Key points:
- Electricity prices have more than doubled in the past 24 months.
- Increases are due to uncertainty around generation (supply).
- There are no signs that prices are going back down anytime soon.
- The time for action is now.
A new reality is sinking in for business owners as energy rates continue to skyrocket:
As we have highlighted in previous posts, wholesale electricity prices have been skyrocketing and there are no signs that the trend is going to be bucked anytime soon. Commercial and industrial electricity consumers are only just becoming aware of how much rates have been ramped up as the time comes to renew their retail energy contracts.
Peak and Off-Peak electricity rates have more than doubled in the past 24 months:
Wholesale electricity futures have experienced extraordinary increases in the past 24 months. These increases are being passed onto the end commercial and industrial (large market) retail electricity customers who are renegotiating electricity supply contracts. The figures below speak for themselves. Prices have consistently gone up to the point where they are now double what they were 24 months ago. New South Wales saw the second highest spike throughout Australia with a staggering 179% increase.
What drives electricity price movements?
Wholesale energy prices in Australia are driven by electricity spot markets. Spot market prices are volatile and suffer extreme fluctuations. As a result, electricity retailers enter into forward contracts (hedging) that enables them to fix prices years into the future.
Once they hedge a deal with energy producers, retailers establish a profit margin which is passed on to the final customer in terms of peak, shoulder and off peak rates time of use rates. Put simply, you – the end user – are potentially paying a premium to avoid being exposed to extremely volatile spot prices.
So what causes this volatility in spot market prices? The answer is quite simple – prices are driven by the disparity between supply and demand for electricity. In turn, supply and demand are driven by a number of factors which combine to determine price:
Demand side factors
- Weather conditions: Weather conditions drive demand for electricity as it directly influences electricity consumption by the end user. Hot weather drives demand for electricity up as use of air-conditioning increases, whereas cold weather does the same in terms of heating. As a result of the extra demand, spot prices shoot up.
- Economic activity: The demand for electricity by industry is significant. The strength of the economy is therefore a key driver in demand for electricity. When the economy is strong, business produce more and demand more power to do so. When the economy is weak, business produce less (and perhaps closedown). This leads to less demand, leading to a surplus in electricity supply.
- Large scale industrial production: Although related to economic output, industrial production on a large scale is a significant driver of electricity demand. Portland Aluminium Smelter in Victoria, for example, gobbles up about 10% of the entire state’s electricity supply. If the smelter was to close, this would have a tangible impact on electricity demand and would free up supply for other users.
- Uptake alternative generation: Households and business are investing more in renewable power generation, which in turn reduces their dependence on grid source electricity.
- Energy efficiency: Investment is energy efficient technology to reduce power consumption and waste in households and businesses. As prices continue to rise, investment in energy efficient technology is increasing making more economic sense.
Supply side factors:
- Weather conditions: As the grid becomes increasingly reliant on renewables sources of electricity, weather is becoming a key driver our the generation mix. Hydro, wind and solar power each rely on certain weather conditions in order to be productive and viable.
Example: Hydro and wind account for around 17% and 7.5% of the NEM’s electricity capacity respectively. A drought or unfavourable wind conditions can therefore have a material impact generation mix and as a result drive up the price of supply. - Raw material costs: The cost of raw materials such as coal and gas are key drivers in the cost of generating electricity. Example: Supply constraints in the wholesale gas market on the East Coast of Australia is currently driving up the cost of running gas fired electricity generation.
- Generator closure or outages: The closure of one of Australia’s large, dirtiest and cheapest coal fired power stations is a key driver to recent electricity price increases in Victoria. Hazelwood is scheduled to shut down this month and the market was given less than six months notice. When privately operated generators can wind up operations at short notice, it creates a significant risk to supply because it can take years for a new producer to come online and fill the void. Such risk creates uncertainty which drives up futures prices.
- Change in generation mix: Our increased reliance on wind and solar power is having a significant impact on wholesale electricity prices. Investment in wind power in South Australia has ultimately led to an increased reliance on intermittent power supply as baseload generators in this state become unviable and are mothballed or closed by their operators.
- Grid reliability: The NEM relies on 40,000 km of transmission and distribution poles and cables. Interconnectors in state boundaries enable the states to share generated power. A faulty interconnector between states can have a material impact on the supply between states in question and can cause energy pricing volatility. Recent examples of this were witnessed in failures between Tasmania and Victoria as well as South Australia and Victoria.
Uncertainty is a key driver of electricity prices:
The level of uncertainty caused by all the above mentioned supply and demand factors is what ultimately drives the pricing volatility of the futures contracts (derivatives) that electricity retailers enter into. Buyers and sellers of these derivatives need to make predictions about the demand and supply factors in order for the market to settle on a price. The more uncertainty the seller of the derivative has, they will demand a high risk premium, which in turn drives prices upward.
Energy policy uncertainty is the main culprit for current price trends:
Supply side factors are to blame for recent increases in wholesale electricity prices. The abrupt closure of the Hazelwood brown coal power station in Victoria had a tangible impact on the market, especially in Victoria. Hazelwood needed to upgrade and refit in order to continue operations. However the owners (French company, Engie) deemed it too risky to invest capital in the facility, given Australia’s carbon policy uncertainty.
Here at Leading Edge Energy, we strongly believe that the time for relying on the introduction of bipartisan government policy to pressure electricity sellers into reducing electricity prices is now over. It is clear that they cannot simply put differences aside and come to agreement in the interest of Aussie families and businesses. The abolition of the carbon tax provided short-term financial relief for energy users. However, scrapping this policy has arguably contributed to the hard landing that electricity consumers are now having to face.
What measures can business operators take to counter electricity price hikes?
- Negotiate: Negotiate the lowest possible rates with your energy retailer. Leading Edge can assist you with this.
- Optimise tariff structure: Ensure your electricity is in the lowest cost market and is on the lowest cost network tariff structure. Leading Edge can assist you with this.
- Monitor: Monitor the way your business consumes power to identify wastage. Leading Edge can assist you with this.
- Change behaviour: Change behaviour in your business and eliminate needless waste. Leading Edge can assist you with this.
- Invest in energy efficiency: Energy efficiency is a general term that may encompass upgrades such as lighting, power factor correction, variable speed motors and drives, natural refrigerant upgrades and more. Leading Edge can assist with each of the solutions identified above.
- Invest in generation: Solar is the most obvious and viable generation solution for business. Solar panels are at the cheapest they have ever been. However, whether or not to invest will depend on a range of factors such as property ownership and available roof space.
About Leading Edge Energy:
Leading Edge Energy is an integrated energy cost-reduction solutions provider. We offer a bespoke service to our clients by following our standard “Loop” methodology. In simple terms, we help our clients reduce their exposure to the cost of grid-sourced energy by guiding them through a path towards energy cost reduction. We follow the path of the highest return on investment to deliver the best possible value to our clients.
Our initial review and assessment process is a complimentary service and you are not obliged to accept our recommendation or offer.
Call us today t. 1300 852 770
