The power to save billions

At around lunchtime on Thursday, Professor Ross Garnaut will deliver the first of the really controversial updates to his 2008 Climate Change Review, the chapter on carbon pricing.

It will be the first tangible input into what promises to be a highly contentious debate about the impact on jobs, industry and investment flows, but most of all about the cost of electricity.

So before the government’s climate change advisor delivers his assessment on the appropriate pricing mechanisms, and the shock jocks and the tabloid bloggers start frothing at the mouth, it is worth considering this: How do the current costs of electricity compare to days gone by, and what can be done to minimise them?

The answer to the first question is quite surprising. As the graph provided by economists at AGL Energy shows below, electricity bills as a percentage of average weekly earnings in the last decade or so have been tracking at their lowest levels for 45 years. In the 1960s, electricity costs represented 2.4 per cent of household income before falling sharply in the early 1970s and then rising to a peak of 2.6 per cent after the effects of the OPEC oil price shock.  For much of the past decade however, it has averaged at around 1.7 per cent, before starting to rise again from 2007 as utilities invested in a rapid upgrade of a largely neglected network, and to cope with the surge in peak demand as two out of three households rushed down to their local retailer to buy air conditioners and wide screen TVs.

Even now, electricity costs stand below 2 per cent of household income. Little wonder, then, that a survey found the electricity account to be the second most boring item in household budgets; only council rates received less attention. That, though, is likely to change. 

As those network upgrades are made, built mostly to cope with the surge in peak demand for those few hours a year when everything is switched on a the same time, the ratio of electricity bills to household earnings is likely to jump again to 2.5 per cent by 2015, when an average home consuming 7.5MWh of electricity will be paying a bill of just over $2,000.

Maybe by then people will start to take an interest in how much they are consuming and what it is costing. As the research paper notes, the way people consume electricity now is a little like using a car, with no odometer or fuel gauge, filling it up at the service station with no indication of how much fuel is pumped and at what cost, and then getting the bill once a quarter. They have absolutely no idea that those who can’t afford the energy intensive mod-cons are subsiding the electricity cost of those who can.

Which leads us to the answer to the second question: how do people avoid rising electricity costs? The response is not necessarily to switch off the air conditioner and go live in a cave, as you might be told on talk-back radio. But the solution may lie in bringing the technology into the 21st century, and taking advantage of the business models that could support.

The AGL economists suggest that if history repeats itself, then the spike up to 2.5 per cent of household budgets will likely spark a series of regulatory changes to the industry. The most important of these, they say, should be the deregulation of pricing mechanisms, and the introduction of smart technologies, beginning with smart meters in the home.

Currently, there is no price signal to deal with the sudden spikes in peak demand – the costs of dealing with 3.5 days of peak demand, satisfied by some 12 per cent of network costs, are spread across the market, pushing up prices for all. Demand response for domestic consumption – even though it amounts to up to one third of electricity demand – has basically been ignored.

“In order to deal with future peak demand, a technology shift is quite essential,” the economists write. Whereas telephones have been revolutionised over the past 100 years to the current 3G handsets, electricity grids have remained a set of "dumb wires." So much so that it is said that Thomas Edison, who pioneered electrification in the 1880s, would be able to run the existing networks as they are based on early- 1900s technology.

The economists have analysed a range of demand response measures that have been tested here and overseas. It concludes that time-of-use pricing – the most basic proposition made by the introduction of smart meters – could reduce peak demand by an average of 4.7 per cent, and as little as 2 per cent. The introducing of technology that could automate demand response (the switching off of non-critical appliances at certain peak times), could reduce peak demad by an average of 17.8 per cent, and possibly up to 32 per cent.

But the system that held the most promise was something called critical peak pricing (CPP), where tariffs of up to three times the normal price are flagged in advance in anticipation of a severe load. Pilot studies in California showed this achieved an average reduction of 20.7 per cent in peak demand at the household level, with results spanning from 10-50 per cent. The studies further showed that if you combine time-of-use pricing with CPP and technology that can automate demand response, the average peak demand will fall by 34.1 per cent.

AGL conducted its own modeling, with particular regard for the Australian industry, and came up with a pricing mechanism – for indicative purposes only – that include a a peak tariff of $232/MWh, an off-peak tariff of $78.10/MWh and a CPP – that’s the critical peak pricing with advanced notice – of $618/MWh.

The economists said their modeling managed to flatten the household load curve from 38.5 per cent to 50 per cent. The benefit of all this? It indicated a reduction in unit costs of about $32/MWh, and if applied unilaterally across the four primary states that form part of the National Electricity Market, it would represent a reduction in costs of some $1.6 billion per annum in the household sector alone.

The AGL economists note that such  a dramatic change in the way electricity use is monitored, controlled and priced must be introduced with great care and over time. Carve outs are essential for those who might be disadvantaged, such as pensioners, because no model will guarantee benefits for all.

But while government’s often baulk at the complexity and the communication task of major reform, this particular reform should be readily embraced. One day, the government is going to have to take the recommendations from its task force on energy efficiency out of the bottom draw. Smart meters, and new business models for energy utilities formed part of the key recommendations. And in comparison to a great big new tax, this should be a relatively easy sell.