AEMC: Retail market mythbusters

The AEMC’s 2018 Retail Energy Competition Review (the Review) landed on 15 June, with a thorough report outlining the ongoing challenges for the retail energy industry, and analysing potential reforms to address them.

The Review is a significant one – a comprehensive report to the COAG Energy Council that its member Ministers should find instructive when considering any policy interventions.

Unsurprisingly, the review finds there is no miracle cure, rather it points to improved retailer practices, a maturing competitive market and targeted interventions where necessary as the collective answer to better consumer outcomes in future years. It also sends a clear message that the sector and government will need to work together to achieve these outcomes.

Consumer confidence

There was much media attention on the loss of consumer trust in energy retailers when the AEMC report was released. It is concerning to see consumer trust in energy retailers has dipped in the past year from 50 per cent to 39 per cent.  The Review attributes this dip in customer dissatisfaction to rising energy bills and confusion over the operation of the market – namely discounting practices.  The unprecedented (and largely negative) political and media attention on the sector over the last year is also flagged as a contributing factor.

This dive in consumer trust is a sharp reminder to the industry and policymakers of the urgent need for changes to re-gain the trust of consumers, who require affordable energy and a market which is able to be navigated with confidence.  The Review sends a clear message that the sector must address the confusion experienced by consumers when engaging with the market.  The positive aspect is that much of this work is already underway at both a State and Federal level but, subject to the outcomes of those market reform processes, more may need to be done.

Assessing competition

In assessing the effectiveness of competition in retail energy, the AEMC had regard to a number of different factors, including:

• Independent rivalry within the market.
• Ability of retailers to enter the market.
• Customers’ ability to exercise market choice.
• Variety of products and services on offer.
• Price and profit margins.
• Customer switching behaviour.

These indicators were considered against a context of the structure of the market, the general conduct of its participants and performance indicators, such as retailer margins and profitability and consumer satisfaction, complaints and disconnections.

Wholesale market volatility

The Review finds that ongoing volatility in the wholesale market accounts for the increase in residential electricity prices of between 2 – 20 per cent over the past year.  Specifically, increases in wholesale energy market costs were found by the AEMC to be a combination of plant closures (Northern in May 2016 and Hazelwood in March 2017) and higher gas prices.

The Review confirms what we know already - consumers would like to see price relief as soon as possible.  The recent flattening of retail prices in the price resets effective 1 July 2018 is welcome, but this is not enough.  The key to addressing the volatility of the wholesale market remains  the achievement of a national policy framework to enable much needed and stabilising investment to flow. This should ensure that prices in the wholesale market will continue to trend downward.

Discounting unpopular

The Review analyses the practice of discounting, which currently accounts for around 80 per cent of offers in the market.  Although offers discounted off the standing offer tariff can represent very cheap deals, customers find them confusing, which in turn discourages engagement with the market to find those good deals.  Not only are discount offers hard to compare (in deregulated markets each retailer offers its own standing offer), but many are conditional.  Price dispersion, usually a healthy sign of competition, appears to be a function of discounting, rather than tailored to specific customer segments.

Price re-regulation: no antidote

Critically, the Review asserts that competition is not to blame for rising prices.  It suggests that retail energy markets are still maturing – pointing out that the mobile phone sector of the telecommunications industry has been de-regulated for over two decades, and is now considered as a good example of a competitive market that delivers good consumer outcomes.  By contrast, retail price de-regulation in energy first began less than a decade ago, in Victoria and is even less mature in other jurisdictions.

There is clearly more work to do to deliver on the competitive market’s promise of improved customer service, cheaper prices and innovative product offerings but over time there is no reason why the energy industry cannot reach this point, as has been seen in telecommunications.

The AEMC’s acknowledgement that price re-regulation is not the antidote to the industry’s poor standing is welcome.  Its view is that re-regulation would do more harm than good, and in fact would:

• Negatively impact stand-alone retailers, who are the most innovative players in the market (and push the larger retailers to match their innovation);
• Reduce choice, decrease customer service and shrink the market so that retailers have no incentive to engage in innovation; and
• Remove the ability of retailers to deliver options for distributed energy resources such as batteries, which assist customers to manage their electricity usage.

This echoes the industry’s position, recently articulated to the Victorian Government, that the form of price re-regulation it is currently considering (as articulated in Recommendations 1 and 2 of the Thwaites Review) would effectively end energy retail competition in Victoria. Customers (including vulnerable and disadvantaged customers) would lose the price benefits they currently receive through very cheap market contracts. The energy retail market would shrink (because most, if not all second tier retailers have left), meaning a loss of jobs and a chilling effect for the investment required in new technologies, demand response and generation.

Barriers to entry – retailer concern

The Review finds that there are 33 retail electricity brands active in the National Electricity Market (16 in gas), and in the past year two new brands have entered each market, while one has exited the electricity market.  It is encouraging to note that market concentration decreased across all jurisdictions in 2017.  The three ‘Tier 1’ retailers are also less powerful in markets that have been deregulated for longer.  Their share of the Victorian market has continued to decline to around 59 per cent, while it is more than 75 per cent in most other, less competitively mature jurisdictions. This again highlights the AEMC’s contention on the maturation of markets.

Although market participation is encouraging, retailers do note that moves away from regulatory consistency across jurisdictions act as a disincentive, because this divergence drives up retailer costs.  The most obvious example of this is Victoria, which does not participate in the National Energy Customer Framework, and recently implemented a ‘go-it-alone’ Payment Difficulties Framework which sets out the rules for management of vulnerable customers in financial hardship in Victoria.

Win-back activity is also identified as a challenge for smaller retailers, who can find themselves acquiring customers only to lose them to the incumbent retailer during the 10 day ‘win-back’ period.  Again, this adds to retailer costs, which makes it challenging to compete against the Tier 1 retailers who have the advantage of economies of scale, and are vertically integrated so as to be able to manage their wholesale market risks more efficiently.  Political and regulatory uncertainty also places upward pressure on retailer costs.

Path forward

The Review comes at an important time for the retail industry.  Neither the industry nor governments can afford to be complacent about its conclusions.  The Australian Energy Council will continue to work with its members and governments on options for retail market reform. With substantial market transparency reforms already underway, policymakers should see them properly bedded down before considering whether further reforms are warranted.

Further data-rich food for thought will be provided by the ACCC’s Retail Electricity Pricing Inquiry, expected to be released next month, after its delivery to the Federal Treasurer on 30 June.  Like its AEMC equivalent, the ACCC Report is reflective of a huge amount of data sourced from retailers and analysed in depth.  Taken together, the analysis in these reports will serve as a valuable tool for the retail industry, governments and regulators alike.