How energy is bought and sold

What are the main costs behind your electricity bill?

By August 20, 2020January 15th, 2021No Comments
Lightbuld in front of trading board

Ever wondered how your energy provider sets the price of your power?

Like any business, energy companies pass their costs onto their customers – so it’s important for you to be aware of what these costs are, and how the energy market actually works.

Understanding your electricity bill is a good start. But there are four major costs to energy providers, that are then passed on to users, that you won’t see listed on your electricity bill – wholesale costs, retail costs, network costs and government costs.

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Video disclaimer: 5 minute intervals are current at July 2021. 

Wholesale costs

Most of us buy our goods from retail stores, which buy their goods from wholesalers. Well, energy works the same way – you buy your power from an energy retailer, which buys its power from wholesalers which generate electricity.

Energy cost breakdown

Most Australians get their power via the National Electricity Market (NEM). Operating on one of the world’s longest interconnected power systems, the NEM is a wholesale electricity market where electricity is sold by generators to the ‘pool’. Energy retailers buy electricity from the pool and on-sell it to consumers. (In Western Australia, energy retailers buy their electricity from the Wholesale Electricity Market (WEM), but the principle is the same.)

The price of electricity on the NEM changes every five minutes – literally. Every five minutes, generators offer up how much electricity they are prepared to sell, and at what price. The Australian Energy Market Operator (AEMO) accepts these offers, starting from the lowest priced offer and working its way up until enough electricity supply has been secured to meet demand.

The dispatch price for all electricity sold in that five-minute interval is then set at the price of the highest offer accepted by the AEMO, and the market price is set by averaging the last six 5-minute dispatch prices.

Example bid stack graph

The market price is subject to both a floor and a cap price, which is adjusted annually in line with the consumer price index – but within that range, the wholesale cost of electricity is largely determined by supply and demand at any given moment. So, for instance, electricity will become more expensive on hot days when we’re all running air conditioners, or when a disruption like a generator failure limits supply.

These fluctuating wholesale costs are then factored into the price set by your energy company. Most electricity retailers manage the risk of high wholesale prices by entering into long-term contracts at a set wholesale price with energy generators – therefore limiting customer exposure to high prices when demand outstrips supply.

In 2019/20, the generation costs of electricity made up approximately 39 per cent of the total electricity price Queensland residential consumers paid.

Network costs

It’s one thing to generate the energy, and it’s another thing to get that energy to you. Power stations are normally located a long way from the places they’re powering, so network costs are the costs of transporting electricity to homes and businesses.

This includes not just the operation of utility poles and power lines, but the cost of building and maintaining them. Network infrastructure needs to be able to meet demand at its peak, which usually amounts to a period of less than 100 hours per year. While it might seem unnecessary to build infrastructure with such a small period of time in mind, the alternative is that the network would simply not be able to cope with these usage spikes when they occur, and you would lose power when you need it most – like on a 40 degree day in the middle of summer!

Network costs are incurred by distributors, which pass them on to your energy retailer, which pass them on to you. Because different areas are serviced by different distributors, these costs can vary from one network to the next.

Network costs account for the largest part of consumers’ energy bills – 49 per cent for Queensland residential consumers in 2019/20.

Electricity Supply Chain

Retail costs

When you think about your energy bill, you might not think about the time and expense your energy company puts into things like answering customer enquiries over the phone, managing customer accounts, or even sending out your bill in the first place – but these are all factors in the price of your power.

Retail costs are the costs your energy supplier incurs in providing retail and customer services. Most retailers will try to minimise these expenses as much as possible – in 2019/20, they accounted for just six per cent of the total electricity price paid by Queensland residential consumers.

Environmental costs

Federal and State Government regulations can also add costs to your energy bill. Your energy retailer’s contribution to compulsory governmental environmental schemes like the Renewable Energy Target, for instance, is classified as a government cost.

In 2019/20, these costs made up approximately seven per cent of a Queensland residential consumer’s energy bill.

Ultimately, an energy retailer is like any company – its goal is to recover its costs and make a reasonable margin of profit. By understanding the costs involved in getting energy from a generator to your light socket, you can make a more informed decision about who you choose to provide your power.