Ai Group. He has worked heavily on climate and energy issues, advising Ai Group’s Leaders’ Group on Energy and Climate Policy and developing reports on natural gas supply, energy prices and energy efficiency. He also works on a range of issues related to manufacturing and innovation. Previously he was an adviser in the Department of Prime Minister and Cabinet, working on fiscal policy, stimulus and infrastructure.

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