Energy market outlook – Overview of presentation*

Rod Sims
Adviser to the Multi-Party Climate Change Committee

• Electricity prices have risen by around 30% in the last 4 years in Australia in real
terms; this is a 30% increase on top of inflation
- Electricity prices in NSW, QLD and Victoria are at broadly similar levels,
while they are higher in South Australia and Western Australia (the latter two
States have not, for example, had the benefit of significant low cost coal-fired
electricity generation).

• While electricity prices have traditionally increased by less than household

income, this has recently changed with significant effects on low income earners
in particular
- Low income earners spend significantly more of their disposable income on
electricity than high income earners
- It is worth noting, however, that Australia’s electricity prices are now at
broadly similar levels to that of 25 years ago after allowing for inflation.

• The recent electricity price increases have mainly been driven by increases in
network costs. For example, in NSW from 2007-8 to 2012-13 around two thirds
of the electricity price increases are driven by rising network costs
- Network costs are rising due to increased peak demand, rising standards that
distributors must now meet, and the renewal and replacement of ageing assets.

• Looking forward, at least four factors will drive increases in future electricity
prices WITHOUT a carbon price. The first two are not driven by Australia’s
response to greenhouse issues, the latter two are
- Continuing increases in network costs
- Rising coal and gas prices
- The fact that the market is already accepting that very few if any further coal-
fired electricity generation plants will be built, yet base load gas plants are
difficult to make economic without a carbon price
- There are many current non market driven greenhouse schemes which result in
high cost outcomes e.g. measures to support household solar in particular as it
is an extremely expensive form of energy, but also the LRET and many others.

• Many analysts have calculated the effect of the imposition of a carbon price by
simply adding that price to the electricity costs we would have if the system were
as it is now, and so based largely on coal-fired generation. Electricity prices in
future will, however, even without a carbon price, now reflect high cost household
solar schemes, and much more wind generation (due to the LRET) and the
accompanying peaking plant, which are higher cost sources of generation.

• Australia’s current main greenhouse response has so far been to provide

incentives for household solar and wind generation in particular. These are high
cost measures and ones where the additional cost is added to the bills of all
electricity consumers
 - Australia’s economic history suggests that where we seek to trial new,
currently higher cost technology this is better done from budget support, for
example through the Solar Flagships program, rather than through “infant
industry” programs which embed high costs into the economy.

• There are many ways to lower carbon emissions with different effects on
electricity prices. We should be aiming to lower carbon emissions at least cost.
For example, base load gas-fired generation has about 40% the level of emissions
of the current National Electricity Market, yet electricity generation from
household solar and wind costs many times that of base load gas generation.

• Australia is currently targeting to reduce emissions by around 30% on a business-

as-usual basis, or around 25% per capita, by 2020. This is usually described as a
5% absolute cut from 2000 levels. If Australia wishes to meet this target it can
choose between at least two approaches: continue using the current high cost and
non market mechanisms described above, or introduce a carbon price. Electricity
prices will in future be lower if we take the latter path of meeting a given
greenhouse gas reduction target through the introduction of a carbon price
- Some greenhouse reduction targets would, of course, drive a carbon price that
is high enough in future to justify a wide range of renewable energy
generation and other steps without any artificial measures. Such responses
would then be market driven and so the least cost options to meet such a target.

* ****

• The Committee is considering a carbon price for Australia in the context of

already steeply rising electricity prices. These price rises have occurred for
reasons essentially unrelated to greenhouse policy.

• The logic of introducing a carbon price is that it will meet a given greenhouse gas
reduction target at the lowest cost. It follows that as we introduce a carbon price
we should allow it to substitute for many other high cost schemes
- Indeed, it would be helpful to the argument for a carbon price to assess and
make public the cost per tonne of the emissions saved from the current and
future range of greenhouse policies, as well as their effect on electricity prices.

10 November 2010

* This presentation has benefited from comments by my colleagues at IPART and at

Port Jackson Partners Limited. Any remaining errors are, of course, mine alone.
 !" # $

STATE ELECTRICITY PRICES, INFLATION ADJUSTED

Steep recent rises; often

NOTE: back to inflation
• NSW, Qld, VIC prices now at similar adjusted levels close to
levels; SA, WA higher as not based on those of 25 years ago
coal-fired generation
• NSW, Qld, WA, SA similar growth
pattern; VIC with earlier price rises
Cents per SA WA
Kwh
22 Australia
Wide
VIC
Prices risen
19 ~30% 2006/07
– 2010/11

16

13
Qld

NSW
TAS
10
1985/86 1987/88 1989/90 1991/92 1993/94 1995/96 1997/98 1999/00 2001/02 2003/04 2005/06 2007/08 2009/10
% &
&' ( (( '

ELECTRICITY AFFORDABILITY

Index of electricity household bills Low income earners spend

versus AWE ($09/10) significantly more of their
disposable income on
electricity, and some are
currently struggling to
2.0 fund their electricity bills

Index of
electricity
prices

AWE

1.0
The share of
AWE spent on
electricity was
less than in 1993

0.0
1993 1996 1999 2002 2005 2008 2013

"
 ' )

PRICE INCREASE DRIVERS E.G. NSW

This breakdown will
likely be broadly
% contribution similar in most States
to price
Cost increases 2007/8
breakdown – 2012/13 Comment

Retail 12% 19% – Higher retail margins largely due to

retailers facing riskier environment as
exposed to competition; increasing
operating and customer acquisition costs
Generation 40% 15% – Increasing costs of new generation;
changing supply/demand balance; some
small greenhouse programme costs
Network 48% 66% – Distribution spend has trebled from
~$1bn pa to ~$3bn pa

Driven by Comment

No of Brisbane • Increase in peak demand (i.e. need larger • No real incentives for
houses with “pipe” to home for given consumption level distributers to curb peak
aircon risen from as electricity consumption increasingly demand
23% to 72% in concentrated) • Need to review network cost
last 12 years • Rising standards to be met (e.g. N-2 in drivers and consider cost
cities; cannot overload feeders) benefit analysis on rising
• Renewal and replacement of ageing assets standards that distributors
must meet

$
+ ( '
NON CARBON PRICE DRIVERS
Driver
• Increase in network costs
• Rising gas and coal prices
• Continuing carbon price uncertainty
• Many current non market driven
greenhouse schemes
Comment
• Significant spend locked in; may need
to review standards, consider These forces
distribution demand management coinciding with,
incentives) but are unrelated
• Gas prices likely to move closer to to, consideration
export parity; coal prices to increase as of carbon price
contracts renewed
Both lead to high cost
• It will be very difficult in future to build
outcomes compared to
coal-fired generation; baseload gas
introduction of a carbon
harder to justify without carbon price
price as future electricity
• Particularly SRES, solar feed-in tariffs generation will largely
(household solar is a very expensive come from wind and
form of energy), LRET, some energy peaking plant
efficiency
*
- ( ( '
(( . ( ' ' ' (( (
)

CARBON PRICE IMPACT ON ELECTRICITY PRICES

Base Pool Price

Real, $/MWh
120

CPRS – 5
100 Traditionally modelled results are
based on comparing Australia with
80
Conceptual prices with and without a carbon price BUT this
considerable wind and comparison is no longer correct.
60 peaking generation
For example, investors already
largely assume coal-fired power
40 Status quo
generation is no longer bankable
20

0
2010 2015 2020 2025 2030

The CPRS was estimated to increase

wholesale electricity costs by 60% by
2015; meaning, all else equal, that retail
electricity prices would rise by 24%

,
- ( ' '
'
ALTERNATIVE ELECTRICITY GENERATION COSTS
Current situation ($MWh)
• Black coal ~$45
• Base load gas ~$60
• Wind ~$120
• Solar Thermal $300+
Current emission intensity of
National Electricity Market ~ 0.9t
per MWh; baseload gas has
emission intensity of around
40% of current levels
'
Possible future
• Solar thermal costs could decrease to
$100 – 200 MWh by 2020
• Will geothermal work and at what cost?
• Can CC&S be competitive?
• What scope for battery technology?
Assistance measures for new
technology are better provided
through budget funded grants, e.g.
Solar Flagships, rather than
embedding high costs into our
electricity system
/
 ( ( '(
SUMMARY VIEWS
Key messages
• This Committee is making decisions on
carbon prices against a background of
steeply rising electricity prices for non
greenhouse reasons
• These price rises are already hurting low
income households in particular
• In future electricity prices will increase
significantly for “greenhouse” reasons
without a carbon price; due to the high
cost greenhouse schemes we already
have and the carbon price uncertainty
already factored into investment decision
making
• A carbon price will see electricity prices
increase by less than they would by
pursuing a given greenhouse gas
reduction target by the current
greenhouse schemes
(
Implications
• Use a carbon price to reduce emissions as a
substitute for many other current higher cost
greenhouse schemes
– Some greenhouse reduction targets would, of
course, drive a carbon price that is high
enough in future to justify a wide range of
renewable energy generation and other steps
without any artificial measures
• Need to model future electricity prices with and
without a carbon price (i.e. model the effects of
the current carbon price uncertainty, and the
future electricity price implications of the many
current greenhouse schemes)
• Need to model the cost per tonne of emissions
saved from current and alternative future
greenhouse policies
• Need to consider how best to introduce a carbon
price so that the above electricity price issues
are taken into account