Rod Sims: shining light on Australia’s energy affordability problem


ACCC energy made easy website

Energy affordability has gone from being a source of economic advantage for Australia to the opposite, according to ACCC chief, Rod Sims. He outlines some hard truths to governments across the nation.

Below is a transcript of ACCC Chairman Rod Sims’ lunchtime address to the National Press Club yesterday.

Thank you for the invitation to be at the National Press Club today.

I value the role journalists play in keeping Australians so well informed. As someone who has been fortunate enough to travel extensively I have seen the results of a press corps that simply spouts the government line, without the capability or the freedom to do otherwise.

Further, without you it would not be possible for the ACCC to communicate our compliance and enforcement actions, our product safety warnings and the outcomes from our work on infrastructure. Being able to send deterrence messages, for example, when we take successful action against companies found to be doing the wrong thing is incredibly important to our work.

The ACCC is always busy.

Recently we had our first successful criminal cartel prosecution, and there will be many more to come. Our competition work also covers action when there is a misuse of market power or a substantial lessening of competition, both of which we alleged in relation to Ramsay Health Care earlier this year.

There are always many mergers or acquisitions to consider. Our recent decision in relation to Lachlan Murdoch and Bruce Gordon’s proposed acquisition of Channel 10 is familiar to you all, as is our current assessment of BP’s proposed acquisition of Woolworths’ retail service station sites.

We are an active consumer regulator with recent court actions against Ford, Thermomix, Viagogo, NIB, Murray Goulburn and Apple, to name a few.

Our product safety work is currently dominated by the recall of the potentially lethal Takata airbags still found in 1.5 million Australian cars; on top of numerous other recalls such as faulty Infinity electrical cables that have the potential to burn homes to the ground.

We are Australia’s economic regulator of telecommunications and transport infrastructure, which sees us involved in NBN speed claims and speed monitoring, as well as issues such as the pricing of services at the Port of Newcastle.

We also initiate market studies such as our study into beef cattle and our new car retailing industry report which was recently released.

On top of all this the Federal Government has directed us to conduct inquiries into dairy, Northern Australia Insurance, residential mortgage products, electricity and gas.

Apparently we will soon be looking into the impact of little-known businesses called Google and Facebook. If this inquiry is as reported it could be one of our most important inquiries yet.

We take these new inquiries as a compliment to the quality of our work, but suffice to say one thing we do not suffer from is boredom.

Today, of course, I am here to talk about electricity and gas.

Energy affordability has gone from being a source of economic advantage for Australia to the opposite.

We all meet, or hear of, potential overseas investors or other visiting business people who cannot believe the electricity and the gas prices in Australia; often multiples of what they pay at home.

I will cover three topics.

First, I will say more about gas and electricity affordability.

Second, I will provide a perspective on why both affordability problems occurred. In electricity this will be quite different to most public commentary.

Third, I will outline some of the issues which the ACCC is now considering.

We are just about to deliver an interim report on electricity affordability and a report on gas supply and demand to the Treasurer. The latter will feed in to the Government’s deliberations on its Australian Domestic Gas Security Mechanism (ADGSM).

The extent of our affordability problems

Under each heading I will discuss gas, then electricity. Each faces very different issues.

1. Gas

I heard recently of a company that went out for tender for one of its plants; it got three or four responses and was able to lock in gas for 2-3 years at under $6 a gigajoule.

This company’s business is in Western Australia.

Contrast this with what’s happened to Coogee Chemicals, also based in Western Australia. It is on the record as saying it shut its plant on the east coast not because the technology didn’t work or was outdated, and not just because of the gas price but also because they couldn’t get the gas they wanted.

On the west coast, five suppliers are securing Commercial and Industrial (C&I) customers at prices of $6gj or lower. On the east coast C&I customers seeking offers in 2017 are usually finding only one supplier, with take-it-or-leave-it terms, and offers are generally in the range of $10-16 gigajoule for supply in 2018.

Figure 1, is based on one east coast industrial gas user’s experience, but it is quite typical. Its 2012 experience could well be that on the west coast today. For 2018 gas, it has only one supplier offering gas, and at $12-15 gigajoule.

Figure 1: Gas prices and supply offers from 2012 to 2018. (click to enlarge)

As part of our current Gas Inquiry we asked gas suppliers for offers they had made over 2016 and 2017 which had not resulted in a contract. For 2018, offers were made to 23 large C&I customers. Only two of these 23 customers received offers from more than one supplier; many suppliers simply had no gas to sell.

Our analysis shows that the majority of these offers had not been settled, and there remains considerable pent up demand.

Australia has many manufacturing plants that use gas as a feedstock or as an essentially irreplaceable source of energy. Industrial gas users made up around 46% of domestic gas sales in 2016. The manufacture of explosives, glass, paper, steel, fertiliser, chemicals to name a few.

The future of these plants’ investments, and sometimes the future of the plant itself, is at stake. Indeed, the ACCC spoke to well over 20 C&I gas users and over a third were actually considering either reducing production or closure due to high gas prices. Jobs will often be lost in regions where new jobs will be hard to find.

It is hard to be a manufacturer in Australia. High wages, a fluctuating exchange rate and often high compliance costs reinforce this.

But while firms come and go it would be sad to see firms fail just because our east coast gas market is dysfunctional.

I have heard some say that our east coast gas market is fine; supply will equal demand after some “demand destruction”. What a stunningly callous approach to people’s hopes and livelihoods!

Of course gas is not just an issue for Australian manufacturing. Wholesale gas prices make up 15-30% of total residential gas bills; household gas bills will increase by 5% in NSW and 11% in Victoria for each $2gj increase in gas prices.

Gas is also relevant to the electricity sector, to which I now turn.

2. Electricity

The large increases in electricity prices over the last decade have not been matched at all by increases in other prices or wages, as can be seen in Figure 2.

Figure 2: CPI for electricity compared with other sectors and wage growth. (click to enlarge)

It is particularly concerning that the burden of higher electricity prices disproportionately affects segments of society which are least able to afford it. The proportion of household disposable income spent on electricity is around five times greater for the lowest income quintile as it is for the highest income quintile, as shown in Figure 3.

Figure 3: Median market offer as a proportion of household income in 2016. (click to enlarge)

Note: As the below is based upon the median offer, the proportion on income will vary depending on whether a customer is on a median or higher priced option including the standing offer.
Source: ACCC/AER analysis, ABS Survey of Income and Housing (catalogue 6553.0), ABS Consumer Price Index (catalogue 6401), ABS Wage Price Index (catalogue 6345).

As we have moved around the country, our Retail Electricity Pricing Inquiry team heard stories of Australians having to ration electricity through winter, having to choose between paying medical bills and paying electricity bills, and having only a small amount to spend on food after rent and electricity is paid for.

And, as with high gas prices, the effect on industry is also telling.

There are many cases of firms facing a doubling or even tripling in electricity prices in their most recent offers over the last 12-24 months, as companies come off 3-5 year contracts. Often electricity is at least 5% of total costs, and firms that are in the traded goods sector cannot pass on these cost increases.

Small businesses are under significant pressure from rising electricity prices. One retail grocer with multiple sites saw in increase of over 50% in their monthly bill, even after taking many energy efficiency measures. Given the thin margins in the industry, the business will need to lose the equivalent of 12 full-time jobs to offset the costs.

Many medium-sized food and non-food manufacturers have seen electricity prices increase by 20% recently or by 100% or more over the last five years. Some had only 1-2 offers for supply; some are so desperate they are buying directly from the spot market, or are considering doing so, which is extremely risky.

Then we have the stories from many large businesses. While BlueScope, for example, has achieved over $300 million in production cost savings to stay in business, it has also seen a near doubling of its electricity costs since 2016, as shown in Figure 4.

Figure 4: BlueScope steel’s electricity costs 2016-2018. (click to enlarge)

We at the ACCC have been sounding the alarm in relation to business energy costs for some time. It is great that there is now considerable focus on this issue.

How have these situations come about?

We have gas affordability issues for completely different reasons to those driving our electricity affordability issues. The gas shortage, however, is making the electricity affordability issues worse.

1. Gas

It has been almost a year and a half since the ACCC delivered its first East Coast Gas Inquiry report to the government.

We held more than 30 private hearings and considered over 73,000 individual documents largely obtained using our information gathering powers.

Based on this raft of information, we found that eastern Australia’s gas market has been upended by a triple whammy.

First, the introduction of the export LNG projects changed gas flows and domestic prices.

Second, oil prices fell faster and further than some thought possible, curtailing investment in gas exploration and development.

Third, regulatory uncertainty and exploration moratoria have significantly limited or delayed the potential for new gas supply.

The simultaneous commissioning of the six LNG trains in Queensland caused significant disruption to the market and the demand-supply balance, with some LNG proponents having to supplement self-supply by contracting gas that would otherwise have been supplied into the domestic market.

When the three LNG projects made their final investment decisions from October 2010 to January 2012, the oil price averaged around US$108 per barrel. It fell as low as about US$30 per barrel in early 2016. It has now recovered to around US$55 per barrel, which is its 45 year inflation-adjusted average price.

Unfortunately for gas users, and producers, the lower oil prices resulted in significant write downs by some producers and prompted some to wind back their expenditure on exploration and development

Greatly worsening the picture is the spectre of regulatory uncertainty and state and territory-based moratoria, which has delayed or stopped development entirely.

Moratoria and other regulatory restrictions in New South Wales, Victoria and Tasmania are preventing or impeding onshore gas exploration and development in those states, and particularly causing higher gas prices in the south.

As we said in our first gas inquiry report, while we do not purport to weigh in on the debate surrounding the environmental issues, we feel that policy makers need to consider the cost or benefits of projects on a case by case basis.

It is easy to accept that some projects will fail on environmental grounds; it is, however, difficult to accept that they all do.

Arising out of this triple whammy we now have an interesting debate about the three Queensland LNG projects.

As our first report pointed out, Australia has enormous gas resources; gas availability is clearly not the issue. The report also pointed out that Australia has and will benefit enormously from the three large LNG projects in Queensland. These three projects also saw the development of significant gas resources that would not have otherwise been developed.

If there is a criticism of the three LNG gas developers it is that they fell into the usual commodity project trap of assuming then high $100 plus oil prices would continue, when long run average oil prices of around $55 would have been a better planning assumption.

The three LNG producers, however, could not have foreseen that after their investment decisions were made the onshore gas exploration and development rules would change completely. I doubt anyone in the industry expected Victoria to ban all onshore gas exploration and production, which has stopped even conventional gas projects; nor could they have foreseen the delays and uncertainty over projects in NSW and the NT.

It is, of course, up to governments to make such decisions. Having made them, however, it is difficult to see how people can then criticise the commercial contracts that were freely entered into by the LNG producers at a time when the likely supply outlook was very different.

Having made this point, however and this is important, I said six months ago at a gas conference that if I were providing private advice to the LNG producers I would say they would be well advised to support the domestic market as much as possible at this crucial time.

They have largely not done so. There have been some transactions, particularly after the Prime Minister called in gas producers to discuss the crisis.

In addition, Santos has taken some highly visible steps under the threat of the Australian Domestic Gas Security Mechanism.

But none of these moves have made any serious inroads into the gas supply problem.

2. Electricity

Much of the debate in recent times has focused on the role of investment certainty or lack thereof in stalling investment and pushing up generation prices. Indeed, many industry players routinely point to this as the sole reason for our current electricity affordability problem. This ignores a lot.

Let’s look at some facts.

The following figures, based on preliminary data sourced from retailers, are very interesting and provide general insights into the drivers of price increases in the NEM. Figure 5 is for residential customers; Figure 6 is for commercial and industrial customers.

Figure 5: Change in cost stack between 2007-08 and 2016-17 (estimate) – $/customer,NEM,real,residential (click to enlarge)

Figure 6: Change in cost stack between 2007-08 and 2016-17 (estimate) – cents/kWh,NEM,real,Commercial and Industrial (click to enlarge)

The first thing to note is that when you divide retailer revenue received by all customer usage then residential bills, in real terms, have increased by “only” around 50%; they have not doubled as we expected to find.

There are at least three explanations:

  • People are using less electricity; indeed, the price for consumers in cents per kWh has, on average, increased 62%, not 49%
  • Some consumers are benefiting from solar panels with generous subsidies, which reduces their bills considerably (albeit some had to outlay large capital sums to install the panels which are not captured in these figures)
  • Third the doubling of electricity prices in the CPI reflects standing offers, and many people are on cheaper market offers.

If you are not able to influence your usage much, do not have solar panels and have not or have not been able to find a cheap electricity plan your electricity bill has likely doubled in real, inflation-adjusted terms. Those with solar panels and/or on the best market rates may not be experiencing as much of an electricity affordability problem.

The second point to note are the drivers of the electricity price increases; mainly network prices (41%), then higher retail costs and margins (24%), then generation costs (19%) and green scheme costs (16%).

Network costs increased largely because particular state governments pushed for and achieved looser regulation of these then largely government-owned monopolies around 10 years ago. They did this to protect their revenues from what they were concerned would be strong Australian Energy Regulator regulation; the weakened rules limited the ability of the AER to ensure consumers pay only for efficient costs.

While the rules have now been tightened, the damage has been done.

The problem remains a contemporary one, however, as shown by the recent appeals by NSW and the ACT against the AER’s ruling that sought to ensure consumers did not pay for inefficient or excessive networks costs. The NSW and ACT appeals sought to have their consumers pay up to $6 billion more for electricity than under the AER decision.

The Queensland Government decided not to appeal a similar AER decision stating clearly that they did not want their consumers burdened by higher electricity prices.

Also pushing network prices higher have been a range of decisions by various governments to increase network reliability standards. It is highly doubtful that consumers were willing to pay the higher prices necessary to ensure a very small amount of increased reliability.

Wholesale electricity prices have only increased recently, largely it seems in response to the closure of the Hazelwood and Northern power stations. The size of the wholesale price increases in response to these closures, of over 100%, has surprised most observers.

Two explanations for these stronger than expected wholesale price increases have been given.

First, changes in bidding patterns by the coal-fired generators that do not appear fully linked to increases in the cost of production. While such behaviour is clearly allowed under the rules, there is doubt about whether the rules ever envisaged a generation market as concentrated as what we now have.

In each state the combined market shares of the two or three most significant generators is well over 70%, sometimes much higher.

The closure of Hazelwood and Northern increased this level of concentration in Victoria and South Australia, and pushed overall capacity closer to demand levels such that more often the generators with high market shares could bid in high prices knowing they will be dispatched.

Generator market power was clearly seen in Queensland with two generators having two thirds of capacity and prices spiking. When the Queensland Government directed its generators to tone down their bidding, prices immediately reduced significantly.

While more generation investment would lower wholesale electricity prices, there are some important questions to be examined.

  • Do the major coal-fired generators have an incentive to invest given it would lower their current high profits?
  • What would happen to future demand if the current government subsidies to particular aluminium smelters were removed? Indeed, what would have been the effect on wholesale electricity prices if the Portland smelter in Victoria had closed when Hazelwood did?
  • How much of the perceived generation gap will be filled by now apparently competitive renewable energy projects, and who will own these projects?

The second explanation for the higher than expected increase in wholesale electricity prices post the closure of Hazelwood and Northern is much higher gas prices and tighter availability. Gas generation now sets the wholesale price around a third of the time in South Australia, and also at important times elsewhere.

While some gas-fired generators are on legacy contracts, some are now or soon could be paying at least three times what they once were for gas.

The third factor increasing electricity prices is the cost of the various green schemes; mostly the Renewable Energy Target and the various premium solar feed-in tariffs, but also energy efficiency measures.

We have had some stunningly generous green schemes. For example, in some states consumers were paid solar feed-in tariffs of 40-60 cents per kWh, many times the cost of energy, not only on the electricity they sent back to the grid, but also, amazingly, on the electricity they consumed themselves.

The cost of green schemes is not transparent; it is smeared over all electricity consumers and can appear costless to some. But they do cost consumers, often inequitably as those with solar panels are being subsidised by those who do not have them.

The average bill of a non-solar customer in the above chart is $1,749. An average residential solar customer has a much lower bill both through lower usage and through a benefit of $700 per year, on average, from solar feed-in payments.

Finally, increased retail costs and margins have played a significant part. Both seem higher than expected.

The retail electricity market is also highly concentrated, with three players (Origin, AGL and Energy Australia) with over 70% of customers. The next largest two players, taking shares in most states to around 90%, are also vertically integrated.

High levels of vertical integration can make it very difficult for others to compete. This concentration was, of course, made worse by the sale by the NSW Government of the Bayswater and Liddell generators (known together as Macquarie Generation) to AGL a few years back, which the ACCC strenuously but unsuccessfully opposed.

The retail electricity market is also characterised by very wide price dispersion (a consumer can save hundreds of dollars by moving from the worst to the best offer), great complexity (the best offers can be hard to find) and a lot of regulation with some unintended consequences.

In our interim report to the Government we will have charts like Figure 5 above for each state. They will each tell a different story. The NEM-wide chart I have provided today conceals some specific features of each state market.

Addressing these issues

So what can be done to reduce electricity and gas prices? As the old Irish joke goes, “I would not start from here”. We are in a bad place in relation to both issues.

1. Gas

The gas supply outlook for 2018 now appears worse than at the time of our first gas report in March 2016. This can be largely explained by three factors:

  • Projected production is now lower;
  • Projected domestic demand is higher, largely due to higher demand from gas-powered electricity generators;
  • Finally, a significant quantity of gas is expected to be sold on the international LNG spot markets in excess of contract requirements.

It must be acknowledged that there are some issues with getting significant quantities of this latter gas into the domestic market. They do not, however, seem insurmountable.

To make matters worse, there seem to be no attempt by the LNG producers to meet some of their contractual commitments via the low-priced international spot market so that they could divert gas to the high-priced domestic market.

In a normal market you would expect the export and domestic markets to arrive at a similar price. This is not happening. International prices are at all-time lows; Australian gas prices are at all-time highs.

Almost to add insult to injury the Australian gas supply situation is so bad we currently have the Esso/BHP joint venture running a reverse auction for those wanting gas. Rather than run any risk of not being able to extract all of the economic rent out of their gas position, if you want gas you must put in a bid to them.

Supply side options will provide more lasting solutions to address shortages in gas and are more likely to result in prices returning to reasonable levels. Even if policy were to change, however, it will take time to get new gas to market.

It is very easy to criticise the Australian Domestic Gas Security Mechanism. It is anathema to anyone with any pro market inclinations.

But consider the choices.

The Federal Government may be faced with a choice of pulling the trigger on the mechanism or seeing factories close and jobs lost.

I am not disclosing the detail of what is in the ACCC’s report to the Treasurer on gas supply and demand. That will be made public shortly.

I am simply pointing out that those who criticise consideration of the ADGSM need to consider all the options available to the Commonwealth right now.

There are not many.

This is a bad place to be.

2. Electricity

With electricity, we have had some positive steps, we can draw some lessons, and the ACCC has a tough work program ahead.

The Government is already taking two steps that we and the AER have recommended. First, getting rid of Limited Merits Review so that the regulator’s decisions (the AER) are subject to a review to see that an appropriate process was followed, rather than a review that in effect remakes the decision in ways that appear to always favour the network businesses.

That is, the electricity network sector will have the same regulatory regime as now applies in telecommunications. Consumers will not have to pay for inefficiency; network owners will still be appropriately rewarded for efficient costs.

Second, the Government is currently trying to get people off the worst retail offers, and the retailers have in response offered to take steps to do this. The ACCC will now monitor these steps, and more importantly the outcomes, carefully.

There are many lessons to be learnt from my description in section 2.2 above of what drove our high electricity prices, as follows.

First, weigh carefully what is spent to improve reliability, because consumers will pay for these measures.

Second, be very careful with new or enhanced ideas that incur costs that are to be smeared across all electricity users.

Third, think carefully about new retail regulations; they can have unintended consequences.

Fourth, and closely linked, realise that moves to re-regulate electricity prices will see many consumers pay more, and may see less of the innovation we now need.

Fifth, factor the existing market power in retail and generation into policy measures. Take steps that improve rather than worsen this situation.

Finally, and overall, keep a clear and separate focus on electricity affordability. We are told we have three issues to deal with in electricity: reliability, sustainability and affordability. Basic economics says with three problems you need three different solutions. Beware of “silver bullets” that are said to address all three objectives.

The ACCC has a tough job ahead. Australia’s electricity affordability issues have been a long time in the making and will be a long time in the solving, unfortunately. In our Interim Report we will lay out a full agenda which I will not pre-empt now.

Figure 7 below, however, lists some important issues that are or need to be considered to make electricity more affordable. They are helpfully aligned with the contribution to electricity affordability from each part of the value chain. Doing this focusses attention on the key cost areas.

Figure 7: Addressing affordability (click to enlarge)

This list is different from much of the current discussion concerning electricity affordability.

If the above lessons are learnt, and given the steps already taken by the Government or that will hopefully be taken as a result of our work, I am hopeful of some quick improvements, and continued downward pressure on electricity prices.

Conclusion

We know we have an energy affordability problem and we have some things we can do to help address it; but more steps, yet to be determined, will be needed. Some steps will be controversial. But the consequences of not acting are dire for many Australians.

Thank you for your time today.