Complex network tariffs: How do we best manage the risk?

When we talk about electricity pricing reform, almost everybody will agree that the changes to date have not delivered positive outcomes for consumers. But what is contested is how to fix it. As we reach a fork in the road, the system has found itself in a blame game, with many stakeholders raising concerns about retailers not shielding customers from complex tariffs, while retailers point out that networks and the regulator encouraged these complex pricing structures in the first place. The output is consumers are being left confused. Now, as we hopefully move into a more constructive phase of market design, the question is whether in the long term we should continue to place the responsibility for end user pricing on retailers alone, or if there is an opportunity for a more holistic system-wide pricing structure that places risks on those best able to manage them.

As the peak representative body for energy retailers, the Australian Energy Council (AEC) strongly believes it is the latter. But to consider where we go from here, it’s important to take a step back and analyse how we got to where we are today.

How did we get here?

Back in 2014, following a rule change request from Energy Ministers, the Australian Energy Market Commission (AEMC) changed the rules regarding how Distribution Network Service Providers (networks) structure their pricing to consumers. The new rules required networks “to develop prices that better reflect the costs of providing services to individual consumers so that they can make more informed decisions about how they use electricity.”[i] To implement this objective, networks were required to “develop price structures that are reasonably capable of being understood by consumers and allow network businesses to manage the impacts on consumers of price changes by gradually moving to new network prices over several years.”[ii]

Whilst the AEMC noted retailers operating in a competitive market shouldn’t be required to price their offers in a way which matches the structure of the network tariff, it did note that “because network charges are retailers’ largest cost, they will have a significant incentive to pass on network price signals to consumers in some form when deciding how to structure their retail prices.” Despite this opportunity not to pass through the tariff structure, the AEMC was very clear that its intent was for consumers to see the impact of their usage on their electricity bills:

“Each network tariff must be based on the long run marginal cost of providing the service. Long run marginal cost is a measure that includes the future network costs that are incurred by using more energy, or the costs that could be saved by using less energy. Using this measure as the starting point for calculating network prices means that prices will allow consumers to compare the value they place on using the network with the costs of doing so.”  (Emphasis added.)[iii]

So what has changed in the decade since this decision and why are we now concerned about retailers passing through network price signals to end users?

In short, it's because more customers are starting to see more complex electricity prices on their bills as the smart metering rollout gathers steam. And as an adjunct, some are highlighting the impact and their concerns about what they pay through the media. With a smart meter an enabler for pricing reform, complex pricing has been conflated with the smart meter rollout, putting pressure on regulators and Governments to try to separate the two reforms. The AEMC has recently proposed to derisk the smart meter rollout, which they are keen to fast track, by suggesting retailers should not be allowed to move customers onto more complex network tariffs without explicit informed consent (EIC). They also propose some retailers should be forced to offer a flat tariff to any customer that wants one.

While the proposal seems to be contrary to the AEMC’s own pricing principles developed in 2014, more importantly, it will likely drive-up prices overall by placing regulatory risks on a party unable to efficiently mitigate them, ie the retailer. To consider the impact of these new regulations, an assessment of the likely outcome on affected parties is necessary.

The driver in this scenario is the AEMC’s decision that all customers must have a smart meter installed by 2030. The practical impact of this is that what was originally proposed as a market-led smart meter rollout where retailers would install smart meters where their customers could derive value from their installation and reduce their costs, is transitioning into a mandated regulatory rollout to every customer. In this new environment, retailers will now be required to install smart meters just to meet the 2030 deadline, regardless of the apparent customer benefit. Inherent to this change is that the ‘customer value’ will move from an individual customer’s opportunity to save money by choosing to install a new meter, to a broader ‘consumer value’ derived by the whole market through better information that will at least theoretically improve investments and lower costs, driving down overall prices.

This change in approach came out of a three-year review into metering arrangements recently completed by the AEMC in 2023. Interestingly, that review didn’t recommend additional pricing protections for customers following the installation of a smart meter was required, other than for the provision of clear information to be provided to the customer.

In 2024, three market participants submitted a rule change intended to implement the recommendations of that smart meter review. Pertinent to this article is a proposed rule change to require retailers to provide customers with 30 business days’ notice of a change to their pricing structure, as opposed to the existing five business days.

The AEMC initially proposed in its draft determination to enact the change as suggested but has recently indicated a preference that it be strengthened, to limit the ability of retailers to pass on network pricing structure changes except in certain circumstances.

The outcome of this proposal is that energy retailers will be billed by the network for a highly complex and often volatile pricing structure, but the structure of the price they will bill customers will be limited to either a flat tariff, or a more complex tariff if they obtain EIC. It seems likely that such a mismatch would increase the risk retailers face in pricing their products, likely driving up prices overall. This outcome was flagged both by the AEMC in 2014 when it made clear that a retailer who did not pass through network price signals in some form would face significant risks, and more recently in 2024, when it noted network and retail costs would likely be higher due to fewer customers being exposed to cost reflective pricing than they would otherwise, and retailers likely increasing their prices to manage the additional risks.

For consumers, a more complex network tariff that is passed through directly by the retailer moves pricing risks from the network and retailer to the customer. Whilst the 2014 AEMC decision said that individual customers are the party most able to manage their own consumption patterns and therefore their pricing outcomes, they importantly tempered that expectation by requiring that the network pricing structure faced by the consumer needed to be “reasonably capable of being understood by consumers. Consumers will not be able to respond to price signals if they cannot relate price structures to their usage decisions”.

From the AEC’s perspective, a demand tariff or other highly complex tariffs, fail this requirement because they are not reasonably capable of being understood by a customer. I’ve personally tried to explain it a few times recently and nobody has left the conversation confident of how these tariffs would affect their electricity bills. If energy experts cannot effectively explain a tariff in a one-on-one conversation, it seems difficult to justify the AER’s decision that these tariffs are reasonably capable of being understood by consumers en masse.  It’s been put to me that electricity demand as a concept appears somewhere in the physics curriculum in the last year of high school.  This is not a good place to start.

So, if a retailer cannot manage a risk, and it’s unreasonable to expect customers to do so, then who else could the AEMC look to in circumstances where it considers a consumer protection is required? From the AEC’s perspective, the only answer is the network itself. The AEC will continue to contend that any limitation on a retailer’s ability to pass through a network pricing structure should be mirrored with an identical limitation on a networks ability to mandate such a structure to retailers. Opponents will likely argue a change of this nature would come at a cost, but such claims need to be considered against a base case of the likely outcome of the AEMC’s alternative rule – not the AEMC’s 2014 rule change. So, what will these arguments likely be, and how would they compare to the alternative of retailers alone bearing network pricing risk?

Unintended consequences of transferring risks from retailers and consumers to networks

While the jury is out[iv] on its effectiveness, it has been said that not exposing retailers to a cost reflective tariff will mean customers are less likely to use the network efficiently and increase the total system costs by forcing new network build, the likely impact of the AEMC’s proposed limitation on tariff changes will result in the same ultimate outcome as the status quo. It is unlikely a customer with a usage pattern that is driving up network costs would change their consumption patterns if they did not see cost reflective pricing on their bill In that scenario, only those with usage patterns benefiting the network would change their pricing structure, whereas those who are driving the impact on the network (and the capital expenditure policy makers were concerned about), would remain on their original pricing structure as it would not affect them financially for the impact they are having on the grid.  

It has also been said that the role of retailers is to manage risk in the National Electricity Market (NEM), and network pricing risk is no different from the wholesale price risk they currently manage. From my perspective, this fails to understand the role retailers play as risk managers. A retailer has an array of tools available to manage wholesale price risk. Predominantly, retailers procure financial derivatives, are often vertically integrated with generation, and will utilise demand response to manage the risks from the highly volatile NEM spot market. There are no comparable tools available for network pricing risk. Whilst it could be argued that economies of scale will enable retailers to balance the impacts of network pricing, this is only true for those retailers large enough to have a representative customer base. For smaller retailers, this will be impossible.

A better solution here would be for retailers and networks to work together to develop an actionable network tariff retailers can translate into a customer product they too can understand.  This was achieved in Victoria to some extent with the most recent approved Tariff Structure Statements reflecting an outworking of genuine consultation.  Network objectives were able to be met without overly complicating pricing structures.

Some have suggested that if network pricing decisions were re-opened to limit the ability of networks to change network pricing structures, it would suggest that networks are a riskier investment than the framework envisaged, and their rate of return should be increased to offset this additional regulatory risk. We would strongly refute this position. There is no additional risk to a network business from delaying the transfer of customers from one tariff to another during a regulatory period. Networks operate under a revenue cap, meaning their total revenues are fixed for a five-year period. If they over-perform and network expenditure is lower, they are allowed to keep the additional revenues as an efficiency incentive. The only impact of delaying the transfer of customers to new pricing structures is that the network may be less efficiently utilised, which the AEMC states would be the case even under the proposed rule that requires EIC before a customer sees a new pricing structure.     

An eye to the future…

So where to from here? The AEC strongly agrees with the concerns raised by consumer advocates that it is unreasonable for small customers to be exposed to highly complex tariffs such as demand tariffs. For the AEMC, an interim rule to preclude a customer from being transferred to one of these tariffs without their consent is a good start, but it’s a rule that should be placed on the party in complete control of the pricing structure, the Network itself. Retailers would not be changing customer pricing structures without EIC if the network tariff they were exposed to wasn’t changing. In circumstances where a new network tariff would be beneficial, individual customers can opt into a more complex pricing structure with the support of their retailer. Where customers want other pricing options, competition will encourage these outcomes, as is the case today with many customers opting into pricing that varies throughout the day, or even highly complex pricing that follows the wholesale price of electricity.

But such a rule should only be interim. The broader review of electricity pricing for a future energy system is a critical piece of work that should be prioritised by governments, regulators, industry, and consumers. We are pleased that the AEMC is taking this review seriously, and in particular, welcome their decision to consult on a draft terms of reference[v]. This review must be set up in such a way to ensure the right questions are considered that will deliver an outcome that enables more efficient utilisation of the network and lower prices. It must also foster a positive relationship between retailers and their customers, as they work together to benefit from an energy system rapidly transitioning, to one where consumers have opportunities to participate if they are willing and able, and treated fairly where they are not.

We look forward to working with the AEMC, the AER, networks, and consumers to deliver on this opportunity over the longer term. In the meantime, a short pause on network tariff reassignments seems a prudent step to prioritise consumer price stability, without the unintended consequences that will come from the AEMC’s proposed rule.

[i]  AEMC 2014, Distribution Network Pricing Arrangements, Rule Determination, 27 November 2014, Sydney, pg i

[ii] Ibid.

[iii] AEMC 2014, Distribution Network Pricing Arrangements, Rule Determination, 27 November 2014, Sydney, pg iii

[iv] See, for example, Energy Consumers Australia, Cost reflective prices aren’t very cost reflective, 2024, pg 5-6

[v] AEMC, DRAFT Terms of Reference, Electricity pricing for consumer-driven future, July 2024