Australia’s energy crisis: it doesn’t have to be this way

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As Australia’s energy prices have surged in recent years, energy prices in the United States have fallen significantly – all while moving ahead of Australia when it comes to emissions reductions. A new report released by the United States Studies Centre explores what Australia needs to do to reverse its energy fortunes; and also models some of the potential implications of not taking action to increase supply and reduce costs.

The United States Studies Centre (USSC) released the report It doesn’t have to be this way: Australia’s energy crisis, America’s energy surplus in December last year, in response to increasing feedback it received from Australian manufacturers and energy users, who were telling the centre they were increasingly looking to the US as the place to grow their businesses over Australia.

Authored by Alex Robson, the former chief economist to the Department of Premier and Cabinet, the report involved several months of analysis and sophisticated economic modelling to paint a picture of the energy market in each country; as well as the potential outcomes for Australia if we continue down our current path.

Setting the scene

Australia and the US have much in common: liberal, democratic institutions; technologically advanced, largely open economies; growing populations; demanding infrastructure; and above all, abundant energy resources.

But with respect to energy, Australia and the US are on radically different paths. Australia faces an energy crisis, stressing households and businesses, and threatening the very existence of some of Australia’s large industrial users of energy.

Meanwhile, the US is reaping the benefits of an energy boom, delivering inexpensive gas and electricity, driving a renaissance in American manufacturing and economic growth.

As a result, Australian manufacturers are now seeing the US as vastly more attractive for investment. In a 2017 study from the USSC, Australian manufacturers indicated that Australia was not a growth market for their businesses, and that the US figured prominently in their plans for growth and success.

And why? In a word: energy. The cost of electricity and gas for large, industrial consumers of energy is simply making Australia uncompetitive. Relatively high labour costs are more or less baked into the Australian social compact. But when another critical business input – energy – becomes as expensive as it has, many Australian businesses face existential threats.

It’s becoming increasingly clear that Australia’s energy woes go beyond household electricity bills. Australian businesses confront energy costs that threaten jobs and investment and reverberate through the entire economy, raising the prices of goods and services for households.

Where did we go wrong?

US electricity and gas prices weren’t always cheap. Indeed, Australia and the US have in many ways reversed their energy situations over the past decade.

Simply put, over the past decade or so there has been a gas revolution in US energy markets. Since 2005, annual US gas production increased by more than 9100 PJ, thanks to the development of previously unexploitable shale gas fields – and effectively all of this additional production has been used for US domestic consumption.

As domestic gas supply has increased, the average real price of gas in the US has declined by about 30 per cent for households, and by more than 50 per cent in real terms for industrial users. Average US household electricity prices have remained fairly steady in real terms over the past decade; and average electricity prices have fallen by more than ten per cent in real terms for US industrial users.

As the price of natural gas decreased, more users have turned to gas over coal-fired electricity, allowing the US to reduce its carbon emissions. Gas consumption in the US has increased to 36 per cent of fossil fuel consumption, from 27 per cent in the previous decade – and as a result, US carbon emissions from electricity generation have declined by more than twice the rate of Australia’s emissions decline.

Meanwhile, in Australia, we have seen a decade of energy policy inaction; a significant increase in gas exports from Queensland’s coal seam gas reserves, linking domestic gas prices with the international LNG market; and an unwillingness from state governments (most notably in Victoria and New South Wales) to allow onshore exploration or unconventional drilling techniques, ultimately denying access to the significant onshore gas reserves both of these states have access to.

As a result, since 2008, average electricity prices in Australia have increased by around 70 per cent in real terms for both households and businesses.

On average, Australian households sourcing electricity from the National Electricity Market (NEM) pay higher retail prices than all but a handful of US jurisdictions (see Figure 1). The price differentials are not small, ranging from double to almost triple the costs when compared to some US states. The same comparison can be made for household gas prices, with similar results.

Figure 1: Residential gas prices, Australian vs US, 2017. Source: Oakley Greenwood, EIA, IMF, author’s calculations

The data in Figure 2 indicates that on average, household gas consumers on Australia’s east coast pay between two or three times the prices that the average US household pays.

Figure 2: Residential electrcitiy prices (PPP adjusted), Australia vs US, 2017-2018. Source: ACCC, EIA,IMF, author’s calculations

The situation is no better for Australia’s businesses. As Figures 3 and Figure 4 demonstrate, if Australia was a US state, it would be one of the most uncompetitive jurisdictions in terms of energy prices.

Figure 3: Industrial gas prices, Australia vs US, 2017. Source: ACCC, EIA< IMF, author's calculations

To put all of this into perspective: in real terms, Australian-based manufacturers are now paying 47 per cent more for gas than they did ten years ago, while an American competitor is paying 63 per cent less. In summary: on electricity and gas price outcomes, the two economies have taken completely opposite paths.

Figure 4: Industrial electricity prices (PPP adjusted), Australia vs US, 2017-18. Source: ACC, EIA, IMF, author’s calculations

Impact on economies

In order to provide further context to what’s at stake in the energy debate, a sophisticated economic model was employed in the development of the report, providing insight into the anticipated economic effects of large, sustained increases in energy costs in the Australian economy.

Two different price scenarios were studied: a ten per cent increase to domestic gas prices, wholesale costs of electricity, and the combination of both; and a 25 per cent increase to domestic gas prices, wholesale costs of electricity, and the combination of both.

The modelling showed that:

  • A permanent ten per cent increase in wholesale generation results in a permanent 0.3 per cent reduction in GDP, or an annual economic loss of around $5.6 billion
  • A permanent ten per cent increase in the domestic price of gas causes a permanent reduction in GDP of 0.19 per cent, which is an annual economic loss of around $3.5 billion
  • The combined effect of a ten per cent increase in both gas and electricity is a permanent reduction in GDP of 0.46 per cent – an annual economic loss of $8.5 billion
  • A permanent 25 per cent increase in wholesale generation costs leads to a permanent 0.76 per cent reduction in GDP, or an annual economic loss of around $13.9 billion
  • A permanent 25 per cent increase in the domestic price of gas causes a permanent reduction in GDP of 0.47 per cent, which is an annual economic loss of around $8.7 billion
  • The combination of both scenarios in a 25 per cent increase is a permanent reduction in GDP of 1.15 per cent – an annual economic loss of $21.2 billion

The overall economic effect is clear: energy price increases impose significant costs on the Australian economy.

Some clear lessons learned on the pathway forward

The very clear lesson from the US experience is this: get the institutional and policy settings right, and the market will transform physical abundance into economic abundance, putting downward pressure on energy prices and emissions.

Unfortunately, over the past decade Australia has had almost the exact opposite experience; and the mistakes or unintended consequences of policy have led to higher prices and weaker emissions reductions than the US.

If Australia’s energy policy settings do not change, many Australian firms will be forced to either scale back production, investment and employment, relocate to Australian states where energy is cheaper, move overseas, or simply shut down. There are no other options.

Increased supply alone will not solve Australia’s energy crisis. Energy market architecture must also be addressed. The design of the National Energy Market – combined with a rapid uptake of renewables – has been a catalyst for recent increases in electricity prices. While renewables and storage capacity continue to grow and become less expensive, they still cannot provide the energy reliability required by industrial consumers of energy that other forms of electricity generation provide.

Amidst all of this, there is little policy certainty. Investors want fair, clear, stable and predictable rules. Without it, the investments required for bringing additional supply to market – of the magnitudes required by Australian industry – are unlikely to happen.

The US experience underscores the critical role of gas. The US shale revolution – combined with the policy settings and infrastructure facilitating it – has seen the trajectory of US energy prices flatten or turn down, for both homes and businesses. With gas now accounting for 33 per cent of America’s energy needs, the US has already met its Paris Agreement emission reduction targets in the electricity sector. Natural gas is clearly the bridge fuel toward a renewable future, while at the same time providing a less expensive and reliable source of energy for industrial users, and a vital input for many manufacturing processes.

With abundant physical reserves, Australia needs to consider policies that will unlock its gas resources, producing similar outcomes to those seen in the US: cheaper energy, a manufacturing and industrial revival, job creation and economic growth, with a smaller emissions footprint.

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