In the past year, Australians have been navigating the rising cost of living, including increased electricity and gas bills.
One tool which gives us an insight into electricity prices for the next financial year is the default market offer (DMO), a draft of which has recently been released by the Australian Energy Regulator. The DMO suggests electricity prices will rise by an average of 20 per cent in the coming year.
In this podcast, Tony Wood, Energy and Climate Program Director, and Alison Reeve, Energy and Climate Deputy Program Director, discuss what the DMO means for electricity prices and consumers, in a conversation facilitated by Esther Suckling, Associate.
Transcript
Kat Clay: In the past year, Australians have been navigating the rising cost of living, including increased electricity and gas bills. One tool which gives us an insight into electricity prices for the next financial year is the Default Market Offer, a draft of which has recently been released by the Australian Energy Regulator.
The DMO suggests electricity prices will rise by an average of 20 percent in the coming year. I’m Kat Clay and today on the podcast, we have a conversation between three members of our climate and energy team, including Tony Wood, our program director, Alison Reeve, deputy program director, and All facilitated by associate Esther Sackling discussing what the DMO means for electricity prices and consumers.
Esther Suckling: So let’s start with the basics, the DMO 101. So Alison, can you please explain to me what the DMO is and how it works?
Alison Reeve: The DMO or the default market offer is, it’s kind of like the plain vanilla flavor of electricity contracts. So for about five years, every electricity retailer has been required to offer to, to all their customers who want it, what’s called the default market offer.
And that offer is the same regardless of which retailer you’re with. The prices in the retail, in the DMO are regulated every year. That kind of has two effects. It gives you an easy way to compare between retailers or to compare offers from one retailer because you have a common reference point. And the other thing it does is it sort of acts like a price cap or a safety net in the market, because it’s not in any retailers interests to offer people prices that are higher than the default market offer.
When the default market offer is made every year, that puts Almost a lid on, on prices above which most retailers aren’t going to go. And it also means if you are thinking of changing your electricity contract, you’ve got something that you can compare to.
Esther Suckling: Just a quick follow up there, Alison. Why was the default market offer introduced?
Alison Reeve: Partly because people were worried about electricity prices a few years ago. They, they had gone through a period of rising rather than a period with just seen where they were falling. Tony, maybe you want to talk a little bit about how they relate to some of the other pieces of legislation that were going on at the time as well.
Tony Wood: Yes, I think there was a interesting, this was happening under a federal coalition government that normally would be a very strong supporter of markets. But what we were seeing happening was, the government’s doing two things. First, you’re becoming concerned that the market wasn’t delivering What they would hope, either governments or consumers.
And that was true of both a federal and a state level. In particular, they were worried about the behavior of some of the energy companies, that they weren’t passing on a cost decreases through to consumers, that they weren’t competing as they should compete to try and bring down prices. And so they introduced a number of pieces of legislation, the one which was Most headlined at the time was the big stick legislation, which probably wasn’t a very big stick.
And most of the time was kept in people’s pockets anyway, but that’s what it was supposed to, it was supposed to be a threat. Governments sometimes find that, you know, heavy handing companies is not a bad idea, particularly from consumers who feel as though, you know, Big companies take advantage of them.
So part of that was to say, look, we’re also finding that, whilst competition is delivering for those people who are prepared to seek out the best deals in the way that Alison was describing, we’ve also found that a lot of customers don’t. We do know that a lot of consumers. Found the electricity system, retail competition, far too complicated.
And at the time we didn’t have some, even some of the simple. Comparator sites we have today where you can easily go online and compare, not just the DMI was Alison said. But also the other retail offers that are being made. Cause sometimes a retailer might offer you a deal. That’s actually got some best good things in it that you are prepared to pay more for.
And so the government decided, look, what we really should do is provide this safety net as Alison described it. So that people who are finding it just too hard, to shop around and get a bit of deal have got that safety net. And that’s what they did. They introduced that safety net. It’s been now going, this is the fifth time, that’s been, put in place has been reviewed on average for the last five years now, and that’s what we’re seeing happen.
So it was an attempt to ensure that people for a commodity like electricity were able to get a fair price, but also. Allow retailers who could do better either on price, providing a lower price or providing a price that had more benefits could still do that, but they were required to offer the DMO. That was the basis of what was put in place.
Esther Suckling: That brings up sort of an interesting clarification that the DMO is in many cases, not the lowest price that a retailer will offer. If you do look around, there are often better deals, but it gives you that cap on What the default price can be. I want to move on now to the AIR’s decision. We’ve heard about this 20 to 22 percent increase in the DMO for this coming financial year.
Tony, I’m wondering what’s driving this increase. And does this suggest that the Albanese government’s intervention with the price caps on wholesale gas and electricity aren’t working the way we wanted them to?
Tony Wood: I think this is the, the second year where we’ve seen the wholesale component of electricity being a driver of price increases, more so than we’ve seen in the past.
We go right back to when the network prices were the ones that were driving up the, the cost of electricity. So the price that We pay, to the, to the, for our electricity, we pay it to mostly to a retailer, either through the default market offer or whatever offer we’ve negotiated. That price includes, all the costs the retailer bears.
By introducing a default market offer or a regulated price, that means the regulator has to take a view on what those costs should be. And that means they have to say, well, okay, what would an efficient retailer have to incur in terms of costs and how should they pass that through to their customers?
That’s obviously a difficult calculation because it goes counter to the whole principle of retailers competing to come up with better deals but that was the nature of what we had for an essential service. The regulator then has to work out okay what’s been going on here as we look at what the cost retailers incur and what’s happened to those costs over the last 12 months and and what we think is going to happen in the next 12 months.
So two things have happened this year that have made life very difficult and contributed to this 20 percent headline price for what it’s meant. Is it the wholesale component? So there’s the wholesale cost of producing electricity. There’s the network charges of delivering that electricity to your house or business.
There’s the cost that retailers themselves incur. And there’s a number of other charges like environmental obligations that businesses have to incur in providing you with, for example, more renewable energy. All those things have to be added up. The wholesale component. Has been somewhere between 30 and 40 percent of the bill.
This time it’s gone up significantly by somewhere around 50 or 60 percent itself, but because it’s only been 30 percent of the bill, that means it’s flowed through to the major impact of the 20 percent you’ve been talking about. So that’s where the, how the arithmetic works. Why has it gone up so much?
Well, two things. Firstly, many of the people who maybe listened to this podcast would recall, there was what was last year called the unprecedented, unprecedented energy crisis. It was so bad because of a range of circumstances, the Ukraine war, flooding of coal mines, coal fired power stations being offline.
All those things contributed to a very difficult situation, so bad that the regulator had to step in and basically suspend the market. In doing so, they incurred a lot of costs. Those costs are now being passed through to the retailers and to us consumers. That’s part of the 20%. And the other thing is that the wholesale prices themselves have decreased from where they were in the middle of last year, but they’ve not gone back to where they were a couple of years ago, so we’re still seeing some of that higher underlying costs coming through last November, the treasurer announced that.
The best estimates they were seeing was across a couple of years, we could see electricity price increases of more than 50%. That was scary. It was certainly enough to scare the government into leaning, as you said, Esther. They then, through the federal government, put a cap on gas prices. Queensland and New South Wales governments put a cap on coal prices.
That has had an impact. It’s hard to say precisely how much because other things have occurred in the overseas markets as well. The net result, however, is that the underlying wholesale prices look like they’ve come down, heading down and the federal government can claim some credit for that. Those other underlying issues are still there.
So we’ve seen a situation where 20 percent is a nasty price increase. To be told that it’s less than it would have been if the government hadn’t intervened is not exactly great, comp, compensation, but that’s the reality of where we are now.
Esther Suckling: Claire Savage, who is the head of the AER said that they would have seen between 40 to 50 percent increases in the DMO, if not for that market intervention.
So that gives a bit of a sense of how this has played out. You know, control the situation that we see today. I want to take a slight sort of turn into a bit of a different territory. We’ve seen a lot of households in the past few years increasingly focusing on electrification and switching out some of their gas appliances for Potentially more efficient electric appliances, something like this announcement of another bump to electricity prices could potentially leave households wondering whether electrification is actually the right solution and whether they might be better off staying on gas from that price perspective.
Should these high electricity prices be making consumers wary of the making that switch for their home.
Alison Reeve: I think the thing to remember is that gas prices are going up as well. Whichever way you go for the next couple of years, you’re probably going to be paying prices that are much higher than the long run average because we are in an extraordinary situation.
You could almost say we’re paying wartime prices at the moment because a lot of these can be traced back to the war between Russia and Ukraine. For households who are thinking of switching, it’s not necessarily the case that just because the electricity prices are going up that they’re not. Nest not going to save because their gas prices will go up as well.
The other thing I think for households to bear in mind here is that hopefully this little period of of high prices is a short period but when we’re buying new appliances for our homes we’re usually expecting that those will last 15 years or longer. You need to sort of have an eye on what the long term situation is going to be as well.
Longer term we know that Some state governments like the ACT government, for example, have already announced that they’re going to phase out the use of gas in homes altogether. Other governments like Victoria have started at least the process of thinking about how they do that. So investing in gas appliances right now, potentially is not the greatest investment you could make because you might be having to switch later to electric anyway.
Largely it is up to households to decide what they want to do, but the long term direction of the whole economy really, not just residential, is towards greater electrification and less use of gas.
Esther Suckling: One other question I had, the DMO is a way I’ve heard from both of you to constrain prices and make sure they don’t exceed a certain level.
I’m wondering, is there a better way to control energy prices for consumers? So the announcement last year of the Victorian government rebooting the state electricity commission, the SEC, that has been proposed by Dan Andrews as away in part to bring down electricity prices. Tony, do you think that is a given?
Tony Wood: What would you say? There’s several things that could emerge here. It was never necessarily the case that a permanent DMO would be necessary because the idea was to get everybody onto a better deal and that’s what it did and sometimes people could still find better offers even better than the DMO.
Having done that, one thing you could think about is, well, do we even need the DMO anymore? Because at least that would still be there as the, as a base. Could you simply Escalate that at CPI, not worry about doing all these complicated calculations. I suspect governments are nowhere near ready to do that.
They like having the DMO in place and they like being able to influence prices that way. So what else could you do? Is it an alternative? Is there a better way of doing this? Well, at the time the Victorian version of the DMO was introduced, it’s called the Victorian default offer. There was a consideration at the time of maybe It would be easier to have a government owned retailer who would offer a no frills, no extras offer, similar to the DMO, and that would then be an alternative that could be used even for people on concessions, low incomes, whatever, would be available.
Similar in principle. to the DMO. When they looked at that, they decided that actually trying to create a business that would compete in the market, would have to still contract for electricity the way the existing retailers did was a bit too complicated. And they decided that it would be a lot simpler just to have the DMO.
There’s been some consideration, of course, with the idea of, reinventing or reincarnating the SEC that it could do the same thing. You wouldn’t need both. So I think before They just, the government decided or not that the, this new SEC might be an energy retailer. You’ve got to sort of question, well, what extra benefit could it provide above having the DMO?
Cause you’d have to set up a business, we’d have to do all the same things, more or less as an existing retailer. It seems to me that’s unnecessary because the DMO does that job. But I have some sympathy for the argument that, we need some form of, of regulation. And to be fair. I’m actually surprised that it, I think it’s actually worked better than I thought it would in terms of the DMO.
I thought that, we wouldn’t see the sort of benefit we have. And I think the industry, the industry has got used to it. And sometimes if it’s working okay, then don’t bother to change it fundamentally. Just make sure that it is delivering what it’s supposed to do. And when the, the regulators do their analysis of what the costs are, that they’re doing that as efficiently as they possibly can.
Alison Reeve: It’s interesting. When you look at the number of people who are on the DMO, it’s actually gone down a little between last year and this year, which might mean that there are more people who are actively looking around and going, am I on the best deal? From that perspective, it is potentially having the impact that it should have.
I think the other thing to remember about whether or not government owned retailers or government owned businesses deliver cheaper costs or not, we need to remember that most of the electricity industry in Queensland is still government owned and they’re still facing a 22 percent price rise this year.
So it doesn’t necessarily correlate that a greater level of government ownership leads to cheaper prices because as Tony said, there’s a lot of factors at play. And governments would still have to go and buy coal for coal fired power stations. They would still have to go and buy gas. They would still be exposed to the international prices when they do that.
They would still need to run a retail business in much the same way that a private sector retailer would. They still have to have a call center. They still have to have a billing system. And all of that kind of still all costs the same amount of money. So it is actually hard to see where you’d really squeeze out a big price difference by having a government owned.
Esther Suckling: Just a question that I thought of whilst you were saying that, Alison, we think a lot when we talk about energy price increases about the household and the families living in those households. What about small businesses and how this impacts them? Price rise might increase. And I’m also just thinking back to a point that I’ve heard you make Allison about how the increase of prices for businesses then flows back through to households in the form of higher food prices.
Could you talk a little more about that? So
Alison Reeve: small businesses are eligible to be on a default market offer as well. Now in this latest version of the DMO that we’re looking at depending on which state you’re in for small businesses an increase in the DMO between 15 and 25 percent. Now 25 percent on an input cost for your business is actually quite substantial particularly if electricity is a large part of your costs. And this is where, as you say, it starts to flow through to the rest of the economy and to all of the things that we buy. So, So, you know, if my local cafe is having to pay 25 percent more for electricity, that means, you know, the, the coffees are costing a little bit more.
And it also means having the lights on is kind of costing a little bit more and the fridges are costing a little bit more. And all of that is going to flow through to the cost of the food, which means that when I go and have breakfast at the cafe, I’m going to be paying more as well, because that cost is being passed through to me.
All of the costs in an economy will end up passed through to an end consumer somewhere. And this is sort of the thing, this is why the government worries so much about the impact of energy prices on inflation, because regardless of whether you’re talking about small businesses or big businesses, High energy prices flow through into all of the stuff that we buy and consume every day.
They also flow through into the cost of government services. So, you know, hospitals and schools use energy too. That sort of puts the, the own, the government’s own bills go up. as well. And so this is why the government is so focused, I think, on keeping energy costs down because it isn’t just about householders.
It’s about everything we consume as householders as well.
Esther Suckling: Coming back to the household consumer, obviously a lot of Australians at the moment are really feeling the pinch and are under a lot of financial stress. And this is another kind of Worrying headline to see in the news, Tony and I went into this question a few podcasts ago, and we suggested bringing out the UDI, but I’m wondering if we have any updated suggestions on how any Australian could manage the cost of electricity and any steps that they might be able to take as these new price increases become apparent.
Tony Wood: I think one thing that’s happening is there is that, we’ve seen a range of different concessions made available by governments to start with, and a lot of social organizations like A Costs and B Costs and so forth, have a look to see if they can help argue for support for people on very low incomes, people who are in serious financial difficulty, for whom These things are just unaffordable and this is an essential service really in our lives.
And so I think what we do need to see is a whole lot more thought given into the way those are delivered. Those benefits are targeted to the people who can benefit most and sometimes it is small businesses for the reason Alison described and we’ll see what comes out of the federal government and state government’s commitment to a three billion dollar package, a commitment they made.
last year, which I assume we’ll see the details of in the federal budget in a few weeks time. So that’s one thing. I think the, the opportunity for consumers to shop around is not as good as it might’ve been a few years ago, where you could save hundreds of dollars by looking for the best deal. But like, you know, if anyone’s ever rung up their bank, if they happen to have a mortgage, and that’s been a painful process as well, of course, just ringing up the bank, sometimes I’ll ask them, are you on the best deal?
And they say, no, we can give you a better deal. Now you might be angry that they didn’t offer you that better deal in the first place, but. Electricity retailers sometimes do exactly the same thing, checking to see you’ve got the best deal. I mentioned before one of the reasons why the DML was introduced because the whole thing was just too complicated.
One of the things that’s emerged in recent years is comparator sites. And so energy made easy, for example, going on one of those sites. Now you put in your details and what will come up is not just the DMA, but the company’s best offers, and you can compare those, and you can switch on a pretty regular basis if they, if those numbers change.
So I very much encourage people to do those sorts of things.
Esther Suckling: Thank you so much for joining us. If you want to get in touch, you can reach out to us. @grattaninst on Twitter or Grattan Institute on all other socials. If you’re interested in supporting our work, you can also visit our website to donate, and we hope you stay tuned for the following podcasts from our team and the other teams here at Grattan.
Tony Wood
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