Re-regulating the market: Short term gains and long term pains

Re-regulating the retail price is back on the agenda with the Federal Government determined to implement the Australian Competition and Consumer Commission’s (ACCC) recommended “Default Offer” and the Victorian Government announcing its “same same but different” Victorian Default Offer (VDO).

But the path to re-regulation can be bumpy. At the COAG Energy Council meeting last Friday, the states declined to unanimously support the Default Offer (DO).  Instead, the Australian Energy Market Commission (AEMC) has been asked to undertake an assessment of the impacts of the DO on both market and standing offer customers. The AEMC will report back before the next COAG meeting on 18 December 2018 for a final decision on whether or not to proceed with the changes.             
Energy Minister, Angus Taylor and the Prime Minister, Scott Morrison say the changes will mean significant savings for “ripped off” Australian families, but is that really the case? Here are the facts. 

So what are default tariffs?

The DO was recommended by the ACCC[i] to act as a both a price capped replacement for the existing standing offers in competitive jurisdictions, and as the basis for a reference bill that would set a common base for discounts.

The DO is intended to replace the current Standing Offers in NSW, South Australia, and South East Queensland[ii]. The ACCC says:

The default offer should not exist to be the lowest price, or close to the lowest price in the market. Its purpose is to act as a fallback position for the disengaged or for those that require its additional protections. Ideally, it should only be utilised by a small number of consumers. [iii]

The VDO’s standing in the market is less clear. Flagged by the Victorian Government as performing the same function as the Thwaites Review’s[iv] recommended Basic Service Offer (BSO), Friday’s long awaited announcement provided little detail about what the VDO is intended to achieve and how it might impact the market. The BSO was criticised by both the ACCC and the AEMC for failing to capture the costs of doing business in its calculations.  It appears that a BSO plus some costs of customer acquisition and retention is where the Victorian Government is aiming to land.  As with all of these processes the devil will be in the detail and the industry is right to be concerned by suggestions that the allowance for CARC will be “modest”.  In a highly competitive market like Victoria with more than 20 retailers, it is imperative that a regulated price is set at a rate that allows smaller retailers in particular to compete below it.  The alternative is those retailers will leave the market, and with them the cheap market deals and innovative offers they provide consumers.

Like the DO, the VDO would replace the standing offer, but likely cap the market at a much lower price.

How would the DO be implemented?

At last week’s COAG meeting, Ministers all agreed that the DO would not be applicable in Victoria, WA, and NT as those jurisdictions have not yet signed up to the NECF. In addition to this, the DO wouldn’t apply in the ACT, Tasmania, and regional Queensland as those jurisdictions still retain regulated pricing controls. This means the DO would only apply in South Australia, NSW, and South East Queensland.

There are two options for implementation. The usual method, and definitely the most preferable for all involved, would be for the COAG ministers to agree to introduce the changes into the National Energy Retail Law (NERL). Changes to the NERL require unanimous support from the jurisdictions, but it is common practice for non-impacted jurisdictions to abstain from such a vote. This means that NSW, Queensland, and South Australia would all need to agree with the Commonwealth that the change was in the best interests of their jurisdictions. Judging by the press releases[v] from the Queensland Government in recent days, unanimous support seems unlikely.

This leaves the Commonwealth in a tricky situation. Retail pricing has historically been the domain of the states by virtue of the Australian Energy Market Agreement (AEMA). Further, the AEMA notes the broad support from all jurisdictions to move away from retail price regulation when they are comfortable adequate competition was present. The DO would be a backward step.

But, mechanisms exist for the Commonwealth Government to effectively overrule this agreement, and legislate a price cap through Parliament. This price cap would be equivalent to the Default Market Offer the Australian Energy Regulator (AER) has been tasked with developing, to commence on 1 July.

Confusing, right?

What about the politics of the Commonwealth taking control over retail pricing?

Given the impacted jurisdictions (who currently own pricing) would have recently objected to the introduction of the default offer, over-riding legislation of this kind would represent an extreme step for the Commonwealth.

Unless the Federal Government can find a legislative pathway to implement the DO prior to receipt of the AER advice due by 30 April 2018 (and assuming COAG doesn’t agree to implement the DO in December), then there will be no implementation prior to the Federal election.  Although the Labor Opposition supports the DO in principle, it is not clear whether they would be keen to assist the Government to legislate it prior to a likely May election.  The Greens (who would prefer much more aggressive price regulation than the DO) have already labelled the policy “a con”[vi].

It is worth noting that the two states most vocally opposed at the COAG meeting to the DO were Queensland and NSW - Labor and Coalition governments respectively.  In each case prices have been de-regulated relatively recently, so it should come as no surprise that they are not keen to be seen to backflip on that decision, particularly when their own market monitoring continually indicates competition is delivering positive outcomes for consumers[vii].

Given all these factors, implementing the DO before the election seems unlikely.

What will these tariffs actually do?

In the short term, both the DO and the VDO will reduce the price for customers who have not engaged in the market and remain on standing offers.

In Victoria, this represents less than 5.8 per cent of customers. In NSW and Queensland, these numbers are slightly higher, but declining rapidly as more customers are encouraged to get on a better deal. All in all, there would likely be an immediate price reduction for about 10-15 per cent of customers who have never bothered to engage in the market, of between $105 and $165 per year.

While something might seem better than nothing, it is critical to note that all the evidence shows that when retail prices are regulated, customers are less likely to shop around for a better deal. The vast majority of customers who will get a $105 saving, could have saved significantly more by simply signing up to a market deal. 

But what about all other customers? 

The DO will not directly benefit the vast majority of customers who have already signed up to market offers. These prices are set by contract with the retailer directly and are already likely to be cheaper than the DO.  

In the short term, market offer customers are likely to benefit from simpler offer comparison. The DO would set the price for a reference bill from which all retailers would need to base their headline discounts off. This solves the confusion that arises when retailers base their discounts off different rates, meaning a deal with a 5 per cent discount can sometimes be cheaper than one with a 30 per cent discount.

But in the long term, price regulation comes with significant risks. Customers comforted by the presence of a “fair” regulated tariff will be incentivised to disengage from the market, and the number of good offers that consumers are benefitting from today will undoubtedly shrink. If the default offer is set too low it can drive smaller retailers out of the market, taking with them energy products their customers want. If set too high, the customers choosing to sit on the regulated tariff pay more than they need to. Either way, consumers lose in the long run with less competition, higher average prices, and less innovation in the sector.

The benefits of a good reference rate

Although the DO and VDO are both problematic and have some way to travel, there is almost unanimous sector support for the implementation of a reference rate. A reference rate would deliver the same benefits of simpler comparison of offers that the DO would, and encourage customers to get on the cheapest deal possible. Discounts would all be calculated off the same base rate, so you would know quickly and simply whether your deal was the best for you.

The reference price still allows retailers of all sizes to recover their costs, and structure their offers in ways that suit their customer’s needs. In a way, you get all the benefits of the default offer for 90% of the customer base, without the negative long term consequences that undoubtedly come from price regulation.

As highlighted in the media recently[viii], should we really be implementing a change that results in a few customers paying a little less at the expense of all those who have shopped around and found a better deal?  

[i] Restoring electricity affordability and Australia’s competitive advantage, ACCC Retail Electricity Inquiry – Final Report, June 2018

[ii] As Victoria has not yet signed up to the National Energy Customer Framework, the Ministers have agreed the DO would not apply.

[iii] Ibid, page 251

[iv] Independent Review into the Electricity and Gas Markets in Victoria, August 2017

[v] Win for Queensland at Energy COAG, Media statement by the Minister for Natural Resources, Mines and Energy The Honourable Dr Anthony Lynham, 26 October 2018

[vi] Government’s plan to bring down prices is a con, Media statement by Adam Bandt MP, 22 October 2018

[vii] Queensland Competition Authority Market Monitoring Report, October 2018; Review of the performance and competitiveness of the retail energy market in NSW, Draft Report, IPART, 2 October 2018. See also SEQ power prices continue to decline, Media statement by  the Queensland Minister for Natural Resources, Mines and Energy The Honourable Dr Anthony Lynham, 30 October 2018

[viii] “States agree on power pricing plan”, Saturday Age 27 October 2018; see also “Why regulating energy prices is stupid”, Australian Financial Review, 24 October