The power to decide?, October 1999

01 Oct 1999Archived News Energetics in the News


Mark Searle doesn't believe that power prices will skyrocket in the brave new world of electricity deregulation. He tells Electrical World why.

Weather and electricity prices seem to have a lot in common. Firstly, they both generate lots of talk and not much action, secondly, there is a multitude of differing predictions and, thirdly, there is no firm methodology to accurately predict trends. The comparison becomes even more interesting if we correlate the effect of weather on electricity prices.

Today, it is still common to see one newspaper headline claiming electricity prices on the up and another prices set to fall. So where is the truth?

The electricity price forecaster must resist the temptation to over emphasise minor aberrations in electricity prices and concentrate on the core principles, which must include:

Investors and stakeholders will not, in the long run, bid below their cost. True, in the short term there has been a dramatic price war and commodity prices of $15/MWh were freely available throughout NSW and Victoria. However, this is clearly below the cost of production and recently prices have moved up and stayed up.

Prices that lead to excessive profit margins are likewise not sustainable. A free market reacts to excessive profits as nature reacts to a vacuum: as in Qld where high prices have triggered NorthPower's Direct Link transmission project, fast tracked the Qld-NSW 330/275kV interconnector and put 4000MW of new generation capacity on the drawing board.

Governments will not allow long-term electricity price distortions that significantly hurt the local economy or voters. The Qld and SA state governments were quick to jump in when their respective markets experienced problems. SA introduced transitional tariffs and Qld announced that all consumers would have the right to remain on franchise tariffs as an alternative to entering the contestable market.
In Victoria, where the industry has already been privatised, is a little more complicated. Nevertheless, we can be sure that no state government will allow electricity prices to rise to the point where they are hurting the local economy.

A short-term price aberration caused by a sudden change in the weather or sudden loss of plant and equipment is not necessarily indicative of things to come.
Real costs

Victoria provides good data on the real cost of electricity. Their electricity supply industry has been privatised and sold for around $25bn. Victoria consumes about 45,000GWh a year; a quick calculation using a WACC of 7.5% puts the cost of capital at about $41.5/MWh. This makes no allowance for operating cost, no allowance for market participation fees and no allowance for profit.

Similar back-of-the-envelope calculations put the cost of capital for the generators alone at about $20/MWh. In fact, it generally believed that generators must recoup between about $37 and $39/MWh in order to remain viable.

Initially dramatic price cuts were fuelled by an unsustainable attitude of sell at all costs. They were also supported by vesting contracts, which provided the generators with a guaranteed revenue base that was in turn used to purchase power for franchise customers. As the market becomes increasingly deregulated the vesting contracts are being wound back and the generators are losing this revenue stream.

Therefore, a floor price for the commodity can be set at about $35/MWh. Add delivery charges (network use of system, or NUoS) and market participation charges and you are likely to get a total of between $60 and $75/MWh delivered, depending on location and usage patterns.

Going up!

At the other end of the spectrum, how high can prices go? In the extreme, they can go to the value of lost load (VoLL). Currently, this is set at $5000/MWh with indications that it could rise to $25,000/MWh. However, this should not be taken as a serious indicator of long term trends. The purpose of VoLL is to set a market ceiling that will encourage the provision of ancillary services and demand side bidding. It is not intended to be a long-term or even medium term price indicator and it is hard to imagine any government or regulatory authority allowing VoLL to continue for more that a few hours.

A more realistic upper limit on the price would be $50 or $55?MWh. At this level competitors can provide new generators capable of muscling in on the high prices.

In the long-term, electricity prices for most consumers are unlikely to be much different from historical franchise tariffs. Astute consumers who put effort into their electricity supply negotiations and who are close to major load centres may see a 10 or 15% but this won't be common.

Those customers who are not close to a major load centre are likely to be the real losers. In the absence of cross subsidies, high NUoS costs may make it impossible for these customers to ever benefit from deregulation. Hence the use of franchise tariff safety nets.

However, in the main, savings are there to be had.

Mark Searle is head of the Energetics' Energy contracts group.

  • Mark Searle, Electrical World October 1999
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