Transcript
Check against delivery.
My thanks to the AFR for putting on this great conference. There are vital issues to discuss.
Energy prices are, quite simply, way too high in Australia. While there have been improvements, there is more to do.
I have been involved in the energy sector for around thirty years, longer than most people here. The current debate about the causes of our current problems in electricity and gas is more confusing than ever which makes it difficult to find solutions to the affordability issue.
Much of the commentary suggests that various government policies are to blame but this is simplistic, and sometimes a deliberate diversion. Industry must shoulder an important part of the blame for where we are now.
Energy policy seeks to meet many important objectives but if we do not align the solutions with the objectives we seek to meet we run the risk of hunting for a silver bullet that does not exist. Instead, if you have three separate issues to deal with (that is, the electricity trilemma of reliability, environmental sustainability and affordability) then you need three different sets of solutions.
There may be arguments about which of the three objectives are most important but, in my view, you don’t need to trade off the objectives against each other. The objectives are addressed largely through different instruments. So, to address the affordability objective, direct measures focussed on this are needed.
Addressing affordability, however, has the payoff of making it easier to address the other two concerns. Achieving gains in affordability will make absorbing some of the costs of achieving the other two objectives more achievable. It is also important to consider the affordability implications of different options to achieve reliability and sustainability.
Today I will cover three topics:
- The different causes of gas and electricity market problems
- Solving the electricity affordability problem without conflating it with other important issues
- Solving the gas affordability problem.
1. The different causes of gas and electricity market problems
By world standards our electricity and east coast gas prices are expensive. We found, for example, in our 2018 Retail Electricity Pricing Inquiry (REPI) that Australia’s electricity prices have gone from the 4th cheapest in the OECD in 2004, to the 10th cheapest in 2016; and then to the 4th most expensive in 2018.
While we have reported that Australian Commercial and Industrial (C&I) gas users are not paying more than their overseas counterparts buying Australian gas, prices paid in the Australian east coast gas market are higher than those paid in other gas exporting countries.
Gas and electricity prices have increased substantially in recent years, which may give the impression that the two are closely linked. They are not; each has its own causes of the current high prices.
Electricity
One year ago, an average household in the NEM paid an effective price of 29 cents for each kilowatt hour of (kWh) for electricity, or $1549 over the year.
This price of 29c represents an increase of nearly 50% in real terms over the last 10 years.
All components have contributed to the increase.
- From networks - 35%; to
- wholesale - 23%; to
- retail - 22%; and to
- green schemes - 20%.
And the reasons behind the increases in each of these components are different.
Network and distribution costs increased largely because the network businesses pushed for, and achieved, looser regulation around 10 years ago.
In Queensland and New South Wales, in addition, there was a tightening of reliability standards in 2005 in a reaction to particular blackouts. These standards led to network investment without regard to consumers’ willingness to pay for minor increases in reliability.
In our 2018 REPI final report we found the increases in wholesale prices have generally been caused by the loss of cheaper dispatchable power from the closures of the Northern and Hazelwood power stations, importantly combined with entrenched levels of concentration in the market.
In relation to retail costs and margins, disengaged or confused customers often ended up on very uncompetitive standing offers, and needlessly paying way too much.
Our analysis shows that customer acquisition and retention costs add around $50 to each customer’s annual bill, regardless of whether they have switched.
Furthermore, the confusing nature of electricity prices and discounting means it is not clear that customers who switched as a result of these acquisition and retention offers were actually on the best deal.
Various green schemes resulted in unnecessary costs to energy consumers.
For example, initial feed-in tariffs for rooftop solar were set too generously. Not only is the price paid for this energy far in excess of the value of the power delivered, the cost of these tariffs and other subsidies is paid for by non-solar customers, which is an unfortunate allocation of costs.
The Queensland Government’s decision to take a number of green scheme costs out of consumer bills and instead pay them through the state budget has set a great example for other states, and is a significant contributor to the reduction in South-east Queensland’s electricity prices.
Gas
The cause of the east coast gas market problems are very different.
First, the introduction of liquefied natural gas (LNG) changed gas flows and domestic prices, as too many gas trains were built given available supply.
When the LNG projects in Queensland were being commissioned, industry promised that this current crisis would not happen. Suppliers assured the Queensland government that investment in gas exploration and development would be timely, there would be enough gas for export and domestic gas markets, and businesses needing gas would be protected and their futures secured.
Time has shown these to be empty promises.
In addition, the NSW and Victorian governments imposed blanket moratoria and regulatory restrictions on gas exploration and production, which has significantly limited or delayed the potential for new gas supply.
All this has been at a time when our traditionally cheap sources of gas, primarily in Bass Strait, are in decline and are producing less. In March this year, Australian Energy Market Operator (AEMO) forecast that gas shortages in the southern states could arise as soon as around 2024.
2. Solving the electricity affordability problem
The dominant debate in electricity today is about our generation mix and the need for more investment in generation. Some argue that if we had a settled emissions reduction policy, or implemented the emissions reduction element of the National Energy Guarantee (NEG), that it would have solved the affordability problem. This is simply not so.
Even if we solve the wholesale market’s reliability and emissions issues tomorrow, we will still face serious electricity affordability issues.
We need separate mechanisms focussed on each of these three issues: and, in pursuing these solutions, we need to be mindful of any unintended consequences on the other objectives. So, in pursuing increased reliability or reduced emissions, we need to be careful in designing the solutions, because there will be consequences for affordability.
The ACCC’s work in the sector shows that the causes of the affordability crises are many, but it also provides many promising avenues to help bring down prices. The final report of our 2018 electricity inquiry set out 56 recommendations of which 10-12 would do most of the immediate work needed to improve electricity affordability. Some of the recommendations have been implemented, such as:
- on network and distribution costs, limiting merits review of Australian Energy Regulator (AER) decisions will minimise unnecessary increases in costs
- introducing the default market offer as a cap on retail standing offers, reducing excessive prices
- requiring retailers to advertise discounts off a common reference price, making it easier for consumers to compare offers and improving retail competition.
Other reforms and initiatives relating to our recommendations are progressing:
- The Australian Energy Market Commission (AEMC) is working on demand response, which could have major price benefits in the wholesale market.
- The AEMC is also pursuing changes to make switching retailers faster for consumers, which will put more pressure on retailers to offer good deals immediately.
- The ASX has recently commenced a voluntary market making scheme for hedge contracts, including in South Australia where liquidity is particularly problematic.
However, there are a number of reforms that have not been tackled that could provide significant benefits to end consumers.
In particular, the largest component of most consumers’ bills is the cost of networks, and a significant amount of this cost is attributable to past over-investment. Removing this over investment from regulatory asset bases would be a big win in improving affordability, and would also boost Australia’s productivity.
I do not want to understate the boldness of this reform; it would require a willingness to right past mistakes, and for some governments to forgo significant revenue. But the flow on effects to the economy are worth the expense.
Similarly, government schemes to promote small scale renewable generation continue to proliferate. Now is a good time to consider whether these schemes continue to provide the value we expect from government subsidies.
In any case, all governments should consider replicating the Queensland Government’s decision to take the cost of these schemes onto their budget, rather than continue to force households that don’t have solar to cross-subsidise those that do.
Finally, the Australian Government is developing a program to encourage investment in new generation and has shortlisted 12 projects. The ACCC recommended that governments underwrite the credit risk (but not the equity risk) of some new, firm generation projects to address what appeared to be a market failure. The program will only be effective in improving competition and outcomes in the wholesale market if it encourages new entrants, or investment from existing smaller players, and does not further entrench the market position of the major established suppliers.
Not only is it the smaller, newer players who will provide this competition, but they are the ones facing difficulty in gaining sufficient contracts to back their investment.
There are also some vital issues facing the electricity market.
First, why is there not more investment in gas peaking plants to firm up renewable energy?
Many commentators have noted that the influx of renewables into the National Electricity Market (NEM) is creating greater volatility in the wholesale market as security of supply is increasingly affected by the weather. Fast-start gas generators are relatively cheap and quick to install and the cost of gas is negligible if the plant targets peak spot market electricity prices.
The second issue which has been much debated recently is whether we want the NEM to remain a price driven market, where generators are only paid for the electricity they produce, or should it change to a capacity driven market, where generators are also paid simply for having available capacity?
Capacity markets have the superficial appeal of providing greater certainty about generator availability and overall reliability of supply, but the lived experience of capacity markets in some jurisdictions has seen over-procurement of capacity and, ultimately, needless additional cost for end consumers.
The Energy Security Board has recently commenced a review to consider exactly this question with a view to potentially having a new market design in place for 2025. While I commend this process, the impact on affordability of alternative proposals must be an essential consideration. The ACCC will continue to argue for this.
Third, in the transition to more renewable energy, how do we avoid the mistakes of the past in allowing new generation to be built divorced from whether it is needed, and without consideration of the cost for consumers imposed by the needed transmission investment?
We should not simply be subsidising new generation without regard to these important factors.
3. Solving the gas affordability problem
Export parity prices are an important factor influencing domestic gas prices and affordability in the east coast gas market.
In October 2018, at the request of gas users, we started publishing our Liquefied Natural Gas (LNG) netback price series. Gas suppliers had this information, while many buyers did not.
Netback prices for 2020 have been trending downwards and for the last three months have mostly been below $8/a gigajoule (GJ).
It is important to note though that the LNG netback price series provides an indicative reference price for gas at Wallumbilla in Queensland. Prices offered and paid in the southern states will be influenced by transportation costs and, crucially, the supply-demand balance in those states.
In our most recent July report, we observed that prices offered by gas producers in Queensland for 2020 supply appear to have fallen at the same time as this year’s decline in the expected LNG netback prices for 2020.
However, this has not been the case with prices offered by retailers in the Southern States. We cannot be definitive, but we do know that sufficient gas is expected to be produced in the south to meet the demand there. It is uncertain, however, how much gas from the Cooper Basin will actually flow south and how much will be needed for gas powered generation in the South.
To get significantly lower gas prices in the south it is crucial that there is more gas supply in the south, to avoid the cost of piping it from Queensland.
One option often put forward as a solution to our current market problems is the construction of a gas import terminal.
Import terminals have the potential to increase and shore up supply in the southern states, particularly during the winter peak. This could be increasingly important given Australian Energy Market Operator’s (AEMO) forecasts of winter shortages in the southern states from 2024 onwards.
An added benefit is that they add storage capacity into the system, with each import terminal capable of holding more than 3 petajoules (PJ). An ability to ramp up and down, can also add to system flexibility.
The impact of import terminals on pricing is less clear, however.
All things being equal, increased gas supply should put some downward pressure down on prices.
Import terminals can also introduce competition to pipelines that we have previously observed have been charging monopoly prices.
However, the impact on gas prices depends on the locations of the import terminals and on how much the imported gas costs. What is clear is that import terminals would likely set a price ceiling based around international LNG prices and the costs of transporting and re-gassifying LNG in Australia.
The key to lower gas prices in the east coast is more and diversified gas supply. There is a role for both government and industry to ensure that more gas is developed and brought to market and it requires active and sustained effort by both.
We have previously reported on write downs of significant quantities of coal seam gas (CSG) reserves in Queensland. Arrow Energy in particular has re-classified nearly 3,000 petajoules (PJ) of its proved and probable reserves into contingent resources, predominantly in the Bowen Basin.
This move has delayed a significant quantity of gas coming to market and will also likely delay the construction of critical pipeline infrastructure that would enable other suppliers in the area to supply significant amounts of gas into the domestic east coast market.
In such a tight market, governments need to actively monitor compliance with licence requirements and implement any measures necessary to ensure that large gas producers do not warehouse gas from development and production to suit their commercial priorities at the expense of the Australian market.
The ACCC will be looking for a clear rationale for recent coal seam gas reserve downgrades, particularly by larger gas producers that have delayed the development of much needed new sources of supply.
We also continue to urge state governments to adopt policies that consider and manage the risks of individual gas development projects, rather than implementing blanket moratoria and regulatory restrictions.
We need urgent action on all fronts.
Concluding remarks
The issues in our gas and electricity markets are very different, and different solutions are needed to address affordability in each markets. In a similar way, the trilemma of electricity issues need to be tackled separately and largely through different mechanisms.
Like most things in life, you will not achieve an objective without a clear focus on it. Without a clear focus on affordability from all players Australia will continue to suffer from excessive energy prices.
Thank you.