Energy plans zapped by diving demand

Falling electricity demand is likely a false dawn in the battle to reduce emissions and is certainly a major headache for policy makers trying to keep power affordable.

Australia’s average maximum daily temperature for January was the highest on record. Yet electricity demand across the National Electricity Market did not reach the summer peaks of a few years ago. Indeed, electricity demand has fallen consistently since 2008, although the trend has flattened in the past few hot months. Greenhouse gas emissions from electricity generation – our biggest source of emissions – have also fallen.

Have the carbon price and low-cost renewable energy already put us on track to the low-emissions future that climate change requires? Sadly, it is probably a false dawn. Even so, policy makers and investors confront substantial challenges arising from falling electricity demand.   

Commentators have identified a number of factors that are most likely to have reduced demand for power from the grid. They include a fall in manufacturing activity, more renewable energy generated not from the grid but from local solar panels, milder weather in the lead-up to this summer, and the likelihood that electricity price increases have led some businesses and homeowners to use less power.

Which factors are most important is hard to say. Many people are ready to have their biases confirmed by the numbers. But since the greatest falls in electricity demand have occurred in the industrial centres of Victoria and New South Wales, the biggest cause is likely to be reduced manufacturing activity, driven by the impact of the high dollar on demand for exports.

Less demand for power is almost certainly driving the fall in emissions. The carbon price is unlikely to have played a major role. Even with the price of $23 a tonne now embedded in the production costs of coal and gas, brown coal – the most emissions-intensive source of fuel – remains competitive compared to black coal and gas. And in 2015, when the fixed price period is due to end, the carbon price will either fall significantly, or it will have been repealed by an Abbott government.

The high price of black coal relative to brown, and steady increases to how much renewable energy electricity suppliers must source under the Renewable Energy Target, have put greatest pressure on black coal generators, with some already shutting down.  

The amount of power sourced from renewable energy, meanwhile, is growing. While government subsidies have led more than a million homes to install solar PV, the overall impact on electricity from the grid remains minor – around 1 to 1.5 per cent of electricity generation. 

Nevertheless, lower demand has real implications for the energy sector. First, investment in new power stations is unlikely to be needed for at least 10 years. Additional supply will be created by companies meeting their obligations under the RET, most likely through building more wind power. Some further growth in solar PV will play a role, although the growth will diminish in the short term as subsidies are withdrawn and the solar PV manufacturing sector seeks to increase prices to cope with financial stress.

Further falls in electricity demand will revive debate over the RET, especially before this year’s election. The federal opposition has yet to clarify whether in government it would leave the target as a fixed 41,500 Gigawatt hours or return to the earlier objective of 20 per cent of electricity by 2020. Projections based on falling demand suggest the fixed target may comprise more than 25 per cent of electricity. Falls in demand will heighten the tension between those who say the RET must be remain fixed to give certainty to investors, and those worried about the cost to consumers.

For electricity distributors, reduced demand will reduce revenue, but that pain will be passed on to consumers. Distributors are regulated monopoly businesses with costs that are largely independent of the volume that passes through their networks. When demand falls, the regulator allows them to recover their costs by charging more per unit of electricity consumed. The Grattan Institute’s report Putting the customer back in front: how to make electricity prices cheaper, addresses the challenge of controlling distribution network costs when demand is falling.

The economist J.K. Galbraith, once said that “the only function of economic forecasting is to make astrology look respectable”.  Forecasting electricity demand is no less tricky. Uncertainty over climate change policy, electricity demand and technology developments mean great uncertainty about how Australia can substantially reduce its future greenhouse gas emissions.

A government committed to that task must combine policy predictability with flexibility. It must set a clear long-term target for reducing emissions, and a clear pathway showing how the target will be reached. At the same time, its policy must be flexible, so that we know how future uncertainties, such as fluctuations in electricity demand, can be managed. Getting this balance right is the great climate change challenge for the party that takes power in September.

Tony Wood is energy program director at the Grattan Institute.