Maintaining the commons

Maintaining the commons

Carbon pricing: a minor shock compared to recent electricity price increases

The cost of upgrading these poles and wires adds much more to electricity prices than the carbon price. Bidgee

There has been considerable hyperbole regarding the impact of the carbon price on household budgets and small businesses. The Federal opposition’s scare campaign has included labelling the carbon price as a “great big new tax on everything”, explaining that it would “play havoc” with household budgets, act as a “wrecking ball”, “clean out people’s wallets” and leave “millions of Australian households … worse off”. The opposition has even suggested that the cost of a roast dinner could reach $100 over time. People, fueled also by the hyperbole of shock jocks and some media outlets, seem to believe these claims with only 35% supporting the carbon price in a recent survey.

Small business owners and organisations continue to describe their confusion about what impact the carbon price will have on their businesses, whether they can realistically pass it on to consumers and whether it will be the straw that broke the camel’s back. The coalition has even distributed leaflets to be used by butchers, bakers and meal makers apologising to customers for price increases and directly linking this to the carbon tax.

These fears and confusions are strange because we have been copping and coping with much larger increases in electricity prices over the last five years due to massive capital expenditure in distribution and transmission networks. This is set to continue and for households and small businesses the impact of the carbon tax is identical, albeit of a much smaller scale.

Electricity prices increased by about 40% from 2007-2010 in real terms – adjusted for inflation – and similar increases are occurring and are predicted for the period 2010-2013. And this is without carbon pricing. Up to 70% of these price increases are due to rising network costs. In the NSW retail-pricing regulator’s latest determination, prices are set to rise by 16.4% from 1 July, 2012 on top of 10% and 17% increases in 2010/11 and 2011/12. Half of this 16.4% increase is due to the carbon tax, and the other half is due to further network upgrades.

Retail electricity prices are essentially set by regulators who determine the maximum price increase retailers are able to impose. This is based on their costs which include retail operation costs such as retaining and billing customers (roughly 10% of retailer’s total costs), network costs (roughly 45%) and wholesale electricity costs (roughly 45%). The regulator also allows for a profit margin of between 3 and 10% depending on the State.

The carbon price affects the wholesale electricity price with power generators passing on their carbon costs to retailers. Because the power-generation fuel mix at any one time is varied and the power generators have different emission intensities, the carbon-price pass-through is about 85c in the dollar. The pricing regulator allows for this pass-through and retail electricity prices therefore reflect the carbon price.

The same process occurs for increased network costs. Retailers must pay the transmission and distribution network owners (a mix of public and private ownership exists) and a separate regulator (the Australian Energy Regulator (AER)) determines the amounts that network owners can charge the retailers. However, these amounts are based on a strict formula which determines the ‘weighted average cost of capital’ – the return on their capital investment. The network owners can invest in network upgrades and receive this guaranteed amount which is around 10%. The AER therefore also specifies the allowable capital investment. However, the AER points out that all capital expenditure increases the network provider’s asset base and they receive this return on capital regardless of whether the expenditure is “efficient, prudent or within forecast”.

Thus, despite the justification that massive network capital expenditure is needed to upgrade aging infrastructure and ensure energy security, there has been some suggestion that a form of price gouging is occurring with network owners overinvesting and ‘gaming’ the regulator. The greater the investment, the greater the return to network owners and a 10% return compares favourably to the return they could earn in capital markets. In fact the AER has recently announced an inquiry into some of these overinvestment practices. In one case, for example, currently being investigated, an approved $107 million investment turned into a $271 million dollar expenditure.

For households and small business, the end result of price increases due to network upgrades is the same as price increases due to the carbon price. The price of electricity rises, this is passed on by the producers of intermediate goods, retailers pay more for intermediate goods and electricity and pass this on to consumers. Only the scale is different.

The government predicts a 10% increase in electricity prices from the carbon tax which adds $3.30 per week on average to household electricity bills. Food and beverage prices have been estimated to rise by around $1 per week while the CPI increase is about 0.7% in the coming twelve months after which the effect of the carbon price on price increases virtually disappears.

These figures pale in comparison to the higher household electricity bills, food prices and CPI due to higher network charges. And of course the government has not compensated households for these increases as they will for low-income earners dealing with the effects of the carbon price.

Thus, we have experience with large electricity price increases, and much larger price increases than will result from the carbon tax. The confusion of householders and small businesses must be the result of illegitimate political hyperbole or ineffective marketing by the government.