A new report by Tony Wood and Lucy Carter, of the Grattan Institute, Fair Pricing for Power, says that over the past five years the average Australian household's electricity bill has risen by 70 per cent to $1660 a year. And this has been happening while the amount of electricity we use has been falling, not rising. Just why electricity demand has been falling is a story for another day. The cost of actually generating the power accounts for 30 per cent of that total. The cost of delivering the power from the generator to your home via poles and wires – that is, the electricity transmission and distribution network – accounts for 43 per cent of the total. That leaves the costs of the electricity retailer – the business you deal with – accounting for 13 per cent of the total bill, with the carbon tax making up 7 per cent and the various measures to encourage energy saving or use of renewables making up the last 7 per cent. Of these various components, the one that does most to account for the rapid rise in overall bills is the cost of the physical distribution network. Whereas there's fierce competition between the now mainly privately owned power stations, the network businesses – still government-owned in NSW and Queensland, but privatised in Victoria and South Australia – are natural monopolies.

This means the prices the networks are allowed to charge – whether government or privately owned – are regulated by government authorities. And this is the source of the problem. Loopholes in the price regulation regime have made it easy for the network businesses to feather their nest at the expense of you and me. Why would a government-owned network business want to overcharge? Because their profits are paid to the state Treasury, which needs all the cash it can get. So the NSW and Queensland governments gain by looking the other way while their voters are ripped off. The gouging hasn't been nearly as bad in privatised Victoria, where electricity prices are well below the national average. An earlier report from the Grattan Institute identified four main faults in the system used to regulate the prices of network businesses: the pricing formula allows excessive rates of return, considering essential monopolies are low risk; government ownership leads to excessive investment in infrastructure and reduced efficiency; reliability standards to prevent blackouts are wastefully high; the pricing formula rewards investment in facilities you don't really need. The various combined state and federal regulatory bodies have belatedly begun attempting to fix these problems, but they could do a lot more if the politicians prodded them harder. Meanwhile, the latest Grattan report proposes a solution to one aspect of the over-investment problem: coping with peak demand. The trouble with electricity networks is that, if you want to avoid blackouts, the network has to be powerful enough to cope with the periods when a lot of people are using a lot of electrical appliances at the same time, which these days is a hot afternoon.

Over the course of a year, these occasions are surprisingly few, so you end up having to build a lot of capacity, which is expensive, but then is rarely used. It would make far more sense to encourage people to avoid such extreme peaks in their demand. The way the pricing system works at present, however, is that far from discouraging people from buying airconditioners and turning them on full blast on very hot afternoons, they're subsidised by those householders who don't. The simple answer would be for the part of people's bills that relates to their share of network costs to be changed from charging for how much power they use to a capacity-based charge. That is, they pay according to the maximum load they put on the network in peak periods. The result would be to remove the subsidy between high and low-capacity users, increasing or reducing their bills by up to $150 a year. The greater benefit would be the price signal sent to high-capacity users to reduce their use of appliances during peak periods and save. As people responded to this incentive, the need to keep adding to the network's capacity would fall, thus reducing the need for higher electricity prices.