Question

Drawing on your knowledge of the theory of specialisation and exchange – supplemented by appropriate media reports – explain what the consequences of rising energy costs will be for heavy industry in Australia. with relevant graphs and around 2500 words

Answer 1

In this new era of relatively higher energy prices in Australia, the rapid restructuring of the more energy-intensive 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. It is also increasing the cost of living burden on all Australians.
Electricity and gas prices on the rise between 2007 and 2013 Australian electricity and gas prices both rising more than 100% in some states.

(Graph Data : Electricity Price index Dec 1980 - Dec 2012 ,Electricity Network Regulatory Frameworks, Inquiry Report, Vol 1, Productivity Commission)

High capital expenditure rates for the networks New South Wales (NSW) were consequently approved, initially in NSW and followed shortly after in Queensland, which set off a major electricity price ratchet in those States.The investment and regulatory challenge at the time was to forecast the effect on demand for power of a major escalation of network prices in subdued economic conditions. The forecasting techniques of old would prove very unreliable. These are the causes of high energy prices in Australia.

There are some consequences of High Energy Prices-

1. The end of “inelasticity” of electricity demand - The traditional wisdom in the energy industry was that electricity use was relatively “inelastic” ,it would not be influenced by price substantially it was an essential service ,the consumption growth graph continuously pointed up even when the consumption trend was down.some challenged the traditional wisdom, arguing that energy was indeed elastic and that the industry would see a decline indemand, that prices would continue to be driven up (due to large fixed costs and lower system load factors) and that the industry would enter a “death spiral” effect until some base usage was reached. The subsequent regulated electricity price shock (there was also a high greenhouse gas mitigation policy part) demonstrated that demand for energy was elastic –just as for the other smart and in line with economic theory.This came as a shock for people working in the electricity industry as many had neverseen a decline in demand in their entire working lives. It was new territory and demand forecasting failure was widespread. At the same time, other policy interventions also contributed to accelerating these effects for example the heavily subsidised and policy mandated take-up of solar technologies. This reduced the revenues but not the costs of networks as they still had to meet the demand at peak times. The early 2014 heat wave provided an example, where peak demand reached close to historical highs in affected states even though overall consumption had been falling.
2. Gas demand also falling - The market prices for gas are escalating on the east coast in response to a huge demand for indigenous gas for LNG production and export, driving up the value of new gas and hoovering up existing low cost of production gas. Some new price balance can eventually emerge on the geographic region domestically reflective of costs of production as the price bubble drives both demand and supply responses. But once again policy issues are limiting the ability to bring on new production in some sectors and the network impacts are yet to materialise. As outlined, investment in network assets comes from either growth in demand or from increases in prices (or a combination of both) and high prices are already driving down demand for gas. The impact on gas use for power generation due to the combined effects of reducing electricity demand and escalating gas prices is becoming stark –several gas generators have shut down or significantly curtailed production.
3. The impact on manufacturing industry-The impacts were also highly predictable and are still playing out in the economy in terms of generational industrial restructuring. Again,industrial restructuring is not a new phenomenon in Australia as during the late 1980s and early 1990s we saw the rapid decline of the textiles, clothing and footwear industry, once tariff protection was removed. There was a rapid restructure in terms of lost jobs in the sector and a shutdown of plants that had been operating for many decades. But it also lowered the anticipated cost of these items in Australia from imported equivalents and what remains of the industry has itself restructured into the value-adding components that can be competitive.One of the key competitive advantages Australian industry has enjoyed has been low energy prices.Electricity from coal was and remains very competitive by world standards.
4. The impact on food processing and packaging - The packaged and processed food sector is also heavily affected and is now going through the same restructuring as the rag trade, with consequences for food growers. The energy content and cost is significant if food has to be processed and put into containers (glass, steel, plastic), or frozen or has to be cooked and then packaged –which is much of what is found on supermarket shelves.The packaged food industry is also more easily replicated than heavy manufacturing in different countries.As well, brands are more and more focused at intervals world firm possession.Often it's merely a case of a world firm shifting production to marginal capability that already exists in offshore jurisdictions.This trend has already started and is likely to accelerate as gas prices continue to rise. The impact on power generation in the Asian regionIn Malaysia, for example, there is a return from gas to coal-fired power generation due to the high LNG price impact. This is becoming a trend in South East Asian manufacturing countries as they seek to remain competitive with China and other BRIC countries.China itself continues to build coal-fired power generation every year equivalent to Australia’s total coal generation capacity.
5. The impact on the Australian energy industry - There are substitution affects that can rapidly distort or restructure investments, and perceived regulatory and policy driven risks can materially add to the costs of investments. For example the concept of using gas to fuel base load (and even mid merit) power stations has gone from being a robust proposition to being placed on the shelf for probably the next decade at least (some modelling indicates a lot of longer) in just a space of 2 years–again through revisions to actual demand impacts from prices and the impact of the RET to date. Renewable power station developments, despite policies for their implementation and major subsidisation, have also largely now stalled andsome coal plants could be mothballed or run intermittently. High gas prices may also see an escalation in the use of residential air conditioners for the winter heating months. These are just some examples of how the interactions of market forces and various levels of policy intervention can drive unintended (and often illogical) consequences.
6. The impact on the cost of living - The rapid escalation of energy prices is also leading to an equally rapid and worrying growth in residential “energy poverty” –defined as consumers who will have to apply more than 10% of their income to pay their energy bills. This burden will eventually also fall on the public purse and is set to be compounded by the rise in gas prices in the populous southern states (NSW, Victoria and SA).There is a need to much better understand the underlying drivers and trends in energy use in Australia which can only be derived from a far more granular approach to forecasting than has been adopted to date and the development of well calibrated economic models. This will assist both policy development and investment analysis considerably.