Could switching off a light bankrupt an energy retailer?

The Conversation

Just how much would it cost electricity generators if I reduced my electricity consumption by turning off just one light? You would think the answer is half of bugger all, and you'd be almost right.

In an attempt to be a bit more precise, let's quantify exactly what ‘half of bugger all' amounts to. Assume that the light I stop using is a 75 watt globe and that I was only using it for about 3 hours a day. So turning it off reduces my average electricity consumption by about 10 watts and saves me about 85 kilowatt-hours over the year.

With my generator expecting to get about 5 cents for every kilowatt hour traded on the wholesale market, the lost income due to my action is a touch over 4 dollars for the year. So ‘half of bugger all' comes in at about 1 cent each day. It means even less to the generator's bottom line, because it no longer has to cover the cost of making the electricity that I no longer want.

So you wouldn't expect the generator to give two hoots about my action. But there are reasons why the generators might be concerned, and they are all about multipliers.

Firstly, demand reduction has a significant multiplier on generator income. Not only does my not using electricity cost the generator a lost sale, it also reduces the price of all other sales on the wholesale market. And in theory, that directly impacts the generator's profit, since that is on electricity that still has to be delivered.

In reducing my demand, I effectively create an oversupply in the market. And, as with any efficient market, prices respond with a signal to reduce supply. In fact recent market trends show that in addition to reducing the revenue in electricity sold by about $4, my turning off one 75 watt globe reduces the revenues of all other electricity sold by more than $10 across the year. So the net impost on the generator's revenue is more than $14, most of which is profit.

Still not too much of a worry, unless of course I am not alone. Multiply my action by seven million, or about one in every three Australians, and generator revenue would be down more than $100 million on a net reduction in demand of 65 megawatts. That is about 1 per cent of expected annual wholesale market bottom line, but a much higher percentage of generation profits. Multiply that again by a factor of 10, and we are talking of losses in the billions, and a potential bankrupting of some leading industry players.

And it is already happening.

Over the last few years, demand for electricity traded on the National Electricity Market – or NEM – has collapsed by over 900 megawatts and over twice that on forward projections. And wholesale electricity prices on the NEM have plummeted to record lows, down some 40 per cent on just a few years ago.

Until early 2009 the demand for electricity traded on the market grew fairly consistently at around 2 per cent each year. Although there was some slackening in demand before 2009, most industry analysts put it down to the GFC and thought it inevitable we would need another gigawatt or thereabouts of supply to meet 2012 demand.

Mean demand traded on the mainland NEM by financial year in gigawatts (GW). Left panel shows total demand, and right panel shows demand deficit relative to 2000-2009 trend growth of 1.9% per annum. Mean demand has fallen at an average rate of 1.4% per annum over the last three years, but is down around 10% on 2009 forward projections. Tasmanian demand is excluded as it only joined the NEM in 2005. data sourced from AEMO - image by Mike Sandiford

That is the equivalent of one big new coal-fired power station, about 3 gigawatts of installed wind power capacity or 6 gigawatts of PV.  

But instead, in 2009/10, demand actually fell in real terms by 140 megawatts, fell again in 2010/11 by 290 megawatts and again in the last 12 months by 500 megawatts. Compared to 2009, demand is now down by about 930 megawatts, or almost 4 per cent. Compared to the forward projections of just three years ago demand is down by about 2.2 gigawatts or 10 per cent. That is the equivalent of two big power stations we thought we would need, but no longer do.

And since 2010, wholesale prices have collapsed. The average price in the last financial year was a touch under $30 per megawatt hour. That is the lowest average annual price recorded on the market since 1999 and is about 40 per cent lower than the long-term average of around $47, adjusted to 2012 dollar terms. Market revenue was down almost $3.5 billion on the yearly average of $9 billion in adjusted terms, and more than $5 billion on forward growth projections.

Mainland NEM average volume weighted prices for financial years in dollars per megawatt-hour. Right panel shows prices adjusted to 2012 dollar terms. Blue line shows the average adjusted prices, to 2010, factoring out the anomalous high price years ending 2011, 2007 and 2008, when extraneous factors, such as drought conditions, impacted supply. data sourced from AEMO - image by Mike Sandiford

These figures give a direct measure of how the electricity market values demand reduction in terms of its impact on wholesale prices or, in other words, the price signal of oversupply. In fact the market is valuing a demand reduction of 1 watt on the forward projection at about $1.40 over the year. That compares to the expected wholesale value for 1 watt-year of electricity of 44 cents.

Mainland NEM traded revenues for financial years in dollar terms adjusted to 2012. Left panel shows total adjusted revenues. Right panel shows the revenues in terms of deficits with respect to the expected revenues assuming the long term average price of $47 per megawatt hour for the actual demand - see also the blue line on the left. data sourced from AEMO - image by Mike Sandiford

And so we get an estimate of our multiplier, of 140/44 or 3.2. Factoring in some other price effects such as the prevailing la Niña weather cycle, and a more conservative estimate of the price signal multiplier is probably a bit lower at around 2.5.

That is a very strong price signal, and testifies to the effectiveness of an efficient market. It may explain why generators are less than enamoured by schemes, such as energy efficiency and distributed PV, that take market share away from their business.

Of course, in the face of plummeting wholesale prices, consumers should be asking if they are seeing any of the benefit. Near record increases in retail prices would seem to suggest not and raise a raft of questions such as what exactly is the function of the wholesale market?

Mike Sandiford is Director, Melbourne Energy Institute at University of Melbourne.

This article was originally published by The Conversation. Republished with permission.