There's no subject more likely to stir people up than rising electricity
bills. With prices roughly doubling since 2007, that's hardly
surprising. But why have prices risen so fast? And will they keep
rising?
It has suited various business lobbies and Coalition
politicians - federal and state - to leave people with the impression
the main reason is the carbon tax and the renewable energy target, which
requires that 20 per cent of Australia's electricity come from
renewable energy sources by 2020.
In truth, the price rises
started well before these measures took effect and they explain only a
small part of the increase. Which suggests the politicians will suffer
yet another loss of credibility when eventually (and stupidly) the
carbon tax is abolished and the renewables target is dropped, as seems
on the cards, but power prices don't seem to fall by much.
The
more important reasons were given by Professor Ross Garnaut, of the
University of Melbourne, in a recent speech. Here's my version of his
explanation.
One part of the reason is that more people have been
using renewable energy and this reduced their demand for conventional
electricity from the grid, which is produced mainly by coal-fired
generators, of course.
Apart from all the wind turbines,
governments - federal and state, Coalition and Labor - have offered
incentives to people to incur the significant expense of installing
rooftop solar power systems.
The most generous of these incentive
schemes have been abandoned but, at the same time, the cost of
photovoltaic systems has been falling rapidly, partly because of
advances in technology, partly because more purchasers mean greater
economies of scale.
The most important economic characteristic of
renewable energy is that once you've incurred the high "fixed cost" of
installing a system, the "variable cost" of using the system to produce
more energy is negligible. Sunshine is free. So once you've got a
system, you use it.
A second important part of the reason for
rising power prices is that many businesses and households have reacted
to the rising price by being more economical - less wasteful - in their
use of electricity.
Another factor (one many economists tend to
ignore) is that all the talk about the need to reduce emissions of
carbon dioxide to stop climate change, and all the talk about how much
power we waste, has made more firms and householders waste-conscious.
Some people are being careful in their use of electricity as a
self-interested response to its rising price, while others - including
businesses - are doing it from a sense of duty to society.
By now,
I trust, a big red light is flashing in your head. If people are using
less power from the grid because more of them are collecting their own
and more are reducing their wastage of electricity, doesn't that mean
demand for conventional power is falling?
Indeed it does.
According to figures from the Grattan Institute, since late 2009
electricity demand in eastern Australia has fallen by about 7 per cent.
But
hang on, is this guy saying the price of electricity has gone up
because demand for it has gone down? Isn't it supposed to be the other
way round? Isn't a fall in demand supposed to lead to a fall in the
price?
Well, assuming no change in supply, yes it is. So you're
right to be to be puzzled. The relationship I've described between price
and demand is, as an economist would say, "perverse".
But why?
Because, as Garnaut explains, we've stuffed up the deregulation of the
electricity market. (Moral: as we're being reminded by the plan to
"deregulate" university fees, if you deregulate or privatise without
knowing what you're doing you can make things worse rather than better.)
Before
the reform process began, each state had its own, government-owned
electricity monopoly, with little trade between the states. From the
late 1980s it was decided to break the integrated state monopolies into
their component parts - generation, transmission, distribution and
retailing - and form one big eastern Australian electricity market with
as much competition and as little monopoly as possible.
The power
stations were separated into individual businesses - some of which were
privatised, particularly in Victoria - and made to compete in a highly
sophisticated "national" wholesale market for electricity. Garnaut says
this has worked well, with competition keeping the wholesale price low
in response to the reduced demand.
But transmission (high-voltage
power lines) and distribution (local poles and wires to the premises)
are natural monopolies. That is, it's not economic to have more than one
network. So whether these businesses are publicly or privately owned,
the prices they charge have to be regulated to prevent them
overcharging.
Trouble is, Garnaut says, we've done this by fixing
the maximum rate of return the businesses are allowed to earn on the
capital they have invested. Economists have known for 60 years that this
always causes problems because it's so hard to pick the right rate of
return.
If it's too low it leads to underinvestment in the
physical network, causing blackouts. If it's too high, however, it leads
to overinvestment in the network at the expense of business and
household customers.
But as well, when monopoly businesses that
are guaranteed a certain rate of return suffer a loss of demand, the
regulator has to allow them to restore their profitability by raising
their prices.
Another red light flashing? Surely if you keep
responding to a fall in demand by raising prices, this will lead to a
further fall in demand (particularly as the cost of renewable energy
keeps falling) and the whole thing will keep going round and round and
getting worse and worse.
Just so. People in the know call it a
"death spiral". One day soon the regulators of the regulators - aka
federal and state governments - will have to step in and call the
madness to a halt. Until then, prices will keep rising.
