Hard lessons and hard decisions ahead

The trials that Australia’s electricity network providers have faced over the past year during the Senate Inquiry into Electricity Prices has provided key insights into the hurdles that gas providers will also encounter as consumers demand lower prices, better
connections and increasingly demand renewables.

It’s a saying that has marketed gas since wood heating was first phased out of society in the early 1900s. But today, the expression ‘cooking with gas’ could end up being a thing of the past if network providers do not accurately estimate household demand and improve efficiencies, according to Rob Murray-Leach, CEO of the Energy Efficiency Council.

“Everyone loves cooking with gas, I love cooking with gas. That’s where the saying comes from,” he says. “But I look at gas and see a bit of a storm for household gas demand. If I was an executive in the gas market, I would certainly be modelling it – what is our high projection and what is our low projection? What is going to happen with appliances? What is the best case scenario?

Murray-Leach’s comments come after the Senate Committee inquiry into Electricity Networks Performance and Management officially wrapped up in June. Some hard lessons were learnt during the inquiry process, he said – some that the gas sector would be advised to pay attention to.

The inquiry identified a raft of issues contributing to exorbitant electricity bills across the country including inflated, excessive and even unnecessary costs associated with building, maintaining and operating the networks.

This “over-investment” came at a time when electricity use was declining and supply was excessively driving Australia’s Renewable Energy Target (RET).

Electricity network providers argued the RET was undermining their business models, exacerbating regulatory costs associatedwith new renewable schemes and provisions, and imposing costly obligations such as bulb replacement programs.

Legislation to amend Australia’s RET was agreed on in June with bipartisan support to reduce it from 41,000 gigawatt hours of annual renewable energy production by 2020 to 33,000 – equating to estimated 23 per cent of all energy consumption in Australia to be derived from renewables.

Citing the fundamental regulatory flaw that electricity providers were not bearing the risks associated with inefficient investments and changing demand, the Senate inquiry called for the Australian Energy Regulator (AER) to employ powers to review the efficiency of electricity network investments, revise its revenue benchmarking process and cap expenditureon regulatory proposals all with the aim of reducing costs passed onto consumers.

“The evidence taken during this inquiry revealed that stakeholders are increasingly starting to consider whether the current system of networks, and the regulatory rules governing it, can be sustained. In the coming years, this arrangement may no longer effectively deal with how a significant amount of electricity is supplied,” the Senate’s interim report said.

“Given the concern that electricity networks are entering a ‘death spiral’, policymakers and regulators need to closely monitor developments in the electricity market to ensure network businesses do not discriminate against customers who seek to generate their own electricity.

“It is also important that the customers who continue to be supplied with electricity in the conventional manner, particularly customers who cannot afford to invest in their own electricity generation system, are not forced to pay an increasing share of network costs as a result of other customers going off-grid.”

LESSONS LEARNED
The past year has revealed massive pitfalls in the energy sector’s ability to forecast demand, according to Murray-Leach.

GAS TO HEED ADVICE
“The story about electricity networks is a very useful lesson for gas networks. Theyneed to really invest time in thinking about what consumers are going to want gas for in the future and understand that we are not necessarily going to get it right. And so at the same time, it is also important for gas networks to manage around risk,” he says.

“Firstly, gas networks should be asking what a rise in gas prices is going to do. I’d say it would be conceivable that there won’t be a substantial drop in household gas demand in the short term.

“But networks need to really start looking at the new uses for gas in the future. One of the biggest new uses is clearly export. But in reality, a lot of the traditional uses for gas might slowly drop off.”

Forecasts around domestic gas prices in Australia are predominantly skewed upwards – pegged to reach $12 per gigajoule by 2018 before slowly easing, as the upstream industry looks towards an export future to meet demand in Asia and renewables are increasingly taken up by small-scale consumers.

Off the back of such a price increase, Murray-Leach says gas network providers must act quickly to install efficiencies that might help retain revenue streams amid an expected shrinking customer base.

“Victoria has a lot of households using gas which means they will have a large incentive to switch over to full electricity if they see a rise in prices on their bill. In NSW you have a low level of gas use, which could slowly expand as people switch over entirely.

“Gas networks are going to have to make very, very sensible decisions about how they price their networks. In electricity, we have started to see networks dealing with dropping demand by changing the price structure to a higher fixed tariff. But that is a very short-term strategy and in the long term, you have essentially encouraged people to disconnect.”

EFFICIENCY AND PRICING IN THE SPOTLIGHT
The need to examine efficiencies and domestic pricing is not new to gas network operators.

On 20 May the AER upheld a decision to reduce allowed revenues for companies transferring electricity and gas in the ACT and NSW commencing 1 July 2015, in a more forceful attempt to prompt more efficient investment and operations.

Meanwhile, the Australian Competition and Consumer Commission in April this year launched a year-long inquiry into whether insufficient competition at the upstream level is driving up wholesale gas prices along the east coast of Australia.

In its submission to the AER’s decision to reduce allowed revenues for gas and electricity supply networks, Jemena Gas Networks (NSW) pointed out the pressures that network operators are facing to provide quality service and maintain long-term customers.

The company stressed the AER’s restrictions did not reflect revenue and pricing principles or the National Gas Objective to promote efficient investment in services for consumers.

“This is despite our 20-year asset strategy clearly setting out the customer outcomes under different expenditure and service scenarios, and our customers telling us directly they were not willing to forgo current service levels for materially lower prices in the short term,” Jemena stated.

“The (AER’s) final decision would result in materially negative consequences for the long-term interests of customers.” Jemena listed reduced asset replacement expenditures, delays on non-urgent gas mains repairs and lower short-term maintenance expenditure resulting in an increased frequency of gas leaks and less resources for emergency response.

It also stated that such a decision would mean fewer connections to new dwellings due to cash constraints and result in higher average prices for all existing customers.

GAS EXECUTIVES ARE ONE STEP AHEAD
The electricity networks inquiry, the AER’s regulatory decisions and the ACCC’s national review have all brought Australia’s energy supply and demand issues to the forefront.

Mark Coughlan, power and utilities leader at PriceWaterhouseCoopers says gas network executives have had their eye on efficiencies for some time with electricity and renewables posing such intense competition.

“There have been some pretty clear indications that electricity networks are going to cut costs. What does that mean for the gas sector? Well my instincts are that gas network owners are also already looking at their costs at the moment,” he said.

“There is a really interesting conversation to have with the entire energy sector including oil and gas and electricity network owners around what is going tobe the average cost of energy for consumers.

“We have a fairly strong view that the energy sector is being disrupted by solar, batteries, and other alternatives purely based of the fact that it it is now cheaper for people to produce their own energy and move slowly off the grid.”

According to Coughlan, efficient gas distribution will come down to one very simple factor: “pure economics of connection costs.”

Some lessons to ponder indeed.

According to PwC’s Mark Coughlan, efficient gas distribution will come down to one very simple factor: “pure economics of connection costs.”

Enter your details to subscribe to the free fortnightly Gas Today e-newsletter

Thank you for signing up for the Gas Today Online Update.