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Will high energy prices derail Australia's return to trend growth?

Will high energy prices derail Australia's return to trend growth?

Australian electricity and gas prices are expected to remain elevated in coming years. What will be the impact on corporate Australia and the broader economy?

The loss of coal-powered generation from the National Electricity Market (NEM) has outpaced new renewable energy supply.

Compounded by renewable energy’s intermittent nature, the NEM has become increasingly reliant on gas for baseload power.

Gas therefore increasingly influences domestic electricity prices - gas electricity generation set the electricity price 24% of the time in May 2017 versus 9% in May 2014.

Meanwhile, the development of huge LNG exporting plants in Queensland is changing the dynamics of domestic gas pricing.

Some plants have drawn on what was cheaper domestic gas to fulfil their export contracts.

Consequently, domestic gas prices rose towards international LNG prices.

With LNG production now accounting for around 70% of gas consumption on the east coast, the link between domestic and international gas prices looks locked in for the foreseeable future.

Linked to international oil prices

Queensland’s LNG exports have long-term contracts with Asia at prices that are linked to international oil prices.

That means Australian electricity prices are now effectively being set by oil prices.

Analysts at CommBank don’t see this changing until new renewable energy supply displaces enough gas powered generation.

That requires improved energy storage capabilities. 

CommBank's commodity research report predicts continuing high electricity prices. Some of the reasons include:

  • time taken to ramp up the required amount of renewable generation
  • electricity prices of $100/MWh needed to support investment in renewable generation and the associated ‘firming costs’ of guaranteeing non-intermittent power.

Fortunately, electricity and gas only represent around 3% of business costs overall although some sectors, such as manufacturing, are more heavily exposed.

The report outlines four ways that companies can mitigate sustained high prices. Nevertheless, corporate Australia - and the broader economy - are exposed to higher energy costs.

Households feel 'under pressure'

Households appear to be feeling that their financial situation is under pressure and CommBank surveys show that perceptions about personal circumstances have typically run below average in recent years.

People report being worried about job security and many are carrying high levels of debt amid talk of interest rates rising.

Cost of living - school fees, health insurance and utility charges - is rising faster than the Consumer Price Index (CPI) and wage growth.

Commonwealth Bank, BPay and direct debit data imply household energy bills rose 16% in the September quarter as recent price increases filtered in.

Households are under pressure to cut spending elsewhere.

Outlook for growth

Despite this, CommBank believes that Australia’s economic outlook is good because:

  • the synchronised global upturn supports industrial production that drives commodity demand and commodity prices
  • after four years of falling commodity prices dragging on income, prices have recovered and stabilised
  • following three years of falling mining capex weighing on spending and jobs, the adjustment is nearly complete

So it is expected that as a result of this, it should be easier for the economy to grow from here.

Where can the growth come from?

  • resources are moving into the production and export phase, with much of the LNG export growth locked in by contracts
  • a major lift in infrastructure spending involving multi-year projects is underway, with spending on transport infrastructure over the next two years expected to be worth 1% of gross domestic product (GDP), while the Federal Government has committed a further $75bn over 10 years
  • growth in Asian incomes continues, driving growth in Australian tourism and education exports
  • Asia's burgeoning middle class also supports Australian agriculture and manufacturing, and eventually, the health and financial services sectors, all big parts of the Australian economy.

Therefore, we predict GDP will lift from 2% in 2017 to 3% next year. That will keep downward pressure on unemployment, and eventually flow through to inflation and wages.

Thus the next move in interest rates may be up, but the Reserve Bank of Australia (RBA) could leave rates unchanged until well into 2018.

This article is solely for information purposes and has been prepared without taking account of the objectives, financial situation and capacity to bear loss, knowledge or experience or needs of any specific person who may receive these insights. The writer believes that the information in the insights is correct and any opinions, conclusions or recommendations are reasonably held or made, based on the information available at the time of its compilation, but no representation or warranty, either expressed or implied, is made or provided as to accuracy, reliability or completeness of any statement made in the article. Any opinions, conclusions or recommendations set forth are subject to change without notice. Any projections and forecasts are based on a number of assumptions and estimates and are subject to contingencies and uncertainties. Different assumptions and estimates could result in materially different results. All analysis and views of future market conditions are solely those of the writer. The Commonwealth Bank do not accept any liability for loss or damage arising out of the use of all or any part of the article.