Cost of supplying electricity

There has been a lot of media coverage over recent months, even years, about the rising cost of electricity.

Here in Victoria, the closure of the Hazelwood power station after 50 years of supplying reliable and relatively inexpensive electricity is, understandably, a cause of concern.

There are many factors that contribute to the cost of electricity to you, the consumer.

At GloBird Energy, we don’t think that should be “secret energy-company business” so we’re going to explain it.

To keep it as simple as possible, we’re going to break it down into three parts:

1. What am I being charged for?
2. How does the energy industry manage the electricity market?
3. How is the closure of power stations changing the equation?

 

What am I being charged for?

According to the Australian Energy Market Commission, which makes the rules for the energy market, your electricity bill is made up of:

• wholesale and retail prices, based on supply and demand;
• the cost of poles and wires; and
• the cost of environmental policies.

A 2015 report found that the average bill in Australia broke down to 39 per cent market costs, 53 per cent network costs, and eight per cent environmental costs.

 

The cost of poles and wires

Victoria’s electrical infrastructure needs to be built and maintained to cope with Peak Demand, not just steady or average demand. Peak Demand is the period when the most power is being drawn from the grid.

For a long time in Australia, the growth of overall electricity demand consistently matched the growth in peak demand. However, in recent years, overall demand has declined steadily, while peak demand has continued to grow.

Since around 2010 this has emerged as a big problem for the distributors who own the poles and wires, as they work to build reliability into the system by replacing aging infrastructure.

Each year, the networks put forward the costs needed for infrastructure work. Once approved by government, this is then passed on to customers.

In Victoria, the split between market and network costs on the average Victorian household electricity bill was pretty much even, at 46 per cent each.

 

The cost of environmental policies

The main costs that can be attributed to environmental policies are LGCs, STCs and VEECs.

Large-scale Generation Certificates (LGCs) are created based on the amount of power generated by an accredited and registered renewable energy power station. An LGC represents one megawatt hour (MWh).

Small-scale renewable energy Technology Certificates (STCs) are similar but based on things like residential solar systems.

VEECs are Victorian Energy Efficiency Certificates. Each VEEC is equivalent to a reduction in one ton of CO2 from the atmosphere.

All of these certificates are tradable just like a share on the share market for renewable energy, and prices therefore fluctuate with supply and demand.

Importantly, energy retailers are obliged to buy them. As a general rule, the more power the retailer sells, the more certificates they have to buy.

 

Isn’t it just a supply and demand equation?

It is and it isn’t. The wholesale cost of supplying electricity actually varies every five minutes across the entire day, even though that’s not how consumers are charged for their usage.

In term of price fluctuations electricity is one of the most volatile markets in the world.

All day every day the wholesale price of electricity reflects the real-time cost for supplying it, and demand is the main contributor to that cost.

Electricity demand is usually highest in the afternoon and early evening so costs to provide it are usually higher at these times.

Most consumers pay prices based on the seasonal average cost of providing electricity, so they aren’t exposed to the daily price fluctuations.

However, in order for an energy retailer to manage the risk of these massive fluctuations, they usually enter into agreements with a generator to buy power at an agreed price in the future. Without Hazelwood, that future price is now much higher.

How all of that is calculated and managed within the industry is a story for another time (like next week).

We hope that everything will be a lot clearer after you’ve read our blog posts, but if you have any specific questions or concerns, please let us know.