An energy crisis in Australia has seen prices spike and supply issues plague much of the country’s east. The federal energy minister, Chris Bowen, claims the previous Coalition government left behind a “bin fire” that meant Australia was “ill-prepared … for the challenges we are facing today”.
But the Coalition has tried to blame the new and “inexperienced” Labor government. What’s actually causing the crisis and what can governments do about it?
How are energy prices set in the first place and who sets them?
The gas market is opaque, meaning few people can actually see what the price is, whereas we can see the wholesale price for electricity every five minutes. By wholesale price, we’re talking about the costs we pay the generators for the electrons travelling down the wires to our homes and businesses.
Only about a quarter of the cost the average consumer pays in their retail bills relates to that cost of generation. On top of that, we are forking out for infrastructure that delivers the power when we flick a switch, as well as all those annoying ads urging us to change our retailer.
But the price of power isn’t just up to the retailers and energy companies. There are also national and state regulatory bodies, of which there are two players you need to pay attention to: the Victorian government which sets a market price for that state, and an Australian energy regulator that sets the standard price for those in south-east Queensland, New South Wales and South Australia. In combination, they’re really setting a standard price that signals to the general market what the cost of electricity should be and nudges the different players to get close to that number. It’s called the default market offer.
Can companies charge more than the default market offer?
The default market offer provides a benchmark and is a way to anchor prices. The retailers typically look to offer around those prices, if not slightly below them because that’s where they expect their competitors to be.
If you are being charged higher than the default market offer, you can switch companies and get a better deal. If you do nothing, that is what you’re going to pay, but if you do a bit of work, you can do better, which is why the Australian Energy Regulator, which sets that offer, does encourage people to look around.
How much are energy bills expected to rise over the next year?
Last month we got an indication of how the default market offer was going to increase. At the most, it’s going to go up by 18%, but mostly it’s less than that. In New South Wales, for example, it’ll probably be adding either $119 or up to $227 more per household. But in South Australia, for example, only $124 on average more, and Queensland somewhere in between. So an extra 18%, or a couple of hundred dollars over the next year, for a regular household in some states. For others it’s probably closer to 8%.
What prompted these price rises?
Energy in general has been getting more expensive since about the September 2021 quarter onwards. As economies started to come out of Covid restrictions there was a rush of demand as businesses ramped up and people returned to offices. But Covid also restricted the supply of energy, and if you’ve got the same demand, but less supply, prices will go up.
That was a factor already in train before Russia invaded Ukraine and kicked everything else up another notch. Russia is one of the biggest energy exporters in the world. And because of the invasion, there were immediate sanctions placed on Russian oil and gas. So Europe in particular, but others as well, had to start scrambling to find sources of energy from elsewhere – and that was a key reason why energy prices started to spike.
Meanwhile, the biggest supplier of electricity in Australia is still coal, but Australia’s coal plants are ageing and many of them are being earmarked for closure. There is less maintenance and there are more breakdowns. In recent weeks we’ve had pretty much a third of the coal capacity offline, which is another key reason why prices have started to rise. On top of that, coal supply has been affected by the flooding.
Then along comes winter to bump up demand – this is the season when sustained energy use is the highest across Australia. And for places such as Victoria, there’s a lot of gas heating, and that puts extra strain on what is typically the busiest time for generators.
There are four factors contributing to the “perfect storm” facing Australia’s energy market right now: the general rise of energy costs, the Russian invasion, coal outages and the weather. The question is whether this is just going to be a short-lived storm or one that rolls through the winter and potentially beyond.
So what happens when the regulator caps prices?
The market rules have built-in price caps so that if wholesale prices are too high for too long, the limits automatically kick in. The calculation is based on a rolling seven-day cycle and if prices total a bit less than $1.4m in any state, the regulator imposes a $300/MWh price.
That’s what happened starting in Queensland on 12 June, with the cap imposed on the other four states in the market within days. One consequence, though, was a bunch of generators would arguably lose money at that price given the soaring cost of gas and coal if bought on the market.
Depending on the efficiency of the gas plant, for instance, it can take $400-$440 worth of gas to generate the 1MWh that it could only sell for $300.
These high-cost generators then withdrew their bids, creating the rolling shortfalls in the days afterwards. As each supply gap loomed, regulators would then order these generators to get spinning with the pledge to compensate for any losses – but they would have to apply for the make-good payments. Delays may be as long as six months, Joshua Stabler, an analyst with Energy Edge, said.
What about when it suspends spot market electricity trading?
The Australian Energy Market Operator (Aemo) effectively pulled the plug on the wholesale market serving the eastern states on Wednesday because the “ring-a-generator” process to order output had become unsustainable given the flurry of forecast shortfalls.
The regulator will set up a “command and control”-like system that will create “one simple place where generators can put all their availability and it can be dispatched in a simple and methodical way”, Daniel Westerman, Aemo’s chief executive, said after the suspension.
“Once we are confident we can operate it and not see generators withdrawing their availability then we will restart the market,” he said, adding regulators will assess conditions every day.
It’s the first time the entire national electricity market has been suspended, so there is some novelty in it. Previously, single markets such as Tasmania and South Australia, had seen suspensions, including the latter’s notorious “black” state event in 2016.
To the extent the problems are based on the reduced availability of coal plants and high demand because of winter chill, it may be a while – perhaps months – before the market resumes normal operations.
During the suspension, the generators get paid a flat rate of $300/MWh and then compensated for any losses.
Parts of this explainer were drawn from the Full Story episode: The ‘energy crisis’ that’s pushing up Australia’s power bills
