Australia’s energy problem

Energy prices. The environment. Climate change. Saving the planet. These issues seem to be increasingly topical, but many of the discussions are not grounded in fact. Below we explain the current state of play when it comes to energy usage in Australia and consider the path forward.

Australians do not use energy sustainably

Each Australian annually uses energy corresponding to 5.7 tonnes of oil. This is in the same range as the US (6.9 tonnes) but much more than the rest of the world, including China and Europe. In other words, there is a lot of room for Australians to use less energy by using more efficient materials and machines or making lifestyle changes.

Australians rely on fossil fuel for about 94 per cent of their total energy needs. The only countries that rely more on fossil fuel are either oil producers (such as countries in the Middle East, North Africa, or the former Soviet Bloc), coal producers (such as Poland) or countries with limited resources (such as Trinidad).

Comparing Australia to other large economies, we rely more on fossil fuel than oil, gas and coal producers (such as the US, China) and materially more than countries that have made fighting climate change a priority (such as those in the EU).
 

The consequence of this intensive use of fossil fuel is that Australia, with less than 25 million inhabitants, emits about 400 million tonnes of CO2 annually.
This is comparable to what is emitted by the 66 million residents of the United Kingdom (410 million tonnes) or the 80 million residents of Turkey (398 million tonnes).

Looking at per capita emissions, each Australian emits about 16 tonnes of CO2 every year. That is about four times as much as the world average and two and a half times as much as developed economies in Europe.
 

Political intervention triggered by higher bills

Coal is the king of Australian power production with a 61 per cent share of the mix. The only countries that rely more on coal are South Africa, Poland, China, India and Kazakhstan. Australia’s use of wind and solar is comparable to the rest of the world but it has very limited hydropower. As a result, Australia relies on fossil fuels produced locally for about 85 per cent of its power production.
 

Australia is the world’s top liquified natural gas (LNG) exporter and the world’s top coal exporter. It exports more than two-thirds of its gas and about 85 per cent of its coal.

There is limited appetite for additional coal fired power plants due to the amount of pollution they produce and gas plants are hurt by the cost of gas.

Australian gas is becoming more expensive as recently-built assets are geared to export, and Australians have the unpalatable choice to either compete with Asian buyers or source gas from ageing fields whose operating costs increases year after year.

Renewable energy has helped reduce the dependency on coal and gas in other countries. Investment in wind and solar is supported across Australia by subsidies, at both the federal and state level. Most of those subsidies are funded by customers, rather than general taxation.

Today, renewable subsidies represent four to eight per cent of the typical consumer bill of A$76-$170.

This varies by state depending on the growth of renewables and the layer of support given besides federal programs. Unsurprisingly South Australia is the state whose residents pay the most for renewables.
 

The rise in coal and gas prices, and to a lesser extent the bill surcharges to fund renewables have added to the combined power and gas bills. In aggregate, Australians of median income now pay about 4.8 per cent of disposable income for power and gas, whereas they only paid 4.4 per cent in 2016.

As for lower income households, they now pay about 10.6 per cent of their disposable income for power and gas, whereas two years ago they paid 9.6 per cent.
These increases would have been higher if the allowed return for power and gas networks had not been cut by the regulator.
 

That pressure on disposable income for households is also faced by industrial companies. This has brought greater scrutiny on the power and gas industry and has already triggered the following political and regulatory interventions:

• Regulators are forcing greater transparency on networks, and besides cutting allowed returns have generally toughened regulation; and
• From July 2019 Australians will benefit from automatic switching to a ‘default offer’ regulated by the Australian Energy Regulator. Customers on expensive tariffs will automatically be switched to this lower offer. For people on the higher tariffs, this could save hundreds of dollars.
   

The way forward: the cheapest and cleanest energy is that which you do not use

AMP Capital has decades of experience investing globally in power and gas assets. As long-term investors, we are called upon to fund new investments or support companies during times of transition. In our experience energy policy has the following pillars:

• Safety of supply: the nation has access to energy, and if possible that energy is domestic or from friendly countries;
• Affordability: residents and business only need a modest share of their income to pay their bills; and
• Environment: environmental damage is avoided or remediated.

These three objectives each cost money and are often divergent (for instance, coal is great for safety of supply and affordability, but is a high pollutant). This means that energy policy is about priorities and investment.
As we look at opportunities in the Australian energy market, we believe that the introduction of renewables can help in two ways:

1. If the renewables are commercially contracted over the long term it will reduce Australia’s dependency on coal and gas, and thus reduce the exposure of ordinary Australians to fluctuations in international energy markets. Instead it would give greater visibility and stability in pricing, aiding both affordability and the environment.
2. As renewables are intermittent (the strength of the wind and sunshine changes during the day they need to be backed up by power plants that can react quickly. These so-called peak plants do not need to be built - Australia can, for a limited amount, convert and subsidise existing assets that are largely amortised to play that role. This would help ensure safety of supply and protect jobs in those plants.

However we believe the real way forward is for Australia to commit to the cheapest, safest and cleanest form of energy: the energy that is not used. Australia should invest much more in energy efficiency and thus cut bills and pollution materially.

While there are upfront costs (upgrading buildings, replacing vehicles, changing machinery) the long-term savings offer a return and the short-term effort creates and supports many jobs and can dramatically improve the living conditions of the less fortunate Australians.