Chasing an energy benchmark mirage

How do you establish a forward price for a retail commodity when you don't know the likely cost of the essential ingredient?

This is the big challenge facing the energy regulator in New South Wales over the next three months.

The Independent Pricing and Regulatory Tribunal, chaired by Dr Peter Boxall, has the task of determining by May benchmark prices for both gas and electricity for the state for mid-2013 to mid-2016 and, in the case of gas, leading players are telling it that the task is mission impossible.

The power chore is hard enough.

IPART, in its issues paper for that review, says: "At this stage it is not clear which policy and regulatory settings will apply over the next three years and what the associated impacts on electricity prices will be.”

However, it says hopefully, "the steep price increases that have occurred over the past five years are unlikely to continue at the same rate".

While power price spikes have been on the front-burner nationally for many months, the east coast problems with gas are emerging as no less important, especially in NSW, where existing supply contracts start expiring next year and the war of words over coal seam gas exploitation in the state shows no signs of abating.

The state's resources and energy minister, Chris Hartcher, is fighting on two fronts just in dealing with the supply issue: the seemingly never-ending argument with the concerned segments of the rural and urban community plus environmental activists on the one hand and the more recent row with federal environment minister Tony Burke over scientific assessment of CSG impacts.

Burke stands accused by the O'Farrell government of playing politics with the federal election in mind.

Meanwhile, the clock ticks on towards the point at which the first gas contracts meeting 95 per cent of the state's needs expire.

Hartcher argues that the impact is already being felt, pointing to manufacturer Incitec Pivot, which has decided to build an ammonia plant in Louisiana, feeding off cheap-as-chips American shale gas, rather than in Newcastle, because of concerns over future gas prices.

One third of the energy needs of NSW come from gas, says Hartcher, and resolution of the issue is "fundamental not only to the economy but the lifestyle of the state".

His concerns and those of manufacturers and other users have ratcheted up this month with the strategic decision by AGL Energy to hang fire on seeking approval to exploit the CSG resources under the Camden Valley in Sydney's south-west.

The company says the additional gas it is seeking could meet the needs of half the state's household gas users – about 580,000 residential customers – but, in the face of a local community backlash, it has opted to postpone planning assessment of its proposal.

This goes nowhere towards solving IPART's regulatory problem.

The Energy Supply Association of Australia sums up the situation like this: "Contract terms (including the length of coverage) may vary from previous market norms as competition for supply is increasing with the entry of LNG proponents.”

Its message to IPART is essentially that it is too hard to set a three-year price path and, if the regulator boxes in the energy retailers, it runs the risk of exposing them to costs they can't recover.

This is Origin Energy's view, too: "A three-year fixed price path is unable to accommodate the material risks posed by the carbon pricing mechanism and the anticipated changes to wholesale gas costs.”

EnergyAustralia says a three-year price path poses "an unacceptable risk” to it and other retailers.

What the retailers want the regulator to do is fix a price only for 2013-14 and to revisit the process annually – but this has the state business community squawking.

Paul Orton of the NSW Business Chamber has written to IPART to say that almost half his members rate energy prices as having a significant impact on their operations and periodic pricing means they will "risk facing severe price hikes combined with minimal certainty about when they will occur”.

Hartcher himself, however, has thrown his support behind an annual review.

He has written to IPART this month to support this approach "until such time that sufficient additional gas production is brought online”.

On the other hand, he's not best pleased with AGL Energy's bid for the first price rise tranche to be 10.4 per cent.

This, says Hartcher, is going to land on the largest part of the 1.1 million households in the state.

The situation is a helluva merry-go-round, with politicians, regulators, retailers and eventually consumers all riding blindfold.

It's hard to see how it can be resolved in the short term.

Looking a bit further forward, ESSA says the real solution is for governments to get out of the price regulation business and, if they are are unwilling to do this, at least allow retail prices to be cost-reflective.

A hard ask if you are a pollie with a poll down the road.

Keith Orchison, director of consultancy Coolibah Pty Ltd and editor of Powering Australia yearbook, was chief executive of two national energy associations from 1980 to 2003. He was made a Member of the Order of Australia for services to the energy industry in 2004.