Wholesale prices are the price of generating electricity and have historically represented around 35% of the final bill for households. There are three key drivers of wholesale prices:
- the cost of building new generation: if capital costs and financing costs for new projects increase, then wholesale prices are also likely to increase
- supply and demand: how much generation is available relative to demand
- the cost of operating existing generation: if input costs, such as coal and gas prices, increase then electricity prices are also likely to increase.
Contrary to much of the existing commentary, it is a combination of the second and third drivers that has resulted in prices increasing to unprecedented levels.
First, let’s look at input costs. The price of coal and gas has surged as a consequence of the Russian invasion of Ukraine.
Due to formal sanctions and informal shunning of Russian exports, thermal coal prices have increased five-fold to an unprecedented $A600 per tonne. This has increased the cost of energy from coal-fired generation to over $250 per megawatt hour. Gas prices have also increased substantially as a consequence of sanctions against Russia. Prices jumped from $6-12 per gigajoule in the first three months of 2022, to around $50 per gigajoule at the end of May. They were so high that regulators intervened and capped prices at $40 per gigajoule. Prices have since fallen to around $30 per gigajoule, but still make the cost of running gas over $300 per megawatt hour.
The second impact is the significant reduction in supply from power stations taken offline for unexpected maintenance or due to fuel shortages from extreme weather.
The third impact is the ability of the construction sector to build the significant amount of renewable energy sources and transmission grid to reduce the electricity prices. The construction sector, as with other sectors, is constrained by labour and material supply.