Embedded networks, regulation and energy innovation: Is IPART on the right track?

Recently the NSW Independent Pricing and Regulatory Tribunal (IPART) conducted its Embedded Networks Review. Embedded networks are private energy networks for services such as electricity, hot water, and gas. Embedded networks are typically found in more recent residential multi-unit developments (a fast-growing sector for embedded networks), larger shopping centres, and caravan parks.

Customers in embedded networks may have limited access to retail competition and competitive market forces to put downward pressure on prices, so IPART has examined appropriate price methodologies for setting electricity, gas, and hot and chilled water prices for customers in embedded networks, along with the compliance and enforcement framework for any new price protections.

We agree that embedded networks needed review.  The Australian Energy Council has consistently argued that the appropriate approach to take in embedded networks is to provide the consumer protection based upon the required level for the essential service provided,  and not based on the assumed capability of the supplier. This is a complex ask for circumstances like long term residents in caravan parks, but nevertheless vital if we are to assume that if all the energy consumer protection regime is essential, then it is clearly essential for all.

Default prices

Most jurisdictions have relied upon the Australian Energy Regulator’s Default Market Offer (DMO) or in Victoria the Victorian Default Offer (VDO) as the appropriate price cap for embedded networks, a reflection of fairness.  However, IPART in its most recent review concluded the AER’s DMO is not an appropriate price cap for embedded network electricity customers.

IPART contends that a price cap that is set to also achieve competition outcomes (like the DMO is in theory) is not suitable where customers cannot easily shop around, as is at times the case in embedded networks. IPART also contends the DMO does not meet their key objective to ensure embedded network customers are not paying more than non-embedded network customers, because the DMO is typically higher than most offers available in the market.  And you can see where they are coming from here, but this is a very narrow frame of reference to adopt.

Back to the DMO for a minute.  The Default Market Offer is intentionally set marginally higher than the AER calculations as to the efficient costs of supplying electricity, and this has two practical effects:

1. Confidence in the DMO setting is maintained as no regulator can replicate perfectly efficient outcomes, and

2. Incentives for competition are maintained, thereby encouraging innovation and investment by retailers, as a regulator cannot perfectly replicate competitive outcomes either.

This approach to price setting also incentivises consumers to engage in the market to get that better deal, whereby excessive margins will be eroded by competition.  The Australian Energy Market Commission (AEMC) embedded network review recommended the rollout suitable market compliant meters that are registered with the Australian Energy Market Operator (AEMO) to embedded network customers to make it easier for customers to switch retailer.  This would make it easier to get that better deal, and the AEMC approach of providing embedded network customers full access to competition remains industry’s preferred option.

Accommodating Innovation for Embedded Networks

Back to the IPART price reasoning, and as with everything it’s never simple. IPART is trying to achieve a lot, and the efficient costs of supplying electricity to an embedded network, were they to exclude any allowance for competition and innovation, creates an internal inconsistency in IPART’s reasoning.  This is because there would appear to then be no available allowance to motivate embedded networks to meet IPART’s further objectives to:

1. Incentivise customers and embedded network sellers to supply and use energy efficiently and enable the efficient use of energy, and

2. Encourage sustainable energy solutions and accommodate innovation and investment in the energy sector.

It represents a conundrum.  Customer price benefits can no doubt flow from innovation as IPART reason, because renewable generators and innovative automation are cheap to run.  But they are also costly to build, much more costly than available alternatives in new builds or retrofits, which means there must be sufficient allowance to recover the cost of capital if these sustainable energy solutions are to attract investment in embedded networks.  Sustainable energy solutions are broadly recognised under the banner of electrification, and IPART acknowledges the benefits of electric hot water systems, for example.  But the proposed approach to the objective of sustainable energy solutions and accommodating innovation and investment,seemingly ignores that the capital cost of electric hot water systems over gas is significantly higher, and the cost of energy efficient heat pumps is higher still; it can be more than triple that for the same capacity when compared to gas.

There are tangible benefits to a sufficient allowance if you want to see electrification and efficiency. The technical and governance complexity of multi occupancy embedded networks (a fast-growing sector) means installing renewable generators or low emissions appliances, or innovative systems and automation as an individual occupant, is an unlikely option. This is clearly a major barrier for the occupants of these properties in accessing renewable energy and innovation, but if correctly incentivised by sufficient allowance, embedded networks can facilitate the occupants access to renewable energy and innovation, to onsite renewable generation, and to other technologies that are shared throughout an entire building - smart buildings.

In practice this will mean centralising and standardising renewable (or other) energy generation infrastructure within buildings, along with energy storage such as batteries and even electric vehicle chargers.  It is then possible to make more efficient use of such assets.  The greater loads present at the point of connection in these larger and often multi occupant buildings mean that the scope for centralised infrastructure is greater and the business case for investing is more apparent. Ultimately, this leads to better outcomes for consumers through access to a secure and more sustainable electricity supply which would otherwise be unachievable as individual occupants. This results in greater tradability of the sites energy resources, and potentially less impact on the distribution system whereby the value of this is returned to consumers over time.  But all of this is only achievable by investment today for a future return.

Unfortunately, the price method proposed by IPART applies directly to metered energy today, as opposed to the future functions of any Embedded Network project, which is where the innovation lies. For example, price prohibitions on a daily service charge ignores the need to match the recovery of fixed costs such as upgrades to, or future installations of, electric hot water systems to the revenue stream.  Any insecurity in cost recovery is likely to lead to lower upfront capital solutions being installed instead, such as gas heating, gas cooktops and gas hot water systems.  The whole of the building infrastructure will likely be built around gas to match with today’s incentives and pricing, and future retrofit will be uneconomic for decades probably.  In practice this undermines the objective of encouraging lower carbon energy solutions and appliance innovation that IPART and the NSW government have made policy priorities. This encouraging retrogression to gas, even if unintended, is inconsistent with NSW policy objectives to reduce carbon emissions.  

The regulation of embedded networks needs to be proactive and sufficiently flexible to avoid inhibiting both technology innovation and the uptake of renewable energy.  NSW has ambitious renewable energy and emission reduction goals, within which embedded networks can make a significant contribution if appropriately set pricing attracts investment for sustainable energy solutions powered by both onsite and offsite renewable energy.  Unfortunately, not meeting IPARTs objectives to:

• Incentivise customers and embedded network sellers to supply and use energy efficiently and enable the efficient use of energy, and
• Encourage sustainable energy solutions and accommodate innovation and investment in the energy sector,

Places the review’s current conclusions at risk.