A tipping point for energy affordability speech

Introduction

It is a pleasure to be speaking again at an Energy Users Association of Australia event even during this most awful time.

This dreadful pandemic we are all experiencing has caused significant personal hardship to many Australians as well as enormous economic disruption for businesses, small and large.

We at the ACCC have been focusing on what we can do to support the economy. This has included issuing strictly time limited authorisations to allow collaboration between competing businesses which might ordinarily be anti-competitive but can result in a net public benefit in a crisis. During this pandemic our authorisations have allowed banks to jointly provide debt relief to borrowers, supermarkets to coordinate supply to ensure shelves remained stocked, and medical equipment manufacturers to coordinate the supply and manufacture of equipment.

The ACCC has also given conditional interim authorisations during the COVID-19 pandemic to the Australian Energy Market Operator Limited (AEMO) to ensure secure and reliable energy supply and integrity of wholesale markets, and to the Australian Energy Council to allow energy businesses to cooperate to provide financial relief to residential and business customers.

We know that before 2020 and the pandemic, energy users have found it incredibly tough. For the past three years the ACCC has been observing the impact of fast-rising energy costs on all users, and in particular commercial and industrial users. Indeed, Australia has gone from a situation where energy was a source of economic advantage to where our energy costs are now a source of disadvantage for our industry, as you all know.

If we can draw a positive from this pandemic it is this: we have an opportunity to reset affordability and competition in energy markets. Perhaps we can regain energy as a source of comparative advantage for Australia. It is those opportunities in the gas and electricity markets that I would like to focus on today.

Gas markets

In preparing our July 2020 Interim Report, we went out and again spoke to both gas users and suppliers to better understand the current market.

Many commercial and industrial gas users told us that they are feeling the effect of the contraction in economic activity resulting from COVID-19. They fear that the shutting of their businesses, temporarily in response to the pandemic, may lead to permanent closure.

In this context, we are very concerned about the widening divergence between domestic gas price offers and the LNG netback price, and the inevitable impact of this on Australia’s industrial sector during what is already a difficult economic period.

The effect of the pandemic, as well as decisions by Russia and Saudi Arabia to increase oil production, has produced a rapid decline in oil and LNG prices.

Brent Crude oil prices fell to a record low of US$9/bbl on 21 April 2020. Similarly, LNG spot prices in Asia fell by around 66 per cent between January and April before recovering somewhat in May.

A sudden drop in international prices should, in a well-functioning market, be reflected in the prices offered in the domestic market. That is not what we have found in our latest interim report, however.

The impact of record low oil and gas prices in the East Coast Gas Market has been most obvious in the domestic spot markets. Average prices in Queensland and southern states fell from more than $9/GJ in October to less than $4/GJ in April.

However, east coast gas users are being offered prices significantly above export parity prices for contracts. The prices offered over late 2019 to early 2020 were $8 – 11/GJ, down only slightly from the $9–11/GJ range we reported was offered over 2019 (for 2020 supply).  

When we sought anecdotal reports from gas users and suppliers about more recent pricing in June this year, the best we heard was a couple of offers in Queensland for gas supply at around $7/GJ. Even this is still well above current netback prices - our last forward netback price for 2021 was for $5.58/GJ.

Others, however, said they are still currently receiving offers of $8-9/GJ for commodity gas.

Figure 1: Monthly average gas commodity prices offered by Queensland producers for 2021 supply

Source: Intercontinental Exchange, Argus Media, Core Energy, ACCC analysis of information provided by suppliers.

I am still waiting to hear a compelling reason from LNG producers as to why they are selling gas to domestic users at substantially higher prices than buyers in international markets.

I have heard the comments from producers in response to our July report, pointing to the longer-term nature of domestic contracts compared to spot sales in LNG markets. There are two responses to this.

First, in a domestic market where parties are contracting mostly for only a year or two, the size of this differential, which has been growing, is difficult to understand.

Second, if you average the international forward prices to, say, 2025, you still get a netback price of a bit over $6 in today’s prices.

It has been said that it was a risk linking Australia’s domestic gas price to overseas prices. That may or may not be so. But what is undeniable is that when we have lower gas prices around the world, and the Australian market linked to world gas markets, it is vital that Australian gas users get the benefit!

Prices offered in the domestic market were quick to follow LNG netback prices when they went up in 2018, and C&I users have told us that some suppliers referenced LNG netback prices as a justification for the prices offered. It is convenient how those arguments seem to have changed now that LNG netback prices are so low.

Added to our concern about the growing price difference is the 18 LNG spot cargoes sold by Queensland LNG producers since September 2019. The prices received for these sales were well below those being offered to the domestic market at the time.

The spot cargo sales, together with the divergence between LNG netback prices and domestic prices, brings into question what is driving the pricing strategies of LNG producers and other suppliers in the East Coast Gas Market.

Recommendations to reset gas affordability

Our most recent report demonstrates that LNG exporters have the opportunity, the responsibility and the capacity to offer gas at reasonable prices to the domestic market.

LNG producers expect to have up to an additional 84 PJ of gas they could supply into the domestic market in 2021. In 2019 they increased their production to meet higher than expected demand, and their sales into international spot markets over late 2019 and early 2020 were at prices well below domestic offers.

Based on all these reasons, we have recommended the Australian government extend or enter into a new Heads of Agreement with LNG producers to ensure they continue to offer uncontracted gas to the domestic market before offering it to international markets.

As well as extending the Heads of Agreement, however, we also recommend the focus move from supply to price. That is, the government should consider referencing the LNG netback price expectations and the prices LNG exporters could expect to receive for uncontracted gas in overseas markets over the relevant supply period.

An extension and strengthening of the Heads of Agreement will help to reset affordability in the East Coast Gas Market and I am pleased that comments from Ministers indicate the government may act on our recommendations.

More measures will, however, be needed.

We therefore recommend governments consider whether further measures can assist timely investment in north-south transportation infrastructure.

We also repeat earlier recommendations that when releasing any new acreage, governments pursue greater diversity of suppliers. We support measures such as active tenement management to ensure producers bring gas to market in a timely manner; where feasible, that state governments coordinate the development of pipeline and storage infrastructure to avoid unnecessary duplication of pipelines and other inefficiencies; and to ensure infrastructure is operated on a third party access basis.

The ACCC, of course, will be closely monitoring and reporting on the behaviour of all gas suppliers and pipeline operators over the remainder of our Inquiry.

We have already taken steps to better understand what is driving the divergence between domestic prices and LNG netback. In May 2020 we issued compulsory information notices to key suppliers, both gas producers and retailers, seeking information on their pricing strategies. We are receiving responses now and starting our analysis.

We will report and make any relevant recommendations in future reports. I am confident this work will provide important insights into how the market is functioning. The transparency we bring will be an important discipline on gas producers and gas retailers to actively compete to supply domestic users.

Leveraging long-term reductions in wholesale electricity prices

Electricity costs for C&I users are often significant and we have the best chance now, as wholesale electricity prices have fallen significantly, to bring those prices down and restore Australian competitiveness.

Wholesale electricity prices have fallen dramatically, largely due to increases in supply.

Despite the widespread impact on the economy of the COVID-19 pandemic, it has only had a moderate impact on aggregate electricity demand; down two per cent in the second quarter this year compared to the same quarter last year. We have seen a decrease in electricity demand by business but this decrease has been offset by an increase in household demand because of the COVID-19 government restrictions and cooler weather conditions.

Importantly, it is the long-term supply factors of increasing renewable generation and falling fuel costs that have been the main drivers of falls in wholesale prices since mid-last year.

Spot wholesale prices started to fall in mid-2019 and this has continued through 2020. Daily spot prices have been consistently lower this year compared with last year (Figure 2). This year’s winter prices to date in the National Electricity Market (NEM) are between $36 per megawatt hour in Queensland to $58 in Victoria, and reductions range from 38 to 51 per cent on the same time last year. These are the lowest levels we have seen for a number of years.

In our work inquiring into the NEM, we have found that large users saw a substantial increase in their bills over the last decade; in some cases a doubling or tripling. Overall, C&I users saw a real increase of 61 per cent in the effective c/kWh of electricity in the 11 years from 2007-08 to 2018-19.

This has placed enormous pressure on businesses.

But the recent dramatic reduction in wholesale electricity prices represents an opportunity to reduce electricity prices for business users and restore Australian businesses’ international competitiveness.

For C&I users, wholesale costs are the biggest cost component making up their electricity bill, at 53 per cent. Network costs are next at 32 per cent, followed by environmental costs at 12 per cent.

It is heartening to see that wholesale spot prices have come down and, as you can see in the forward curves, we can expect this to continue (Figure 3).

The new Prohibiting Energy Market Misconduct laws came into effect in June this year and the ACCC is responsible for enforcing them. These laws will ensure retailers pass on sustained and substantial cost reductions to small customers, and we would expect this to also flow through to large users.

If retailers are not passing on these wholesale price reductions, they will need to explain why consumers haven’t experienced cost reductions. The ACCC will take action where retailers have not reduced their prices.

The new laws also stop generators from inflating wholesale prices or blocking access to critical contracts. We will be monitoring conduct in these markets to check for any anti-competitive behaviour and will take action where there is a breach of the law.

Together with this specific electricity enforcement role, we will continue monitoring the market and prices as part of our inquiry work, with our next report due to the Treasurer in September. This report will focus on analysing retailers’ billing data and give insights into what different customer segments are paying.

We will also continue to advocate for customers and contribute to policy discussions in the energy market where affordability is an issue. As the NEM undergoes rapid change with the transition to more renewable generation, there is great opportunity for lower costs for customers. However, we remain concerned about measures which may add significant dollars of cost onto consumers.

One example is reliability standards. There is an inherent trade-off between reliability and affordability, and the pursuit of marginal increases in reliability in the NEM will have negative impacts on the prices that consumers pay for their electricity. The ACCC considers that, while customers value reliability, they are very concerned about affordability. Marginal increases in reliability should not be pursued at the expense of significant damage to affordability.

We know only too well that past decisions to enhance the reliability of supply in the NEM have had unintended and enduring impacts on affordability that cannot be easily unwound. Past significant overinvestment in state-owned networks across New South Wales, Queensland and Tasmania were driven by an increase in network reliability standards. The excess costs associated with these new reliability standards are estimated to be in the tens of billions of dollars and customers in those states continue to pay for over-investment in networks intended to meet higher reliability standards.

Concerns about reliability have recently dominated conversations about the future of the NEM. We recently submitted to the Energy Security Board our concern that increasing the reliability standard will have negative affordability implications for all users, and particularly for residential users. We urged the ESB to consider these affordability impacts.

On a more positive note, wholesale demand response represents an opportunity for consumers to respond to price signals and be rewarded for reducing their demand in times of tight markets. We recommended a mechanism be introduced to promote competition and ensure load and generation are valued based on the benefit they provide to the wholesale market. We have supported the recent Australian Energy Market Commission (AEMC) rule change made to implement a demand response mechanism in the wholesale market.

I know that large users are looking forward to significantly greater opportunities to emerge as a result of the wholesale demand response due to commence from October 2021. This will help avoid the costs of building an energy system designed around peak demand, including both network and generation assets. It will reduce the need for costly interventions and give energy users more control, helping to reduce costs and increase competition. Demand-side participation and, ultimately, the development of a two-sided market is a critical part of the energy market reform, which we will continue to support.

So, while the future is always uncertain, and particularly so in these times, for businesses that have faced such high electricity costs over the last decade, there should be better times ahead. The reduction in wholesale prices is positive and, together with large users continuing to be active participants in both the energy market and non-energy market mechanisms, this is the opportunity to restore Australian businesses’ international competitiveness.

Table 1 Volume-weighted average winter prices per NEM region

Conclusion

I think we are at a tipping point for energy costs in Australia.

We must ensure that we do not let the prize of competitively-priced energy escape us.

Thank you for your time today.