Why politicians have to stop promising to cut electricity prices

by Tony Wood

Published by the Australian Financial Review, Sunday 1 July

Australian households and businesses are waiting with intense frustration for governments to fix the problem of high energy prices. But they will not easily forgive the same governments for more blackouts, or for failing to confront the challenge of climate change. Herein lies the trilemma for governments and the reason for the intense policy debate on the National Energy Guarantee (NEG).

For more than 20 years, governments have espoused a commitment to the primacy of markets to deliver a better result for consumers than a nationalised, regulated system. For most of this time, the National Electricity Market (NEM) delivered reliable, low-cost electricity. What was not well understood was that part of this success arose from an over-supplied generation sector fuelled by low-cost coal and gas. As aging legacy assets such as Hazelwood power station closed, and as fuel prices, mainly gas, rose, the market responded as efficient markets will – prices rose, sharply.

The annual value of electricity traded in the wholesale spot market rose from about $8 billion in 2015 to $18 billion in 2017, 60 per cent of this rise due to supply reductions and 40 per cent to higher input costs. There has been some modest cost relief in recent months.

Markets are good servants but poor masters. Faced with rising prices, politicians from both sides of the fence forget that the market is there to work for us, not the reverse. Labor’s inherent suspicion of privatisation and markets drives calls for strong intervention; more surprising, the right of the Coalition also turns to intervention such as capping prices and various forms of renationalisation. Both responses are understandable but misguided.

A new Grattan Institute report, Mostly working: Australia’s wholesale electricity market, shows how the market has responded as designed to changing circumstances. But there is a sad overlay: governments have failed to deliver stable, credible climate policy, integrated with the NEM. This failure curtailed an efficient market response to high prices that would deliver new, lowest-cost, reliable electricity.

Our report exposes a nasty reality: new supply, whether coal, gas, or renewables with back-up to cover intermittency, is more expensive. It costs around $80 per megawatt hour or more, compared to the wholesale prices of less than $50 per megawatt hour the NEM was delivering only three years ago. Prices closer to $80 seem far more likely than $120 or $50. The NEG will help avoid the former; it will be some time yet before renewables with intermittency coverage deliver the latter.

And even if more subsidised renewables do lower prices, this will be transitory because more closures will follow and the full cost of the intermittency of wind and solar electricity will emerge.

So, if governments want price reductions, they will have to put pressure on the electricity networks and retailers. We urge politicians to be honest with Australians about this reality. They might find that people accept, albeit reluctantly, a credible narrative consistent with their real-world experience over an incredible promise that never seems to be met.

The loosely connected regional markets that comprise the NEM are moderately concentrated. Generators’ market power increases when major coal-fired power stations close, and again when periods of high demand coincide with transmission constraints. Prices in such situations can rise sharply to bring on new supply and, if sustained, provide incentives for new investment. This is good.

But when a generator uses these conditions to create high prices for periods of only five minutes with little net benefit to the system, that is hardly reflective of an efficient market. Our report shows such ‘gaming’ behaviour can add as much as $800 million to the value of traded electricity in a single year. And further plant closures and/or higher market concentration could make the gaming problem worse.

It’s hard for government to directly address concentration. But they should change the market rules to prevent or limit gaming. This is not to say that rule changes already made had no impact. It’s just that they haven’t addressed all the problems that have emerged or are looming.

Most importantly, governments must provide stable, integrated energy and climate-change policy to deliver investment in lowest-cost, reliable, low-emissions electricity. The NEG coupled with the Finkel Blueprint could do this.

Australia could lurch to the right or the left. We could choose continual market intervention or government nationalisation and price regulation over markets. This choice might have some short-term appeal. But it would be a poor choice. Dealing with real markets and regulating them well remains the best, but least understood, alternative.