The Consequences of Rising Energy Costs in Heavy Industry of Australia
Introduction
Australian industry and our community have enjoyed the benefits of relatively low electricity and gas prices for many decades, without suffering any significant price shocks. Competition policy reform brought significant benefits to the energy sector in terms of productivity gains. This relative energy price stability underpinned the international competitiveness of many of our industries, trading off other higher costs (labour, $A, etc.) whilst striving to be productive and efficient. This also materially underpinned the affordability of energy for all consumers in our community through access to relatively low priced energy in households, competitively priced goods and jobs in local industries.
This has now changed as electricity and gas prices escalate rapidly, driven by market factors to some degree but more by energy policy decisions – in the absence of a cogent overall energy policy framework in Australia. The three tiers of Government have all contributed to price escalation without anticipating the impacts that would follow from their cumulative effects.
In this new era of relatively higher energy prices in Australia, we are witnessing the rapid restructuring of the more energy-intensive or energy cost-exposed businesses, driving many to move production abroad. Many cannot manage multiple changes in costs and have lost the edge that low-cost energy gave them to remain competitive. It is also driving the restructuring of investments in key parts of the energy supply sector in a way that is not largely reflective of an open, competitive market sector.
Unhappily, it is also increasing the cost of living burden on all Australians, propelling many on low or fixed incomes into energy poverty – which may eventually result in a restructuring of welfare benefits and the way people accommodate themselves.
Whilst it is recognized that Australia needs to remain internationally competitive and that the allocation of resources needs to be market-driven, even if this entails losing key industries such as packaged food, metals, etc., this is somewhat hollow rhetoric when policy decisions have been a major driver of energy price rises resulting in a reduction in competitiveness.
It has also left our energy supply industry in free-fall domestically as demand declines. Electricity demand has proven to be elastic. This was not anticipated by the supply industry historically although forecasts of this effect go back to 2008 when major price increases were first anticipated. Worse, this impact is still not well understood or calibrated; the forecasting of energy demand in Australia lacks credibility and a robust methodology - to the detriment of sound investment decisions.
Analysis
Prices for electricity and gas are made up of wholesale costs for the energy; charges for the networks that bring the energy to users; fees for retailers’ costs; and costs related to government policies and levies. Energy costs have been a persistent issue over the much of the last decade, with enduring price hikes caused by surging network costs, and a brief spike from the former carbon tax. Now changes in wholesale markets are bringing fresh pressure to energy prices.
Rising energy prices (and reliability of energy supply) are again emerging as a key risk for Australian businesses. For 2016, 39% of businesses experienced energy price increases, only 9% experienced price decreases and around half (52%) experienced no change. Of those businesses that had flagged energy price increases, the average increase was 9%.
It should be noted since the time of the survey (late 2016), wholesale and energy futures prices have increased significantly. It would be reasonable to expect these results to be more negative in early 2017.
Prices are rising for a broad range of businesses, although manufacturers seem to be feeling the most pain:
- 47% of manufacturers experienced price hikes in 2016. Of those with increased prices, the average increase was 14%.
- 39% of services businesses experienced increasing prices in 2016. Of those with increased prices, the average increase was 7%.
- 36% of construction businesses experienced price increases in 2016. Of those with increased prices, the average increase was 19%.
Expectations for energy prices in 2017 are much more pessimistic, with over half (51%) of businesses expecting price increases and only 4% expecting a decrease. Around 46% of businesses will expect no change, which may reflect that their supply contracts are not due for renewal in 2017, or that their energy prices are already elevated. Increasing costs appear to be a common theme across industries for 2017:
- 57% of manufacturers expect an increase energy prices, with only 6% expecting reductions.
- 48% of services businesses expect an increase in energy prices and only 3% expect a decline in prices.
- A large 63% of construction businesses expect an increase in energy costs while 7% expect a decrease.
High energy costs also impact on industries that are not recognized readily as energy-intensive. The energy costs for materials (no matter how materials are sourced) are an input component to many other industries. A good example is housing (bricks, glass, tiles, steel, concrete, etc.) but the whole economy is in a similar dilemma the cost escalations are unavoidable in many cases because they are embedded. The competitive advantage of energy was not just enjoyed by industry but added to the affordability for consumers of a wide range of products.
Conclusion
Energy is a significant input cost to many Australian industries and is accounting for a growing proportion of residential disposable income for low-income households. The consequences of rising energy prices are predictable and are now playing out in what may become a classic case study in economics in the years to come: demand destruction; loss of competitiveness of Australian industry that relies on reasonably priced energy driving offshoring of production; and rising energy poverty in the residential sector.
The offsets are intended to be greater national income from international sales of energy and the associated economic benefits from being able to source goods from more cost-competitive countries. There is rigor and logic to these arguments, but many of the domestic market consequences come from policy decisions, not from efficient resource allocation, so the full impacts of what may seem reasonable policy decisions at the time are now coming to light and will become more transparent over the next 3 to 5 years and will be unpalatable.
The question then is do we have the trade-offs right are the impacts of the policy decisions worth the pain of the restructuring? Do we even understand the consequences? It is interesting that strong economic argument is put forward for the development of energy export industries but that the same rigor and logic is largely lacking for domestic energy policy decisions. A more holistic approach is required, with rigor, and this needs to be redressed urgently.
References
- Energy Industry Supply and Demand. (April 2009). Responses to the Carbon Economy. Sydney: Australian Institute of Energy.
- Jim Snow, D. a. (February 2014). THE ECONOMIC IMPACT OF HIGH ENERGY PRICES IN AUSTRALIA. Energy Policy Institue of Austraila.
- Nelson, S. a. (June 2012). Rethinking Customer Hardship. The Energy Market Death Spiral. AGL Applied Economic and Policy Research Working.
- The Australian Industry Group. (2017, FEBRUARY). ENERGY SHOCK:. NO GAS, NO POWER, NO FUTURE? The Australian Industry Group.
- Weller, M. W. (2001). “Refashioning the Rag Trade: Internationalising Australia’s Textiles, Clothing and Footwear Industries”. UNSW Press.
