Demand for Electricity and its Determinants in Australia: Policy Implications

What the paper says

ABSTRACT: The electricity industry has emerged as a crucial driver of the Australian economy, undergoing significant transformations shaped by industry reforms initiated in the early 1990s. These reforms include the introduction of full retail contestability in the electricity markets to stimulate competition by encouraging new market entrants in the retail sector. This paper investigates the response of residential electricity consumers to these reforms by estimating residential electricity demand as a function of consumer income, electricity price index, gas price index, and two temperature variables. The analysis employs annual data spanning from 1989 to 2019 and applies the Autoregressive Distributed Lag (ARDL) framework, a bound testing approach to cointegration, to estimate both long-run impacts and short-run dynamics. The ARDL framework is particularly advantageous in this context, as it accommodates variables with different orders of integration, includes lagged variables to capture the dynamics and time lags in electricity demand and its determinants, and provides consistent long-run demand elasticities with superior sampling properties especially in short time series spans like the one used in this study. The findings of this study reveal that electricity prices and gas prices are the primary determinants of long-run electricity demand, while short-run demand changes are predominantly influenced by consumer income. Specifically, the study finds that a 1 percent increase in the electricity price leads to a 1.34 percent reduction in the quantity demanded for electricity. The elastic nature of electricity demand suggests that price increases could serve as an effective tool for long-term energy conservation. However, the unpopularity of price hikes, particularly among low-income consumers, makes policymakers cautious about implementing Pigouvian taxes aimed at reducing greenhouse gas emissions through higher electricity prices. The error correction model indicates that consumers do not treat electricity prices as a control variable in the short run, likely because electricity is an essential commodity with few substitutes in the short term. These results have important implications for policymakers seeking to promote sustainable energy consumption. Price-centered policies could be effective in curbing electricity consumption in the long run, as the negative impact of price increases is expected to outweigh the short-term positive effects of income growth on demand in a growing economy.