The Australian energy industry has received an unprecedented level of attention of late, with electricity price increases and issues of affordability taking centre stage.
Given the level of government interest in this area, it is an ideal time in which to embrace a reform agenda that is genuinely effective in injecting a level of economic efficiency into the industry that is currently lacking. The interests of customers should be explicitly considered when contemplating reform priorities, and initiatives implemented that encourage active participation by customers in decision making related to energy use.
It is imperative that the current energy reform agenda incorporates the following distinct but interrelated priorities:
-- Effectively addressing peak demand growth.
-- Engaging and empowering consumers.
-- Rethinking customer hardship and concessions frameworks.
Addressing peak demand growth through cost-reflective pricing and smart meters
Electricity cannot be stored economically. Therefore it is necessary for network infrastructure and electricity generation capacity to be able to meet projected peak demand levels at any time despite the fact that such peak demand occurs very rarely. This has to date led to economically inefficient outcomes and the expenditure of significant capital costs – 12.5 per cent of the south-east Queensland network has been built for use on 3.5 days per annum.
These inefficient outcomes are perpetuated by the current flat electricity tariff structure that exists, under which businesses, which have higher load factors corresponding to more efficient capital utilisation levels, are subsidising ‘peaky’ households that have lower capital utilisation rates.
Raising capital utilisation rates must be an immediate priority, and this is looking increasingly feasible with the shift towards digital metering (which should be rolled out under a contestable, as opposed to mandated, model). When combined with the deregulation of retail electricity prices, efficient cost-reflective pricing will become possible.
It will enable pricing at a time of peak demand to reflect the cost of underutilised capacity, in this way providing users with incentives to substitute their consumption during peak times with consumption during non-peak times, if they value the benefits of doing so above the costs of changing their behaviour.
Extensive dynamic pricing trials were conducted across North America, Europe and Australia and analysed by economist Ahmad Faruqui in 2010. Overall, these showed that critical peak pricing pilots averaged a 20.7 per cent reduction in peak demand at the household level, with results spanning 10 – 50 per cent. Technology-driven demand response led to an even greater 34.1 per cent reduction in peak demand.
Such evidence provides a compelling reason for policymakers to urgently consider rolling out smart meters and removing retail price regulation.
When introduced with appropriate policy consideration for the relatively small number of vulnerable customers who are not able to shift their consumption from peak times, dynamic pricing would lead to a number of important benefits.
First it would have the effect of significantly improving economic productivity rates by improving the capital utilisation rates of Australia’s electricity infrastructure. It would also contribute towards rectifying the equity imbalance that currently exists whereby businesses and low energy-consuming households effectively cross subsidise high energy-consuming households, such as those with air conditioning and high energy-consuming appliances.
Empowering customers and reviewing hardship and concessions frameworks
The capabilities of dynamic pricing and digital metering will amount to nothing if customers are not interested, engaged and actively involved in their electricity consumption. It is imperative that the introduction of dynamic pricing and smart meters be preceded and accompanied by a comprehensive consumer engagement and education campaign. This would need to involve the government, industry and community sectors working together to ensure that consumers are provided with all the relevant information to be able to benefit from the new pricing structures and technology on offer.
A further crucial aspect of empowering customers is ensuring that customer hardship and concessions frameworks target and provide assistance to those customers who have the greatest need.
Research has shown that households in the family formation demographic, where the principal electricity account holder is aged between 35 and 55 years old, consume more electricity than average, and have a lower median income per person per household. They are, proportionately, the group of households most likely to be at risk of financial hardship, with about one in four households currently showing a sign of energy vulnerability such as failure to pay a bill or disconnection.
However, of concern, there is no eligibility criteria designed to identify hardship within the family formation demographic. In fact in all states besides Victoria, energy concessions are paid as a lump sum, irrespective of energy consumption levels.
Accordingly, there is an urgent need for a comprehensive review of concessions frameworks with the aim of better aligning concession payments to customers in need, such that payments are a function of both household income and consumption, rather than one or the other.
Very importantly, the energy reform process should not be delayed on the grounds that such a delay will protect vulnerable customers. Retail price regulation is in fact a highly ineffective way in which to reduce or manage vulnerable households, and represents a poor de facto hardship policy because it will not achieve outcomes consistent with reducing hardship, and the attempt to do so is likely to damage the competitive market.
Deregulated markets encourage the introduction of greater pricing innovation and the development of products that are likely to better suit vulnerable households. Regulated tariffs on the other hand, discourage such diversity of product and tariff offerings.
A suite of reforms
The reforms identified above are by no means new. In fact the 2002 Parer Review stated that: “All states and territories should … work towards removing retail price caps and mandate the installation of interval (or smart) meters.”
These recommendations were not prioritised at the time given that electricity prices were declining in real terms. However, in the current environment of increasing electricity prices since 2008 due to factors such as spending on electricity networks, overlapping renewable energy policy, and a decline in the utilisation of electricity networks, it is essential that reforms beyond those that have been implemented to date be embraced to increase levels of economic efficiency and productivity in the industry.
If rising prices are to be addressed, the following initiatives must be considered as a suite of reforms – better utilisation of Australia’s electricity infrastructure which will result in lower unit pricing for all customers, combined with greater consumer choice and engagement. This would undoubtedly be a winning combination that is in the national interest.
Anita George is Manager Energy Policy & Strategy at AGL Energy and Tim Nelson is Head of Economic Policy and Sustainability at AGL Energy.