Wednesday, 26 February 2014

The ACCC and removing carbon from energy bills

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The ACCC has been directed to monitor the reduction of electricity prices when the carbon price legislation is repealed. This would be fine, if the ACCC actually understood what the carbon price is and how it works.

Rod Sims, the Chairman of the Australian Competition and Consumer Commission, did an interview with Fran Kelly on Radio National Breakfast on Tuesday morning. He was discussing the federal government’s direction to the ACCC to ensure that the savings from scrapping the carbon price will be passed on to consumers.

As Kelly said in the interview, Tony Abbott promised that axing the tax will provide a 9% savings on electricity bills and a 7% saving on gas bills, delivering a savings to the average household of about $550 per year. The ACCC has been directed to ensure that this saving is passed through when and if the carbon price legislation is repealed.

There are a number of concerns with this, not the least of which is that the ACCC has already proven its inability to understand or manage the price gouging that occurred with the carbon price was introduced. From Sims’ interview on Tuesday, it doesn’t appear that they’ve improved their understanding a great deal since then.

Sims started with the not unreasonable proposition that the first thing they need to do is work with the retailers to determine the carbon price component of electricity bills under the current regime and then ensure that this component is removed as soon as the carbon price is abolished. Or at least, it would be reasonable if the carbon price was actually a tax, like the GST, which has a straightforward charge on every unit sold. But it isn’t, it’s a levy imposed on large scale emitters, who may or may not pass the cost through, at whatever rate they see fit. And the units are not sold simply, like loaves of bread.

The electricity market is highly complex, retailers buy the wholesale product from a number of sources – the spot market, the futures market and in medium to long term contracts with generators. The carbon component in those various forms of purchase is sometimes a clearly defined separate pass-through, but is more often an inextricable component of the total price.

For example, Retailer A might have negotiated a three year contract (known as an OTC contract) with Generator B to buy electricity at $40 a megawatt hour (MWh) as a carbon inclusive price. That is, the carbon component is not a defined separate charge, it is included in the total price. Generator B may have discounted the carbon component built into that $40 because they were given government assistance to cover the levy on carbon emissions, or were reducing prices to be competitive, or were offsetting higher carbon pass-through on other contracts or any number of other reasons. The point is that there is no way to identify how much of that $40 is the cost of carbon.

Some OTC contracts may include a separate carbon price pass-through calculated (as recommended by AFMA) by multiplying the average carbon intensity of the National Electricity Market (~0.9 tonnes of carbon for every MWh) by the carbon price set by the Federal Government. The carbon price was set at $23 per tonne of carbon for 2012/3, so the price of carbon would be 0.9 x $23 = $20.70 per MWh across the NEM. This formula was used in most OTC contracts, regardless of the actual carbon intensity of the specific generator.

Somewhere between a third and a quarter of the electricity traded in the NEM is bought through the futures market on the Australian Stock Exchange, where carbon is included in the price per unit. Again, because it is a carbon inclusive price rather than a clearly defined separate tax, no one can be sure exactly how much carbon increased the total price.

However, it is instructive to consider the price path for the 2013 Fin year electricity futures in Victoria as shown on the graph below (from data published by the ASX). The horizontal axis shows the date the futures were settled, i.e. in May 2010 you could buy electricity for Fin13 at $55/MWh.

electricity future prices

The carbon price was announced in February 2011, and you can see the corresponding jump at the red line. The detailed package was released in July 2011 (purple line) and the legislation passed in November 2011 (green line) so you can see the market response to all the announcements in the pricing. Interestingly though, the overall increase from the announcement to the passing of the legislation was only about $15/MWh. Not the $20/MWh claimed and charged by most of the retailers.

Electricity is also traded on a spot market through a wholesale pool, again prices are carbon inclusive so it is difficult to know exactly what how much the carbon component is worth. The Wholesale Electricity Price Index (WEPI) is another product calculated and published as one of the data services provided by the ASX. It tracks the pricing of the spot market over time. So this is current pricing of the day, not futures. The graph of the Victorian WEPI below shows a jump of about $10/MWh at the introduction of the carbon price in July 2012, but this was a mere blip in comparison to the massive price spike in 2007 which was attributed at the time to water shortages caused by drought.

 WEPI

It’s worth pointing out again, that all these trading options where the carbon component is included in the purchase price are not excluded from the carbon cost the retailers “pass through” to their clients. E.g.: Retailer A above who bought electricity at $40/MWh has already paid a carbon cost because the price was carbon inclusive. Then they add a carbon cost on top of that when they calculate the final price for their customers – the $20.70 outlined above. This has been going on since the introduction of the carbon price, the ACCC is aware of it and has not taken any action.

There is a well-known variation in the average carbon intensity of electricity generation in each state. Victoria, because it is so depended on brown coal, has much higher carbon emissions from electricity than Tasmania, which primarily used hydro generation. But the NEM is one big grid and electricity retailers in the NEM buy a mix of contracts from many different sources. Retailers selling electricity in Victoria may well be buying it from Tasmania, and vice versa.

Even this quite complex explanation is a huge simplification of the wholesale electricity market. Because of these complexities, the retailers operating in the NEM (QLD, NSW, ACT, Vic, SA and Tas) were passing the carbon cost through to consumers at the national average price of around $20 - 22/MWh, because calculating their actual carbon costs and allocating that to individual or even state specific customers was unfeasibly complicated.

Futures prices have been falling as repealing the carbon price seems more likely, and it seems logical that the same thing has been happening in the OTC market, but until we know that the legislation will be repealed and the effective date of the repeal, retailers will continue to purchase some form of carbon price in contract they already have and may have to negotiate over the next year or so.

If (and it’s a very big “if”) the Abbott government is able to get the repeal through the new senate in July 2014, the retailers will not be able to immediately or simply strip the cost of carbon out of our electricity bills. They will still be carrying contracts for carbon inclusive prices that cannot be changed, they will still own carbon inclusive electricity futures that cannot be changed and they will not reduce their prices by 9% overnight.

Sims said in the Radio National interview that he would expect prices to drop by the estimated 9% across the board within one or two months after the carbon price is repealed. He also said that he expected state based variations because of the varying carbon intensity of each state. The concerning thing about this is not just that it’s not possible, but that it demonstrates that the person in charge of ensuring the reduction in energy costs (the sole justification for removing the carbon price) is passed through to consumers doesn’t actually understand the market he is supposed to be monitoring.

Jane Gilmore

Jane Gilmore is the editor of The King's Tribune.

Follow Jane on Twitter: @JaneTribune