Published by The Australian Financial Review, Wednesday 3 December
Reform of electricity network tariffs is about to become a blood sport. Last week the Australian Energy Regulator (AER) announced draft decisions about how much the businesses that run networks in NSW and the ACT can charge consumers over the next five years. The companies want to charge $24 billion; the AER has reduced this by a whopping 32 per cent. The businesses and their industry association are not happy and the gloves are off.
The draft decisions were made under new rules set by the Australian Energy Market Commission (AEMC) two years ago. By coincidence, the AEMC also made rule changes last week. These will require network prices to better reflect the cost of meeting the increasingly diverse ways in which electricity is being consumed today.
The vital backdrop to this dispute is that over the five years to 2013 the average Australian power bill increased by 70 per cent. Australians are paying too much for electricity because the way network prices have been set is broken. The Grattan Institute estimates that fixing it will deliver savings of more than $2 billion a year. Reform of electricity tariffs is urgently needed for a second reason: to prevent some consumers paying more than their fair share.
Grattan’s 2014 report, Fair Pricing for Power, recommends a different way of charging that could, over five years, save network businesses nearly $8 billion in reduced investment, with the savings passed onto consumers as lower bills. These problems have several causes. Electricity distribution networks are natural monopolies, so the laws of the pure market cannot apply.
Time to restore balance
Therefore the government requires the AER to set the revenue a company can collect from consumers in order to fund the company’s investment and costs.
Historically, it has allowed these businesses to make unduly high profits, given the relatively low risks they face. In addition, the regulation of network businesses has not been responsive to changes in financing costs. The AER allowed companies to set prices based on the projected cost of finance over five years. But when that actual cost fell, the benefit was not passed on to consumers in lower prices.
Nor was it passed on when electricity demand began to fall over the past decade; instead, the regulator accepted optimistic forecasts of rising demand, allowing the businesses to maintain high profits. It is time to restore the balance and the AER has moved to do just that. It has knocked back excessive claims for capital and operating costs, inappropriately high rates of return and forecasts that fail to reflect falling consumption levels.
As a result, its recommendations could deliver savings to average households ranging from $160 to nearly $350 a year. Separately, the AEMC’s proposed tariff reforms would change the way networks charge for usage, raising prices for those who use more power in periods of peak demand and reducing them for those who use less power in these times. Cost-reflective pricing, as the proposed reforms are called, would remove subsidies that on average cost households and small businesses about $150 and $2000 a year respectively.
In the long run, consumers will respond to cost-reflective tariffs by reducing their use at periods of peak demand when the system is most under strain. As a result, unnecessary infrastructure to cope with peak demand will no longer be built, and higher prices will be avoided.
Critical next steps
Yet the AEMC’s decision still leaves too much power with the businesses, potentially allowing them to game the process again. The AEMC envisages “gradually moving to new network prices over several years”. That’s too slow. Consumers have been disadvantaged for too long and the Council of Australian Governments’ standing council on energy should be demanding clearer outcomes and a more aggressive timetable.
The next steps will be critical. Affected network businesses will be able to submit revised proposals in early 2015. Stakeholders will be able to respond to these proposals before the AER decides by the end of April.
We can expect the businesses to run a sustained public campaign to maintain the status quo, and we should not be surprised if that includes claims of threats to investment, safety and reliability if reform proceeds. In fact it’s already begun.
The journey on which our regulatory bodies have embarked is one of the most important in the recent history of energy network regulation. It is vital that completing the journey does not become mired in process and legal argument.
The history of energy market reform in Australia is already littered with the wrecks that foundered on such rocky shores. Australians are tired of paying too much for power. If politicians and regulators do not stand firm, they will miss a once-in-a-generation opportunity to make prices fairer and cheaper for everyone.