Electricity prices are a hot topic at present. Amidst the welter of claim and counter-claim as to what is the cause of higher electricity prices, there has been remarkably little use of the available evidence.
In the first Oil Crisis back in 1973, OPEC not only jacked up oil prices, but actually stopped the flow of oil altogether to some European countries. Since then there have been recurring international oil and energy price crises, and the price of energy has been a hot topic, with petrol prices being particularly closely watched and widely discussed in Australia. Recently, however, the price of electricity seems to have replaced the price of petrol as the most sensitive price.
The widespread assumption seems to be that electricity prices have recently risen extraordinarily fast, and ipso facto they are higher than they need to be. Nor are we short of possible explanations. On the one hand, the Right led by Tony Abbott have claimed that the price of electricity first rose to unacceptable levels because of the carbon tax and later because of the impact of the renewable energy target. More recently, it would seem that the Left, as epitomised by some readers of this blog, have persuaded themselves that the high price of electricity is due to privatisation.
Both explanations are distinguished by their failure to examine the evidence regarding how much electricity prices have in fact risen and when.
In any such examination, it is important to establish a standard against which the rise in electricity prices can be compared, and the obvious standard is the rate of inflation generally as measured by the consumer price index (CPI). In the table below I compare the increase in household electricity prices as measured in the CPI with the increase in the CPI itself. The periods chosen are when the increase in the CPI exceeded the increase in electricity prices for a sustained period of two or more years or vice versa.
Comparison of increase in electricity and all consumer prices
Average annual rate of increase between the June quarter
in the initial year and the June quarter in the final year
Looking at this evidence of what has happened to electricity prices, I would like to suggest that the following tentative conclusions emerge. First, the two periods when electricity prices increased by much more than consumer prices generally were 1981-1985 and 2007-2014, and they were both periods when international energy prices increased dramatically; the latter period being especially true for international gas prices, which is increasingly being used to fuel electricity generation. In this context, it is also worth noting that international gas prices fell in 2015 and 2016, which is the obvious reason for the low rate of increase in electricity prices shown for the last period, 2014 to 2017. However, over the last twelve months international gas prices have accelerated again, and electricity prices increased by as much as 7.8 per cent between June 2016 and June 2017, after having fallen in the previous two years.
The second interesting observation is that the period when retail electricity prices hardly changed was 1993-2000, and this was the period when national competition policy was being introduced. Both electricity generation and retailing were made competitive, although transmission inevitably remained a regulated natural monopoly. In addition, electricity authorities were corporatized to make managers more accountable for their performance, and some were privatised.
Along with most of the economic literature, I personally doubt that ownership matters all that much, but competition and corporatisation does. Furthermore, I think the above evidence does suggest that the introduction of these policies did help in restraining and even lowering electricity prices in the 1990s, although any such impact is inevitably mostly a one-off impact while the new competitive regime is being bedded down. After that competition can help restrain future price increases, but it will not actually drive prices down further after productivity reaches best practice levels.
Furthermore in 2005, the Productivity Commission in an exhaustive review of the impact of National Competition (NCP) found that ‘Before NCP and related reforms, it was widely recognised that electricity production and distribution activities were working well below best practice’. I can also vouch for this in my role as Chairman of the Independent Pricing and Regulatory Tribunal of NSW (IPART), which used to be responsible for determining retail electricity prices in that State. IPART used to benchmark the NSW electricity authorities against best practice elsewhere, and found that there was considerable room for improvement in efficiency before competition policy was introduced. As the Productivity Commission put it: electricity production and distribution were ‘characterised by significant over manning and sub-optimal reserve plant margins’. The increased productivity in response to the reforms led to much bigger increases in productivity than before or since, with the Productivity Commission finding that ‘The largest improvement in labour productivity has been observed in Victoria followed by South Australia and New South Wales.’
In sum, discussion of electricity prices needs to start first from an assessment of what has been happening to the price of the raw materials, which in the case of carbons are internationally traded and highly volatile. In addition, it is likely that increased reliance on renewables could reduce the volatility of future electricity prices, especially if the capability and cost of battery storage comes down as can be expected, as the cost of electricity will then reflect much more the conditions in local markets rather than in international markets.
Second, the available evidence when independently assessed strongly suggests that the neo-liberal reforms of the 1990s did result in a substantial improvement in productivity and brought down electricity prices. However, the biggest impact of such reforms on productivity is a one-off. Subsequently competition can keep the producers honest, and create the incentives for further improvement, but the big gains from removing previous poor practices can only be gained once.
Michael Keating was formerly Secretary, Department of Finance, and Secretary, Department of Prime Minister and Cabinet.