Just how much would it cost electricity generators if I reduced my electricity consumption by turning off just one light? You would think the answer is half of bugger all, and you’d be almost right.
In an attempt to be a bit more precise, let’s quantify exactly what “half of bugger all” amounts to. Assume that the light I stop using is a 75 watt globe and that I was only using it for about 3 hours a day. So turning it off reduces my average electricity consumption by about 10 watts and saves me about 85 kilowatt-hours over the year.
With my generator expecting to get about 5 cents for every kilowatt hour traded on the wholesale market, the lost income due to my action is a touch over 4 dollars for the year. So “half of bugger all” comes in at about 1 cent each day. It means even less to the generator’s bottom line, because it no longer has to cover the cost of making the electricity that I no longer want.
So you wouldn’t expect the generator to give two hoots about my action. But there are reasons why the generators might be concerned, and they are all about multipliers.
Firstly, demand reduction has a significant multiplier on generator income. Not only does my not using electricity cost the generator a lost sale, it also reduces the price of all other sales on the wholesale market. And in theory, that directly impacts the generator’s profit, since that is on electricity that still has to be delivered.
In reducing my demand, I effectively create an oversupply in the market. And, as with any efficient market, prices respond with a signal to reduce supply. In fact recent market trends show that in addition to reducing the revenue in electricity sold by about $4, my turning off one 75 watt globe reduces the revenues of all other electricity sold by more than $10 across the year. So the net impost on the generator’s revenue is more than $14, most of which is profit.
Still not too much of a worry, unless of course I am not alone. Multiply my action by 7 million, or about 1 in every 3 Australians, and generator revenue would be down more than 100 million dollars on a net reduction in demand of 65 megawatts. That is about 1% of expected annual wholesale market bottom line, but a much higher percentage of generation profits. Multiply that again by a factor of 10, and we are talking of losses in the billions, and a potential bankrupting of some leading industry players.
And it is already happening.
Over the last few years, demand for electricity traded on the National Electricity Market – or NEM – has collapsed by over 900 megawatts and over twice that on forward projections. And wholesale electricity prices on the NEM have plummeted to record lows, down some 40% on just a few years ago.
Until early 2009 the demand for electricity traded on the market grew fairly consistently at around 2% each year. Although there was some slackening in demand before 2009, most industry analysts put it down to the GFC and thought it inevitable we would need another gigawatt or thereabouts of supply to meet 2012 demand.
That is the equivalent of one big new coal-fired power station, about 3 gigawatts of installed wind power capacity or 6 gigawatts of PV.
But instead, in 2009/10 demand actually fell in real terms by 140 megawatts, fell again in 2010/11 by 290 megawatts and again in the last 12 months by 500 megawatts. Compared to 2009, demand is now down by about 930 megawatts, or almost 4%. Compared to the forward projections of just three years ago demand is down by about 2.2 gigawatts or 10%. That is the equivalent of two big power stations we thought we would need, but no longer do.
And since 2010, wholesale prices have collapsed. The average price in the last financial year was a touch under $30 per megawatt hour. That is the lowest average annual price recorded on the market since 1999 and is about 40% lower than the long-term average of around $47, adjusted to 2012 dollar terms. Market revenue was down almost $3.5 billion on the yearly average of $9 billion in adjusted terms, and more than $5 billion on forward growth projections.
These figures give a direct measure of how the electricity market values demand reduction in terms of its impact on wholesale prices or, in other words, the price signal of oversupply. In fact the market is valuing a demand reduction of 1 watt on the forward projection at about $1.40 over the year. That compares to the expected wholesale value for 1 watt-year of electricity of 44 cents.
And so we get an estimate of our multiplier, of 140/44 or 3.2. Factoring in some other price effects such as the prevailing la Niña weather cycle, and a more conservative estimate of the price signal multiplier is probably a bit lower at around 2.5.
That is a very strong price signal, and testifies to the effectiveness of an efficient market. It may explain why generators are less than enamoured by schemes, such as energy efficiency and distributed PV, that take market share away from their business.
Of course, in the face of plummeting wholesale prices, consumers should be asking if they are seeing any of the benefit. Near record increases in retail prices would seem to suggest not and raise a raft of questions such as what exactly is the function of the wholesale market?
Wholesale Prices in U.S. Rise for First Time in Four Months - Businessweek
Wholesale prices in the U.S. unexpectedly rose in June for the first time in four months, reflecting an increase in food costs.
The 0.1 percent gain in the producer price index followed a 1 percent decrease the prior month, Labor Department figures showed today in Washington. The median estimate in a Bloomberg News survey of 70 economists called for a 0.4 percent fall. Excluding volatile food and energy, the so-called core measure increased 0.2 percent as projected.
A. Schulman Inc. and Kennametal Inc. (KMT) (KMT) are among companies anticipating raw materials costs will remain restrained as markets from Europe to Asia cool. Weakening growth in the U.S. also may limit price pressures through the production pipeline, reinforcing Federal Reserve policy makers’ projections that inflation is likely to be subdued.
“I’m not concerned about inflation at all at this point,” said Michael Moran, chief economist at Daiwa Capital Markets America Inc. in New York, who correctly forecast the gain in prices. “Some decline in commodity prices and a slower rate of growth in both the U.S. and globally suggests restrained prices in coming months.”
Stock-index futures held earlier gains after the report as slowing growth in China fueled speculation policy makers will boost stimulus measures. The contract on the Standard & Poor’s 500 Index maturing in September climbed 0.3 percent to 1,333 at 8:44 a.m. in New York. Treasury securities were little changed, with the yield on the benchmark 10-year note at 1.49 percent compared with 1.48 percent late yesterday.
Survey Results
Economists’ estimate for producer prices ranged from an increase of 0.2 percent to a decline of 1.3 percent.
Compared with the same month a year earlier, companies paid 0.7 percent more for goods, matching the 12-month gain in May as the smallest since October 2009.
The core index increased 2.6 percent in the 12 months ended in June, the smallest year-to-year gain since June 2011.
The gains in the PPI were led by a 0.5 percent increase in food, reflecting the biggest increase in meat prices since July 2011, the report showed.
Energy costs dropped 0.9 percent from the prior month, which included a record 2.1 percent drop in residential electricity.
About 70 percent of the increase in the core measure was attributed to a 1.4 percent advance in the cost of light motor trucks, the biggest in a year.
Raw Materials
Expenses further down assembly lines continued to drop last month, indicating price pressures will remain restrained. The cost of intermediate goods decreased 0.5 percent, the third consecutive decline. Crude goods fell 3.6 percent, the fourth straight fall.
Akron, Ohio-based A. Schulman (SHLM) (SHLM), a supplier of plastic compounds, anticipates raw-material costs will be relatively unchanged and said companies from which it buys goods seem to have little pricing power.
“Every month somebody tells us they’re going to increase their price,” Chief Executive Officer Joseph Gingo said on a July 10 conference call with analysts. “And every month, they’re not able to push it through because there is no demand, or soft demand.”
Producers benefiting from retreating costs for oil and other materials include Kennametal, a Latrobe, Pennsylvania- based supplier of cutting tools to manufacturers. The lower expenses will be a “tailwind,” Chief Executive Officer Carlos Cardoso said on a June 6 conference call with analysts.
Fed Outlook
Contained price pressures give the Fed more room to try to spur the three-year expansion. Declining consumer inflation reflected reductions in the price of crude oil and gasoline, and “measures of long-run inflation expectations continued to be stable,” policy makers said in minutes of their June meeting released this week.
Producer prices are one of three monthly inflation gauges reported by the Labor Department. The import-price index fell 2.7 percent in June, the biggest plunge since December 2008, a report showed yesterday. Prices excluding fuel fell 0.3 percent, the most in almost two years.
The cost of living index, the broadest of the three measures, may have been little changed last month, economists predicted ahead of the July 17 data.
To contact the reporter on this story: Shobhana Chandra in Washington at schandra1@bloomberg.net
To contact the editor responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net
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