AGL seeks a regulatory circuit-breaker

The $60 million question mark over the earnings guidance AGL Energy gave to its annual meeting today is another pointer to the failings of competition policy within the electricity sector.

AGL downgraded current year earnings by $45 million for the anticipated effects of regulatory pricing decisions by the Queensland Competition Authority and a draft pricing decision by the Essential Services Commission of South Australia (ESCOSA). The full-year effect of the decisions, if implemented, would be $60 million, it said.

The QCA decision earlier this year to freeze retail prices and ESCOSA's draft decision to reduce prices has already resulted in Origin Energy, which is challenging the QCA decision, winding back its marketing and discounting in Queensland.

AGL will do the same in both the states and has also suspended any further investment in generation in South Australia while warning that it is reviewing its retail activities in NSW because of the potential flow-on effects of the ESCOSA and QCA decisions.

The concept of the national electricity market was based on an eventual displacement of state-based and intrusive regulation of electricity by competition, which would lead to increased efficiency and market-based pricing signals for new investment. That has been largely the outcomes in Victoria.

The development of the market has, however, been distorted by continuing state ownership of generators and retailers and the continuing intrusion of state government and their regulators in pricing decisions. Politicians have difficulty in putting their faith in markets to produce better outcomes than direct regulatory intervention, despite the evidence in Victoria and elsewhere that competition works.

One can understand the political appeal of intervening in decisions of electricity pricing during a period where the combination of inefficiency and ‘'gold-plating'' by state-owned generators and distributors, the desire of cash-strapped state governments for dividends from their state-owned enterprises, the impact of mandatory renewable energy targets and schemes at state and federal level and the carbon tax have seen electricity prices soar.

Those kind of interventions, however, have the potential to produce unintended consequences.

An obvious one is that setting prices too low deters new investment, leading to under-supply and higher prices for consumers in the longer term. The obvious response for integrated energy companies like AGL and Origin Energy when appropriate risk-adjusted returns are withheld is to stop competing for new customers, go on a capital strike, milk the returns from existing investments and shift the focus of their investment to unregulated sectors.

In a complex and volatile market where investments are massive and long-term, where there can be massive fluctuations in demand and prices and where retailers, wholesalers and generators use billions of dollars of derivative contracts to hedge their exposures the potential for something catastrophic to occur is real.

The crisis in California's electricity market a little more than a decade ago, where retail price caps introduced with good intentions deterred new capacity, sent retailers broke, triggering shockwaves through the generators and their financiers and ended in taxpayer bail-outs provided a salutary lesson in how not to intervene in energy markets.

AGL's chairman, Jeremy Maycock said the Queensland and South Australia decisions would cause significant long-term cost increases for consumers, damage competition and innovation and make the national electricity market an unviable investment proposition for new generation of all forms, including renewables.

‘'When these decisions are added to the current policy uncertainty around the future of carbon pricing and the 2020 renewable energy target, no-one should be surprised to see new investment in the NEM evaporate, with all the consequences that would follow.

‘'The continued regulation of retail prices and over-lapping state and federal regulatory structures creates a real risk of systemic failure of the national electricity market,'' he said.

That risk has always been latent but because the national market has been adversely impacted by continuing state ownership and regulation of large slabs of the sector, the inefficiencies and the corruption of commercial behaviours that has produced and the additional layers of distortions created by the various incentives for renewables and now the carbon tax that risk is increasingly real.