During the conference The Conversation is publishing a selection of articles by the authors of papers being delivered at the conference. Others are here.
Wholesale prices in the National Electricity Market have climbed significantly in recent years. The increase has coincided with a rapid increase in the proportion of electricity supplied by wind and solar generators.
But that needn’t mean the increase in wind and solar generation caused the increase in prices. It might have been caused by other things.
Colleagues Songze Qu and Tihomir Ancev from the University of Sydney and I have examined the contribution of each type of generator to wholesale prices, half hour by half hour over the eight years between November 1, 2010 and June 30, 2018.
We find that, rather than pushing prices up, each extra gigawatt of dispatched wind generation cuts the wholesale electricity price by about A$11 per megawatt hour at the time of generation, while each extra gigawatt of utility-scale solar cuts it A$14 per megawatt hour.
Merit order matters
In Australia’s National Electricity Market, prices are determined at five-minute intervals and averaged over 30-minute intervals for settlement. Generators place bids for supplying electricity to meet the expected demand which are accepted in a “merit order” of cheapest to most expensive.
The final price – awarded to all the bidders accepted – is determined by the final and most expensive bid accepted, which is often a bid by a gas generator.
Wind and utility-scale solar generators bid into the market at low cost because their power is essentially free when the wind is blowing or the sun is shining. They displace higher cost bids, usually from gas or diesel turbines that have high fuel costs. We find this effect on prices (known as the “merit order effect”) has grown as wind and solar generation has grown.
The daily impact of wind and solar on wholesale prices is somewhat lower. A 1 gigawatt per hour increase in daily wind generation
is associated with about a A$1 per megawatt hour decrease in
the average daily wholesale price. The same increase in solar generation is associated with A$2.7 per megawatt hour decrease in daily wholesale electricity prices.
These findings and those of others since 2003 challenge the previous conventional wisdom that mandating renewable generation necessarily increases prices.
So why are prices climbing?
Natural gas prices have been climbing dramatically over the recent years, mainly due to the opening up of east coast export capacity and the integration of the Australian market with international markets. The higher prices have made it more expensive to run gas turbines and have pushed up the price of what is often the last bid to be accepted.
We find the price of natural gas has a strong positive effect on wholesale electricity prices. An increase of A$1 per gigajoule in the natural gas price pushes up wholesale electricity prices by about A$5 per megawatt hour.
Although in recent years the upward price pressure from more expensive gas has overwhelmed the downward pressure from greater wind and solar capacity, it is nevertheless true that wholesale prices are lower than they would have been without renewable generation.
Therefore, a continued expansion of renewables is likely to put downward pressure on wholesale prices for some time.
There’s a case for moving away from gas peaking plants
This means that rather than reconsidering renewables, authorities should reconsider their reliance on gas plants for handling peaks in demand. While peaking plants are more needed with the increased penetration of renewables, there is a case for switching to alternative providers of peaking power, such as large-scale batteries and pumped hydro.
In doing so governments should also consider something else. Wholesale prices that are too low will discourage investment, leading to higher prices down the track.
The lower prices go, the more the government might need to provide investment incentives.
For now, all other things being equal, more wind and solar power means lower wholesale prices. But they’ll have to be watched.
State elections are always about spending promises, but this time not much is being said about how they will be funded.
Last minute costings on individual announcements tend to rely on the general presumption that the state economy will keep growing and somehow produce the needed revenue.
This is evident in the costings released by the NSW Parliamentary Budget Office, which show that new spending promises from both major parties exceed new revenue promises.
The Labor Party has managed to find some new revenue through increased taxes on luxury cars, boats and vacant properties, while the Coalition has unveiled no new revenue initiatives at all.
While the property market has been climbing this needn’t have mattered that much. But for the past 20 months Sydney prices have been falling. Projected stamp duty revenues are being repeatedly revised downwards. The latest wipes A$9.5 billion off what was expected at the time of the 2017 budget.
NSW state revenue by type, A$ billion
Austerity, or an alternative?
It’s looking as if the incoming NSW government will need to moderate spending including spending on essential services and infrastructure, but there might be a way out.
Politicians of all parties tell us that fiscal rules create binding constraints for state governments and they are right.
But there are imaginative ways to strengthen state finances and to interpret those constraints.
Alternative 1: taxing residential land
Although land used for holiday homes and rental properties faces land tax, land used for owner-occupied housing is exempt in NSW, meaning as much as A$1 trillion of land is exempt.
It is a source of wealth – one of the few covered by state tax powers – that the budget can no longer afford to ignore.
Extending NSW land tax to owner-occupied residences with safeguards could fund much of the state’s needed service and infrastructure spending and wind back the outsized reliance on stamp duty.
With so many people locked out of home ownership altogether, it would make the tax system fairer.
Alternative 2: redefining ‘investment’
Under NSW budget rules spending on services is defined as cost that needs to be matched by immediate revenue. Spending on infrastructure, often on infrastructure which will later be privatised, is defined as an investment, meaning it doens’t have to be matched by immediate revenue.
It is why there is talk about a squeeze on services in the midst of record spending on infrastructure.
There’s room to change those definitions.
While there are good macroeconomic and budgetary reasons to differentiate day to day spending from investments, much of what is defined as day to day spending is in fact an investment.
There’s no reason why the state’s power to borrow to invest in infrastructure couldn’t also be used to invest in public services like health and education. With a change of rules, governments could borrow to invest in nurses and teachers at interest rates currently reserved for toll roads.
A practical starting point would be to connect spending on public services to the savings they create in other parts of the state budget, and account for this as the return on the investment.
As an example, “justice reinvestment” could fund programs aimed at reducing Indigenous incarceration out of the savings those programs would eventually deliver in other areas.
The redefinition would remove the present bias towards programs that build only physical infrastructure that has to be paid for later with tolls or privatisations.
Both ideas could help whichever party or parties form government after Saturday’s election, and help NSW. Without them, budgeting will become more difficult.
And who wouldn’t enjoy a bit of a stoush between the big bad generators and the government, trying to break them up on our behalf?
Even if it was largely tangential to keeping prices low.
The “big stick” of forced divestiture, where the government through a court could order an energy company to sell off bits of itself, never made it to a vote in the final chaotic fortnight of parliament just finished.
It will be the subject of a Senate inquiry that will report on March 18. After that, parliament is set to sit for only seven days before the election, so its possible it’ll never happen, under this government.
It found against forced divestiture, but thought along similar lines to the government in some respects.
The legislation presented to parliament this month bans three types of misconduct:
electricity retailers’ failing to pass on cost savings
energy companies’ refusing to enter into hedge contracts (agreements to buy and sell at a particular price) with smaller competitors
generators’ manipulating the spot (short term) market, for example by withholding supply.
It imposes civil penalties for the first, forces companies to offer contracts for the second, and provides for divestiture orders for the third, after they have been recommended by the government and approved by the Federal Court.
There are good reasons for the government to act on the three behaviours, although each of the its proposed solutions raises concerns.
The ACCC wants something similar but different
Firstly, the ACCC did not identify the legislation’s first target as a major cause of high prices. They did observe that it is complicated to shop around and the offers are confusing, and sometime next year Australian governments will force retailers in some states to offer fairer default offers at an affordable price.
But it not clear why the energy sector has been singled out as an industry whose retailers have to pass on cost savings, and not supermarkets or banks or airlines or petrol stations, or any other kind of industry.
Secondly, the ACCC most certainly did raise concerns about dominant generator-retailers preferring not to enter into hedge contracts with competitors, particularly in South Australia.
It recommended that the Australian Energy Market Commission impose a “market making obligation” forcing large, so-called gentailers to buy and sell hedge contracts.
Its recommendation has the same intent as the one proposed by the government, although it has the advantage of being administered by a regulator that already exists.
Thirdly, the ACCC also concluded that concentration in the wholesale market means higher prices. Its report focused on the bidding activity of the Queensland government owned generator Stanwell Corporation.
The ACCC recommended giving powers to the Australian Energy Regulator to investigate and fix such problems.
It considered a divestiture mechanism of the kind in the government’s leglislation, but rejected it as extreme.
Its own less extreme recommendations would “if implemented, be a better means to restore competition to a level which serves consumers well”.
Breaking up corporations is a broader question
There may well be a case for breaking up corporations whose size prevents or substantially lessens competition. It happens overseas.
The government cites the example of the United States Sherman anti-trust legislation. It has been in place since 1890 and has been famously used to break up Standard Oil and AT&T. The ACCC does not have this power.
There is debate about whether it would work in the much smaller market of Australia.
It’s worth considering divestment powers broadly, rather than rushing to introduce them in one sector of the economy in what was to have been the leadup to Christmas because of a concern that its prices were too high.
The ACCC has already delivered a comprehensive report on the means to bring them down.
The government would be better served acting comprehensively on its recommendations.
Governments have got the message: Australians are angry about electricity prices. On Monday, Prime Minister Malcolm Turnbull announced a decisive shift away from reducing emissions to reducing prices.
This move means that both the federal government and the opposition have adopted an Australian Competition and Consumer Commission (ACCC) recommendation to cap electricity prices through a regulated “default offer”, although whether the states and territories will support this approach is unclear.
The good news is that price caps will probably work as advertised. That is, they will reduce prices for a relatively small number of customers who are currently on bad deals.
The bad news is that capping prices could also have unintended consequences.
Electricity prices have risen much faster than inflation for more than a decade. From around 2005 to 2014 the cost of the electricity network (the “poles and wires”) increased substantially, mainly through over-investment by various state government owners, and highly prescriptive (and expensive) reliability standards.
Since 2016, wholesale electricity prices have increased rapidly as gas prices have risen and as old coal-fired power stations were retired at the end of their life, reducing supply. During the same period governments required prices to rise to pay for renewable energy subsidies, particularly for rooftop solar systems.
Together, these three factors account for about 80% of the increase in household electricity prices over the past decade. Bashing big companies is the flavour of the month, but there was not a lot that energy companies such as AGL, Origin and EnergyAustralia could realistically have done to mitigate any of this.
But several other factors have driven prices still higher, including the substantial profit margins charged by the big energy retailers. This prompted the ACCC’s recommendation of a “default offer”, to ensure that a customer who does not sign up to a market contract pays no more than a regulated price.
Both sides of politics say that this policy will save some households more than A$100 a year. But this is only true of the relatively small number of households who have not signed a contract with a retailer and so are on a “standing offer”.
In Victoria, the state with the most developed retail market, this is only 7% of households. That figure is higher where price controls have been removed more recently (around 19% in Southeast Queensland), but it is declining rapidly (see page 244 here).
So there will be large savings, but only for a small proportion of households. What’s more, the ACCC’s analysis suggests that the measure will not particularly benefit lower-income households, because those on hardship payment programs are less likely to be on a standing offer (see page 245 here). Think beach houses, not working families.
A quick fix
The danger is that politicians may be tempted to use price caps as a quick fix to reduce prices across the board. Given the many factors that have pushed up electricity prices in recent years, this approach is likely to be counterproductive.
It is likely to damage competition and inadvertently benefit the biggest power companies. An aggressively low price cap would make it impossible for many retailers to recover their genuine costs of supplying electricity. Fewer retailers would mean increased market concentration. And because most power companies are both retailers and generators, a small saving for consumers from lower retail margins could be more than offset by price increases resulting from a less competitive wholesale market.
Now is not the time to abandon market-based competition, given the rapid change in Australian and global energy markets. International companies such as Neoen, SIMEC ZEN, Total Eren and BayWa r.e. are investing in renewable generation and battery storage, and increasingly selling power directly to commercial and industrial customers. It is only a matter of time before these players begin to compete in the wider retail market.
What’s more, while product innovation in retailing has been limited to date (indeed, one of the critiques of a competitive electricity retail market is that they are all supplying the same electrons through the same wires), the prospects for future innovation are good. Rooftop solar panels and batteries provide a new way to supply power, and companies can increasingly use data from smart meters to inform and empower consumers.
It is understandable that governments want to protect consumers from high electricity prices. A modest price cap through a default offer, implemented cautiously, might be analogous to existing measures under Australian consumer law that limit excessive credit card payment surcharges. But the ACCC does not directly regulate credit card fees, and nor should governments directly regulate electricity prices, the drivers of which are complex and constantly changing. Rather, the focus should be on helping consumers to navigate a competitive electricity market.
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The ACCC’s default offer recommendation is not just about capping prices for a small number of disengaged customers. It is also intended to provide a clear benchmark against which all customers can compare offers and get a fair deal. Both major federal parties have indicated their support for a range of ACCC proposals to help consumers understand electricity prices. The government should implement the full package, with price caps playing a limited role, if any. Price caps are a seductive short-term solution with dangerous longer-term consequences.
The final design document for the National Energy Guarantee (NEG), released this week, contains a range of claims about the policy’s ability to drive down both greenhouse emissions and electricity prices. But still there is precious little detail on how exactly these assertions are backed up.
Specifically, two claims in the new document released by the Energy Security Board (ESB) are difficult to reconcile with other reputable modelling results.
First is the claim that greenhouse emissions will fall further under the NEG than they would in the policy’s absence. But a fine-grained analysis published a week earlier by the Australian Energy Market Operator (AEMO) suggests that the target of cutting emissions by 26% will be met regardless of whether the NEG is implemented or not.
If the AEMO analysis is right, the NEG in its currently proposed form will do nothing to cut emissions.
The second claim is that wholesale electricity prices will fall by a further 20% under the NEG. But it is hard to see how this will happen, given that the policy is not expected to trigger large changes to the energy landscape. The ESB’s document provides no raw data on this, but if we squint hard at the graphs provided in its modelling summary, we get the following:
This is not just a technical quibble. Much of the political justification for the NEG rests on the hope that it will deliver cheaper electricity. But how?
Taking the assumptions provided in the ESB’s document, we can attempt to deduce what will be the main drivers of price changes, in rough order of importance:
The modelling assumes that contract coverage – electricity retailers and generators currently use electricity contracts to manage their exposure to fluctuating prices in the spot market – will increase by 5% under the NEG.
This is based on the notion that the NEG’s reliability requirement – which would require electricity retailers to hold an appropriate portfolio of electricity contracts in dispatchable sources of generation – would incentivise retailers to buy more electricity contracts.
Even if contracting does increase by 5%, how does that push down prices? This is a crucial point and yet it is not backed up by adequate analysis or evidence in the ESB report.
The ESB’s chain of reasoning appears to be: the NEG will result in a greater share of electricity output being sold under contract in anticipation of the reliability requirements kicking in; this will lead to lower spot market prices; this in turn will also pull down prices in the contract markets, reducing average wholesale prices overall.
So it all hinges on retailers changing their wholesale purchasing habits so as to ensure they meet the reliability requirement – even though, as discussed above, the reliability requirement is unlikely to be triggered Moreover, it is hard to believe that contract prices would fall as a result; it seems just as likely that the generating companies that sell those contracts (and which wield significant market power) would raise their prices, not lower them.
The ESB assumes that the NEG will deliver an extra 1,000 megawatts of renewable capacity.
But this is an assumption, rather than a modelled outcome. The only justification offered is the ESB’s assertion that “recent renewable investment trends have been in part supported by the likelihood of an agreement to implement the guarantee”.
This is surprising, given that the NEG’s emissions target is so weak as to be ineffective, and ESB’s assumption that the policy will drive down power prices (and therefore profits for renewables generators). Any direct incentive for investment in renewables is highly unlikely to be coming from the NEG; the only plausible reasons would be greater confidence and lower financing costs.
Demand response – in which consumers alter their power consumption so as to reduce peaks in electricity demand in exchange for payment – can potentially make a big difference to power prices by reducing the incidence of high-price events.
The use of this strategy is already growing strongly among electricity market participants. But once again, the ESB has given us little evidence to back up its assumption that the no policy case will have lower demand response than under the NEG. It all again hinges on the effect of the reliability requirement on contract coverage and on the extent to which emerging demand response products can take advantage of this. Very little analysis and no evidence to back up the choice of assumptions is contained in the ESB’s policy document.
The ESB assumes that the NEG will reduce the uncertainty premium – an additional amount required to finance projects in the face of policy uncertainty – by 3 percentage points. It is clear that a policy uncertainty premium currently exists, although it is unclear how high it might be. The Finkel Review assumed it is 3%. So does that mean investment uncertainty would completely disappear once the NEG is legislated?
Certainly not. Given the highly publicised political disagreements (even within the government’s own ranks) about the NEG’s emissions target, it seems likely that substantial policy uncertainty will still linger.
Regardless, this scarcely matters for the price outcomes modelled by the ESB, given that the model is predicting very little new electricity investment and the small amount of additional investment in the model attributed to the NEG is entirely assumption-driven, rather than a modelling outcome.
Overall, the latest policy details don’t inspire confidence that the NEG will actually drive down power prices relative to what will happen anyway. We need a credible analysis of these assumptions, and modelling to tease out the effect of varying them.
It is helpful that the final report by the ESB does include at least a summary of the modelling. From here, it would be useful for the ESB, and the modellers it hired, to provide an investigation of the issues we have outlined here, or to undertake one if this has not yet been done.
The good news is that after two years of big rises, wholesale electricity prices have fallen somewhat since mid-2017. The bad news is that prices are still much higher than they have been for most of the past 20 years. And the worse news is that we had better get used to these high prices.
A new Grattan Institute report, Mostly working: Australia’s wholesale electricity market, shows wholesale prices jumped from less than A$50 per megawatt hour (MWh) in 2015 to around A$100 per MWh in 2017. But it finds that most of this increase is the market working as it should. And it urges politicians to tell consumers a harsh truth: high electricity prices, well above A$50 per MWh, are here to stay.
The best thing our political leaders can do to keep a lid on electricity prices is to help create stable, bipartisan energy and climate-change policy. This will encourage new investment so Australian households can get low-cost, high-reliability, and low-emissions electricity.
For most of the past 10 years, Australia’s National Electricity Market (NEM) was oversupplied and powered by low-cost fuels in old power stations. Then things suddenly changed. Big, coal-fired power stations were closed – Northern in South Australia in 2016, followed by Hazelwood in Victoria in 2017. So supply was reduced, pushing prices up. At the same time, gas and coal prices rose rapidly, increasing running costs for electricity generators, which pushed up prices even further.
Our report shows about 60% of the wholesale price rises were caused by the
fundamental changes in supply. The NEM now needs new investment, particularly because more old generation assets, such as the Liddell power station, will be turned off in coming years as they reach the end of their working life. But the electricity produced by new generators of any type, including coal, is expected to cost more than the electricity produced by the old legacy assets.
Up to 40% of the wholesale prices rises of recent years were caused by the higher
input costs for generators. Coal and gas are two of the main inputs to electricity produced in the NEM (which covers Queensland, NSW and the ACT, Victoria, South Australia and Tasmania). Coal prices nearly doubled between 2015 and 2017; gas prices more than doubled. As a result, wholesale electricity prices increased so generators in the NEM could cover their costs of generating electricity. The direct cost of higher fuels to generators is up to A$4 billion a year.
Higher fuel costs for one generator can increase revenue for all generators, because all generators get paid the same spot price. If the generator that is setting the price at a given time needs a higher price to cover their costs, all other generators that produced electricity at that time also get a higher price, even if their costs have not risen. This encourages new investment in cheaper generation and is the market working as it should.
But a small amount – about 2% – of the wholesale price rises of recent years was caused by generators “gaming” the system. And that is certainly not the market working for consumers.
Big generators can game the system by using their market power to create artificial supply scarcity, which forces short-term price spikes. It is not illegal. Currently it is within the market rules for generators to bid up the price of their electricity until just 67 seconds before it is needed. By then it is often way too late for other generators to respond with lower prices. It’s a bit like Uber surge pricing but with no warning. Ultimately, the consumer cops the bill.
So what can be done?
Our report has three main suggestions.
First, politicians should be honest with the electorate, and explain why prices are unlikely to fall to the levels seen in 2015. Historic oversupply in the NEM is disappearing, gas prices are unlikely to fall back to where they were in the past, and new-build generation, including coal, is expected to need revenue well above A$50 per MWh to be viable.
Second, governments should finally provide Australia with stable energy and climate-change policy to make the transition to new generation technologies as smooth as possible. This would also reduce risk for new investment, which lowers financing costs and electricity prices.
Former deputy prime minister Barnaby Joyce says he would be “100%” behind the government constructing coal-fired power stations if that would lower the price of electricity.
“My exasperation is that we have been talking about cheaper power and nothing is happening. No government has dealt with the power issue in a form that has brought down the price over the medium-to-longer term,” he told The Conversation on Tuesday. “The carbon tax’s removal brought it down only briefly.”
One of the signatories of the Coalition backbench Monash Forum’s call for the government to build “Hazelwood 2.0”, Joyce described his support for the group’s manifesto as “like signing a birthday card”, adding: “It would have been more surprising if I didn’t sign it”.
“I want cheaper power prices in country areas for the poor people who can’t afford it. Winter is coming,” he said.
He said the government building a coal-fired power station would be consistent with its planned investment in Snowy 2.0 and its regulatory support for renewable energy.
The public push on coal by the backbench group is being made in the run up to the Coalition’s expected 30th consecutive Newspoll loss.
It is being seen as another hit at Malcolm Turnbull’s leadership. Among those prominent in the group are Tony Abbott and his close allies Kevin Andrews and Eric Abetz. But Joyce stressed that “for me, it’s not about Malcolm’s leadership. It’s about power prices.”
The manifesto has been signed by several Nationals. While signatories may have different motives, some backbenchers have reportedly refused to put their names to it because of the implications and timing for Turnbull.
The name “Monash Forum” refers to first world war general John Monash, who subsequently headed the State Electricity Commission of Victoria, spearheading the development of the Latrobe Valley coal reserves and power industry. Some signatories would have preferred a plainer name.
The manifesto says: “If the government can intervene to build Snowy 2.0, why not intervene to build Hazelwood 2.0 on the site of the coal-fired power station in Victoria that is now being dismantled?
“All the transmission infrastructure already exists; all the environmental permits have already been obtained; and a new, low-emissions coal-fired power station can certainly be built for no more than A$4 billion.”
Turnbull has trumpeted the expansion of the Snowy scheme as one of his big policy initiatives.
Backing coal-fired power has been among the issues Abbott has strongly promoted from the backbench. He said last August: “If we are prepared to go ahead with pumped hydro, and we are neutral on technology, we should certainly be prepared to go ahead with a new coal-fired power station”.
Last week, launching Pauline Hanson’s book, he was highlighting that “we should build new coal-fired power stations”.
The backbench push coincides with the government working to bed down with the states and territories its National Energy Guarantee. This effort has been helped by the recent win by the Liberals in South Australia. The policy is described as “a technology-neutral approach that does not provide direct subsidies to renewables or any other particular technology, creating a level playing field for all energy sources”.
Turnbull said on Tuesday the guarantee “provides every incentive for the energy sector to invest in dispatchable power”.
“[For] those who are concerned that there should be more investment in coal -fired power stations, the [guarantee] puts a premium on dispatchability, 24/7 power. Now coal can obviously provide that, so can gas, so can hydro, so can other technologies.”
Asked whether it was a slight to his leadership that the Monash Forum was formed rather than the normal policy channels followed, Turnbull said the National Energy Guarantee had been endorsed by “the whole Coalition partyroom”.
Tony Wood, energy program director at the Grattan Institute, said it seemed like an extraordinary approach for members of a Coalition government that had championed markets and the private sector to be advocating going back to a nationalised system.
It also seemed highly unlikely that a coal-fired power station would be a commercial investment for the government. “The longer-term prospect of the investment providing a return to taxpayers would be remote. So it would be writing off a relatively new asset in a relatively short time. It would be a highly questionable use of public funds.”
Private investors were not going into new coal-fired power stations because they did not see a prospect of them making money, Wood said.
“It may very well be that keeping existing stations going longer would be justified but that would be relatively modest expenditure,” he said.
Wood said that to lower prices to consumers it would be more cost-effective to give them refunds – although he wasn’t advocating that.
“A well-designed NEG, or an equivalent, that provides clear policy on emissions reduction and values reliability will provide the best policy framework to deliver efficient new investment in affordable energy,” Wood said.
Australia should cut its immigration intake, according to Tony Abbott in a recent speech at the Sydney Institute. Abbott explicitly cites economic theory in his arguments: “It’s a basic law of economics that increasing the supply of labour depresses wages; and that increasing demand for housing boosts price.”
But this economic analysis is too basic. Yes, supply matters. But so does demand.
And while migrants do live in houses, the federal government’s fondness for stoking demand and the inactivity of state governments in increasing supply are the real issues affecting affordability.
The economy isn’t a fixed pie
Let’s take Abbott’s claims about immigration one by one, starting with wages.
It’s true that if you increase labour supply that, holding other factors that affect wages constant, wages will decline. However, those other factors are rarely constant.
Notably, if the demand for labour is increasing by more than supply (including new migrants), then wages will rise.
This is a big part of the story when it comes to the relationship between wages and migration in Australia. Large migrant numbers have been an almost constant feature of Australia’s economy since the end of the second world war, if not earlier.
But these migrants typically arrived in the midst of economic growth and rising demand for labour. This is particularly true in recent decades, when we have had one of the longest periods of unbroken growth in the history of the developed world.
In our study of the Australian labour market, we found no relationship between immigration rates and poor outcomes for incumbent Australian workers in terms of wages or jobs.
Australia uses a point system for migration that targets skilled migrants in areas of high labour demand. Business is suffering in these areas. Migrants into these sectors don’t take jobs from anybody else because they are meeting previously unmet demand.
These migrants receive a higher wage than they would in their place of origin, and they allow their new employers to reduce costs. This ultimately leads to lower prices for consumers. Just about everybody benefits.
There’s an idea called the “lump of labour fallacy”, which holds that there is a certain amount of work to be done in an economy, and if you bring in more labour it will increase competition for those jobs.
But migrants also bring capital, investing in houses, appliances, businesses, education and many other things. This increases economic activity and the number of jobs available.
Furthermore, innovation has been shown to be strongly linked to immigration. In the United States, for instance, immigrants apply for patents at twice the rate of non-immigrants. And a large number of studies show that immigrants are over-represented in patents, patent impact and innovative activity in a wide range of countries.
We don’t entirely know why this is. It could be that innovative countries attract migrants, or it could be than migrants help innovation. It’s likely that the effect goes both ways and is a strong argument against curtailing immigration.
Abbott’s comments are more reasonable in the case of housing affordability because here all other things really are held constant. Specifically, studies show that housing demand is overheated in part by federal government policies (negative gearing and capital gains tax exemptions, for instance) and state governments not doing enough to increase supply.
Governments have responded to high housing prices by further stoking demand, suggesting that people dip into their superannuation, for instance.
In the wake of Abbott’s speech there has been speculation that our current immigration numbers could exacerbate the pressures of automation, artificial intelligence and other labour-saving innovations.
But our understanding of these forces is nascent at best. In previous instances of major technological disruption, like the industrial revolution, the long-run effects on employment were negligible. When ATMs debuted, for example, many bank tellers lost their jobs. But the cost of branches also declined, new branches opened and total employment did not decline.
In his speech, Abbott said that the government needs policies that are principled, practical and popular. What would be popular is if governments across the country could fix our myriad policy problems. Abbott identified some of the big ones – wages, infrastructure and housing affordability.
What would be practical is to identify the causes of these problems and address these directly. Immigration is certainly not a major cause. It would be principled to undertake evidence-based analysis regarding what the causes are and how to address them.
A lot of that has already been done, notably by the Grattan Institute. What remains is for governments to do the politically difficult work of facing the facts.
The preliminary report on energy prices released last week by the Australian Competition and Consumer Commission (ACCC) suggests that the consumer watchdog is concerned about almost every aspect of Australia’s electricity industry. It quotes customer groups who say electricity is the biggest issue in their surveys, and cites several case studies of outrageous price increases experienced by various customers.
The report is long on sympathy about the plight of Australia’s electricity users. But the true picture is even worse – in reality, the ACCC’s assessment of Australia’s energy prices compared to the rest of the world is absurdly rosy.
The ACCC quotes studies from the Electricity Supply Association and the Australian Energy Markets Commission (AEMC) to compare electricity prices in Australia with those in other OECD countries. But the ACCC’s comparison is based on two-year-old data, and badly underestimates the actual prices consumers are paying.
The AEMC’s analysis assumes all customers are on their retailer’s cheapest available offer. This is an obviously implausible assumption, and gives a favourable impression of the price that customers are paying.
As previously pointed out on The Conversation, the Thwaites review – which looked at customers’ actual bills – found that in February 2017 Victorians were typically paying A35c per kilowatt hour (kWh) – 42% more than the AEMC’s estimate. What’s more, we know that Victoria’s electricity prices are lower on average than those in South Australia, Queensland and New South Wales, and hence below the Australian average.
A part of this 42% gap – around 15% – is explained by the latest price increases that are not included in the ACCC’s comparison. But this still leaves a 27% gap between what the AEMC assumes and the evidence of actual prices.
This begs the question: why did the ACCC not recognise the widely known flaw in the AEMC’s analysis?
The real problem is overbuilt network infrastructure
The report estimates that rising network charges account for more of the price increase than all other factors put together. There is no doubt that network charges are a real problem at least in parts of Australia, although their significance relative to retailers’ costs is contested territory.
But why would distributors build far more network infrastructure than they need? And why have government-owned distributors built far more infrastructure than private ones, despite having no more demand?
The answer to this perplexing question is to be found in part in Australia’s “competitive neutrality” policy. This is Orwellian doublespeak for an approach that is neither neutral nor competitive.
Under this policy, government-owned distributors are regulated as if they are privately financed. This means that when setting regulated prices, the Australian Energy Regulator (AER) allows government distributors to charge their captive consumers for a return on their regulated assets, at the same level as if they were privately financed. That is despite the fact that private financing is much more expensive than government funding.
It’s no surprise that when offered a rate of return that far exceeds the actual cost of finance, government distributors have a powerful incentive to expand their infrastructure for a profit. This “gold-plating” incentive is a well-known in regulatory economics.
Regulators, the industry and their associations have explained higher spending on networks in a variety of ways: higher reliability standards; flawed rules; flawed forecasting of demand growth; and the need to make up for historic underinvestment.
But was there ever historic underinvestment? A 1995 article co-authored by the current AEMC chair concluded that distribution networks had been significantly overbuilt. That was more than two decades ago, government distributor regulated assets are at least three times bigger per customer now.
The chart below – based on data from the AER’s website – examines how the 12 large distributors that cover New South Wales, Victoria, Queensland and South Australia spent their money on infrastructure between 2006 and 2013. This period covers the last five-year price controls established by the state regulators, and the first control established by the AER. It was during this time that expenditure ballooned. The monetary amounts in this chart are normalised by the number of customers per distributor.
The first five distributors from left to right (and Aurora) were owned by state governments and the others are privately owned. A clear pattern emerges: the government distributors typically built much more infrastructure than the private distributors. And the government distributors focused their spending on substations, which are much easier to build (or expand or replace) than new distribution lines or cables.
We also know that the distributors’ spending on substations far outstripped the increases in the peak demand on their networks. The figure below compares the change in the government and private distributors’ substation capacity (the blue bars) with demand (the red bars) over the period that most of the expenditure occurred. Again, the amounts have been normalised by number of customers.
The gap in spending between government and private distributors is stark. It is also obvious that in all cases, but particularly for the government distributors, the expansion of substation capacity greatly exceeded demand growth – which hardly changed over this period (and is even lower now, per connection).
To put it in more tangible terms, as an average across the industry, peak demand between 2006 to 2013 increased by the equivalent of the power used by one old-fashioned incandescent light bulb, per customer. But government distributors expanded their substation capacity by more than one 100 light bulbs, per customer. The private distributors did relatively better, but still increased the capacity of their substations by the equivalent of about 30 light bulbs per customer.
My PhD thesis included econometric analysis that shows government ownership in Australia is associated with regulated asset values that are 56% higher than private distributors, and regulated revenues that are 24% higher, leaving all other factors the same.
To some, this evidence supports a “government bad, private good” conclusion. Indeed it was this line of argument that the Baird government in New South Wales used to justify its partial privatisation of two network service providers.
But in international comparisons of government and private distributors in the United States, Europe and New Zealand, no such stark differences are to be found. The huge disparity between government and private distributors is a peculiarly Australian phenomenon.
In response, the AEMC said the regulations were consistent with the “competitive neutrality” policy. But this is not true: in the policy’s own words, it was designed to stop government businesses from crowding out competitors. Distributors are protected monopolies; they do not have competitors.
The AEMC also argued, somewhat bizarrely, that it was good economics for a regulator to assume that government distributors are privately financed.
This represents the triumph of an idealistic “normative” regulatory model in which regulators act on the basis of how the regulated entity should behave rather than how they actually behave.
But it would wrong to blame the AEMC alone for this failure. All of Australia’s key institutions and governments have agreed that government distributors should be regulated as if they are privately financed. For governments that own their distributors, this has been a wonderfully profitable fiction.
Therein lies much of the explanation for what is effectively, if I may call a spade a spade, a racket.
It is an indictment of Australia’s polity and so many of its economists that the 2011 Garnaut Climate Change Review stands alone, in a library of reviews, as stating this problem clearly. In fact, if you review last week’s report from the ACCC, you will not find a single distinction between the impact of government and private distributors.
And if you thought this was yesterday’s war, you would be wrong. Despite the mass of evidence, our regulators persist in the fiction that ownership and regulation should be independent of one another.
It is difficult not to lapse into despair about Australia’s energy policy morass. Despite the valiant attempts by many, a deeply entrenched culture of half-truths, vested interests, ideology and wishful thinking still characterises all too much of what emanates from the political and administrative leadership of this industry.
Some energy consumers – Prime Minister Malcolm Turnbull among them – will buy their way out of this problem through solar panels and batteries. But the poorest households and many business customers will increasingly be left carrying the can.
Australians are angry about electricity. Not unreasonably.