The federal government has committed to tackling a major cost-of-living problem – alarmingly big increases in gas and electricity prices over the next 18 months. Labor’s solution will either continue its generally strong start to government or open a major point of attack for the Coalition and plague the rest of this term.
On Tuesday, Treasurer Jim Chalmers revealed Treasury assumptions that retail electricity prices will increase by an average of 20 per cent nationally in late 2022 and a further 30 per cent in 2023-24. In addition, retail gas prices are expected to increase by up to 20 per cent in both 2022-23 and 2023-24.
While part of the electricity price rise has already been incurred, these increases would be politically untenable. The opposition is already using power prices as a line of attack, made easier by Labor’s promise to reduce power bills by 2025. The treasurer and Prime Minister Anthony Albanese have committed to taking corrective action. Yet, their choices are limited, and any option is laced with nasty side effects. It is a tricky challenge created by factors outside their control, but it goes with the territory.
The underlying cause is clear. High international gas prices for cargoes of liquefied natural gas (LNG) have followed the war in Ukraine. Australian LNG producers can get prices for their exports as much as four or five times previous levels. When large industrial companies, gas retailers, or operators of gas-fired power plants seek supplies, the producers reference the high international spot price as the competitive price they have a right to expect. The recently renegotiated Heads of Agreement between the government and the producers recognises that the Asian spot price should influence domestic prices.
The Australian Competition and Consumer Commission has already warned that there will be grave consequences if these high prices flow through to domestic consumers, and Treasury has recognised that reality.
Gas-fired power was already the most expensive electricity source, and as with an auction, the highest bidder into the national electricity market sets the price. All suppliers – coal, gas, and renewables – get windfall profits. The market works as designed but the consequences are unacceptable, economically, socially and politically.
A central goal of the government’s budget is to gain control of inflation. It therefore ruled out the option of some form of government payments to consumers. The alternative is to reduce the prices and the windfall profits. The solution must be direct, reasonably quick to impose and to remove when the cause dissipates, and should not damage Australia’s reputation as a reliable international supplier. Three other options emerge.
The first would be to directly cap the wholesale gas price. That seems almost impossible since there is no transparent spot market that covers this gas supply. It’s almost all short-term commercial contracts.
The second option would be to impose a windfall profit tax. Such a tax should be fairly simple to impose on the domestic sales of the LNG exporters and could work best as a threat to trigger their agreement to voluntarily reduce the prices. If it was applied, then there would be complications such as applying it to others in the supply chain and how to use the tax receipts to support consumers. The government has ruled out this option, presumably because any new tax would be a political liability.
The third option would be for the government to use the Heads of Agreement to dictate what price should be used to represent “competitive terms” for domestic supply. This price could be calculated by the ACCC, initially referencing the spot prices that were in place before the recent escalation – a fair price providing a fair profit. The budget already includes extra funding for the ACCC to monitor the gas market, and this fair competitive price could be set transparently, reviewed regularly, and would not apply to exports.
There have been calls for a gas reservation policy like that used in Western Australia. This would not be simple to calculate or design and was more suited to when the objective was to support growth of the gas market. Growth in the market for a fossil fuel is inconsistent with Australia’s climate objectives.
There may be other choices. But all the options carry difficult consequences. The producers will strongly resist any government intervention that reduces their pricing power and will threaten all sorts of consequences.
Market intervention is always undesirable yet in this case seems inevitable. It’s a tough decision for a new government.
While you’re here…
Grattan Institute is an independent not-for-profit think tank. We don’t take money from political parties or vested interests. Yet we believe in free access to information. All our research is available online, so that more people can benefit from our work.
Which is why we rely on donations from readers like you, so that we can continue our nation-changing research without fear or favour. Your support enables Grattan to improve the lives of all Australians.
Danielle Wood – CEO