A Breakdown of the Cost of Energy in Australia

Electricity costs from a consumer standpoint have more than doubled over the last ten years with a majority of that increase coming in the last four years. But why, when Australia has such significant natural resources, is power so expensive? In fact, electricity in Sydney is now twice as expensive as it is in New York City.

Electricity costs can be broken down into the following segments:

  • Retail costs – the fixed costs of selling on the retail market
  • Retail margin – the markup charged by retailers
  • Environmental costs – the financial impact of environmental measures
  • Wholesale costs – the amount charged by the electricity wholesaler
  • Network costs – maintaining the physical infrastructure, such as power lines

The assumption is often made that retail costs and margin make up a significant amount of the overall cost of electricity, but this is simply not the case. In fact, retail costs make up only 8% of the overall cost, while retail margin sits at 13%. Environmental costs contribute 15% to the overall cost of electricity, with wholesale and network costs making up the remaining 64%.

Network costs have been a major issue for Australia since the 1970s when various governments decided to invest heavily in an infrastructure that would be robust enough to avoid blackouts. Redundancies were put in place, and as a result, Australia has one of the most extensive physical electricity networks per capita in the world. The problem is that infrastructure deteriorates and requires ongoing maintenance. The costs related to maintenance have increased exponentially since the 1980s, and replacement costs are set to continue for a long time to come.

 

 

While network costs make up a staggering 38% of the overall cost of electricity, the remaining 27% is allocated to wholesale electricity pricing. This is the amount that is charged by the wholesaler to the retailer and includes the wholesaler’s margin. Critically, in many transactions the retailer and the electricity generator are the same company, essentially selling themselves the power they generated. These businesses have little incentive to seek competitive offerings which may have been directly or indirectly responsible for high profile cases where electricity businesses were accused of “high-pressure sales tactics,” resulting in ACCC (The Australian Competition and Consumer Commission) involvement.

It is also important to look at environmental costs, constituting 15% of the overall cost of electricity. Crucially, this figure represents well-intentioned but clumsy attempts to transition a large percentage of the power grid to renewable energy. Additional research costs, engagement with specialist businesses and additional infrastructure have added to the cost of energy. Australia’s participation in the Paris Agreement will affect domestic policy in the future, but current renewable energy targets were set in June 2015, six months before the Paris Agreement was signed.  In January 2018, the Australian Government predicted that strong investments will deliver the 2020 renewable targets ahead of schedule.

The issue of rising electricity prices in Australia is a complicated one but is underpinned by a misalignment between the public conversation – focused on retail – and the realities of the situation. To create a sustainable solution, both from a financial and environmental standpoint, a more complicated discussion must be conducted. The solution will not be a simple one, with every component of the cost of electricity needing evaluation, but it must be one that has long-term sustainability and consistency in mind.

Technical and economic considerations aside, there are also deep divisions in Australian politics over the urgency to address decarbonised energy generation. While politics are unsettled, capital markets are nervous about investing funds with an uncertain policy horizon.

 

This story is featured in the 2 November 2018 edition of The Warren Centre’s Prototype newsletter. Sign up for the Prototype here.

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