What to do about rising electricity prices

By Jim Snow, Oakley Greenwood director.

Electricity prices have increased significantly since 2006 and most studies forecast that price rises will continue – with some studies forecasting residential prices to double by 2017.

Government policies and programs have focussed on assisting customers to use energy efficiency measures and renewable energy resources to reduce their utility bills. While these strategies do work for individuals, and can have broader beneficial impacts, Oakley Greenwood believe the best way to reduce electricity prices is to ensure that the electricity market itself is as efficient as possible. The critical factors in this regard are to ensure:

• Consumers have adequate information, access to services and other resources to assist them in using electricity in the amounts, times and types of equipment that maximises their welfare;

• The electricity supply industry meets consumers’ demands as cost-effectively as possible;

• Prices are as cost reflective as possible, promoting economically efficient electricity use which in turn will ensure aggregate demand can be met at least cost; and

• Subsequent prices reflect the impacts of the above measures.

In a study undertaken for the Australian Industry Group, Brotherhood St Laurence, CHOICE and the Energy Efficiency Council, we identified a total of 19 options consistent with these considerations. The groups commissioned the study to support informed debate by the entire community. The sponsoring organisations don’t necessarily support all of the options identified, but have put forward a joint set of policy proposals drawing on our report (available at the Oakley Greenwood website) and other inputs.

Options for the generation sector

Prices in the generation sector have been relatively stable and are projected to increase primarily due to the cost of generation fuels (over which policy does not have a great deal of control without introducing other biases) and the introduction of a price on carbon. As a result, the options put forward address other means for reducing price pressure in the sector, including:

• Facilitating the provision of demand response by consumers in order to reduce peak demand and associated capital investment requirements in both the generation and network sectors;

• Considering the addition of a capacity mechanism to the NEM market design if the above and other approaches for facilitating demand response are not successful; and

• Reviewing the NEM’s reliability standard to determine whether a lower standard (which would further reduce capital investment requirements) would be acceptable to consumers.

A review and possible reform of the gas supply market to ensure it is as liquid and competitive as possible is also warranted.

Options for the network sector

There is significant potential for measures that build on current regulatory arrangements to reduce upward pressure on prices in the network sector. These lie in four separate areas:

• Enhanced and strengthened regulation, including: 1. Greater exercise of existing regulatory powers by the AER; and 2. The establishment of a well-resourced consumer advocate as a regular participant in network regulatory processes.

• Incentives to encourage greater efficiency in network capital and operating expenditures, including:
1. The introduction of a capital efficiency carryover mechanism, which would provide an incentive for network businesses to be more economically efficient in their capital expenditure; and 2. Making total expenditure the basis on which network businesses would earn a return, thereby overcoming the bias that currently exists toward capital expenditure.

• Increased network business proactivity in using demand-side resources, including distributed generation, including: 1. Increased use of interval metering, which could work in concert with the use of more cost reflective network pricing structures; 2. A requirement for networks to publish demand-side plans; 3. The introduction of targets with incentives/penalties for networks regarding the use of demand-side resources to defer augmentation; and 4. The ability for networks to own and earn returns on assets and services that facilitate demand response and/or distributed generation.

• Review of the nature and level of the reliability standards that are applied to network business. There is a substantial body of research that suggests that some standards are imposing costs that exceed the benefits that consumers obtain from the reliability delivered, and that probabilistic standards can further the level of capital investment deployed;

• Privatisation of government-owned network businesses.

Other, more radical options also exist that could be investigated instead of these approaches, or if these approaches do not sufficiently improve the economic efficiency of the sector.

Options for the retail sector

Although the retail sector’s operating costs and margin account for only about 10 per cent to 15 per cent of the average residential bill, there are several options applicable to the sector that could put downward pressure on prices or provide consumers with better information or other benefits. These include:

• A requirement that retailers provide more cost-reflective pricing options

• Monitoring of retail costs and margins to ensure competition is effective

• Implementing the National Energy Consumer Framework.

Other considerations

Fully optimising supply and demand requires action beyond just the electricity market – it also requires efficient markets for other goods and services and policies and programs to address other market failures, such as information asymmetries, transaction costs and access to capital.

It must also be recognised that low income and vulnerable residential consumers have specific concerns that will need to be considered if some of the options identified are implemented. The report does not seek to address in detail the implications of the options presented for vulnerable and at risk residential consumers.

These issues can be addressed in part through a robust system of consumer protections, but additional work will be needed to ensure that any policies or initiatives that are undertaken do not have an adverse impact on vulnerable and at-risk consumers.