The cause and consequences of lowering of electricity price in Hong Kong

25 April 2017

Aude Pommeret and Lin Zhang

On December 13th, 2016 Hong Kong Electric (HKE) announced a reduction in the Net Tariff by 17.2% starting January 1st, 2017. In the meantime, CLP announced the frozen Average Tariff for 2017 with a rebate. The official justifications provided by HK Electric were first that in reducing its electricity price, the utility was returning to customers the refunds HKE had received from government as rents and rates had been overcharged in the past. Second, the operating cost of the utility had been lower than expected due to lower fuel costs.

At first sight, this price decrease seems to be a generous move from HKE with the utility sharing part of its profits with the consumers. It is in fact far from being the case. Recall that the tariff encompasses three components.1 The first is the Basic Tariff, the second comes from the Fuel Clause Recovery, and the third concerns the rebates from the Tariff Stabilisation Fund and the Rate Reduction Reserve.

Since January 2017, the Basic Tariff has in fact increased by 3.2% (going from HKD105.5 to HKD 108.9). However, it has been more than covered by a rebate of 3.8% (from HKD108.9 to HKD104.9) and more importantly by an adjustment of the Net Fuel Clause Charge going from HKD27.9 to HKD5.5 that is, decreasing by 64%. All in all, the total Tariff has therefore decreased by 17.2% (going from HKD133.4 to HKD110.4). The total decrease is therefore mainly due to the fuel clause (see the following figure).

As acknowledged by HKE itself, the current price decline is viewed as a strategy to help customers prepare for the tariffs changes with the projection of increased fuel price: HKE will increase the use of natural gas from 33% of electricity generation (present) to 50% by 2020, which will generate a rise in tariffs as natural gas is more expensive than coal.

What needs additional attention is that HKE takes advantage of the Net Fuel Clause Charge to increase the Basic Tariff, which is hardly noticeable to the public. This is because the increase in the Basic Tariff is hidden behind the huge decline in the Net Fuel Clause Charge, and this part of the tariff will not decrease in the future to compensate for the increase in the Net Fuel Charge. In doing so, HKE enjoys a higher Basic Tariff together with a Fuel Clause Charge increase adjusted to the larger share of gas for electricity generation. Therefore, what HKE has done is to exchange some current profits for secured future profits, but certainly not sharing benefits with its customers.

If this were happening with no harm to the rest of the economy, HKE’s decision on current tariffs in order to secure future profit would not be so bad. This is, however, not the case. There are several economic and environmental impacts to be taken into account.

By adjusting tariffs up and down frequently, HKE is generating fluctuations in the price of consumers’ purchases and creating uncertainties as consumers face incomplete information regarding HKE’s pricing strategy. Uncertainty will increase the precautionary savings of individual consumers. In the end, this reduces the welfare of consumers who make financial decisions over their lifetime in order to smooth their year-by-year consumptions.

At the same time, the lowering the of electricity price is very likely to increase electricity consumption, which obviously has some adverse consequences for the environment, as a large part of electricity in Hong Kong is generated using fossil fuels. In 2008, the HK government offered a HKD 3,600 per annum of electricity subsidy for each household and it had already been perceived by local environmental groups as counterproductive to the earlier initiatives to promote energy saving (the subsidy has been abandoned in 2015). 2

In fact, we can perform simple calculations to estimate the potential environmental impacts. In economics, the change of electricity demand with respect to the price change can be measured by the price elasticity of electricity. Based on the electricity consumption and the price change between 2015 and 2016, the price elasticity across all sectors in HK is about -0.3. For the residential electricity demand, the elasticity is as high as -1.8. Given the 17.2% decline in electricity price, total electricity demand and residential electricity demand are therefore expected to rise by 5.16% and 30.96%, respectively. This is equivalent to 13350 Terajoules of electricity demand increase per year for HK residents.

Considering the fuel mix in Hong Kong’s electricity generation, the price decrease in electricity will result in more emissions: 2.23 million tonnes of CO2 equivalent, 1484 tonnes of SO2 and 2251 tonnes of NOX per year will additionally be released in the atmosphere. These additional emissions will implicitly increase potential health problems and the costs we have to pay for pollution mitigation and adaptation.

Therefore, a careful analysis of the reasons behind HKE’s decrease in tariffs and of the consequences, suggests that HK residents should not take it as good news. Alternatively, there is another way HKE can secure future profits together with a cleaner environment: HK utilities are constrained to a maximum return of 9.99% based on electricity generation from fossil fuels. However, they can enjoy an 11% return if they were to use renewables instead. Of course, it would have different implications on their tariffs, which may not be so popular, but this is another story….

1https://www.hkelectric.com/en/OurOperations/Documents/HECsca_full_Eng_.pdf
2 See Daphne Mah and Peter Hills, 2016 “An international review of local governance for climate change: implication for Hong Kong” Local Environment 21(1), 39-64.