Risky business

The Australian Competition & Consumer Commission chairman, Rod Sims, opening a regulators’ conference in Brisbane this week, spoke at length (unsurprisingly) about electricity issues and, in particular, about affordability. (His talk is on the ACCC website and well worth reading.) What I find interesting, and somewhat surprising, is that not one of the 1,013 words he used on the electricity aspect was “risk.”

One of the (many) problems with public debating of this issue is the lack of appreciation of the risks involved along the supply chain. This doesn’t apply to Sims, who understands energy risks as well as anyone in the country. What attracts my attention is that he didn’t choose to canvass the point even in passing this week.  It will be interesting to see how he and his ACCC team tackle this issue when they deliver their preliminary report on power bills to federal Treasurer Scott Morrison late in September.

Meanwhile, the 339-page Australian Energy Market Commission report on retail energy competition published this week contains quite a lot on the topic (and certainly much more than I can canvass in a blog post).

One of the aspects lost on the media (and quite a few others) in lashing out at energy retailers is the danger of crippling costs the sellers run as they juggle their way through the east coast market.

As an example, here is an excerpt from the AEMC report: “Energy retailers face a range of financial risks. The scale of this risk means that a retailer, if improperly hedged, could become insolvent within hours.”

It explains: “Spot prices can rise from average levels around $60 to $100 per megawatt hour in one trading interval to the market price cap of $14,200 per MWh in the next interval. If a customer withdraws energy when the price is high, the retailer must pay for the energy at the prevailing spot price.

“A retailer supplying a customer load of 1,000 megawatts at the market price cap could incur costs of up to $14 million in a single hour. At the same time, the retailer might only receive $250,000 (25 c/KWh × 1000 MW × 1 hour) from its customers under their retail supply contracts. The retailer must bear the difference of $13.75 million, whilst continuing to be able to pay network businesses the relevant network charges.”

AEMC adds: “To manage, retailers require large proportions of financial capital, as well as potentially some physical capital. As such, a retailer needs to make a margin commensurate with the costs associated with the provision of this financial and physical capital.

“Some commentators have suggested that the net margins of energy retailers can be compared with (those) of other retail businesses such as supermarkets. Energy retailing is fundamentally different to food retailing; energy retailing relates to the selling of financial products whereas food retailing relates to the sale of physical products. The gross and net margins of energy retailers reflect compensation for incurring risks that are fundamentally different from the risks associated with food retailing.

“Energy retailers’ risks are more similar to those of banks or financial institutions. Therefore, to the extent that comparisons are to be made, energy retailers’ margins are better compared against those of banks or financial institutions.”

As the report illustrates, there are a multitude of issues with which the retailers have to contend on a continuous basis. For example, “the (wholesale electricity) market price in each (bidding) period is set by the price bid by the marginal generator (and) there is no guarantee that this price will fully recover all the costs associated with generation, including the return on and of capital required by each generator, in each and every period.

“The entry of wind and solar generators into the market, with their low short-run marginal costs, can reduce prices in the wholesale electricity market when there is excess supply of generation capacity. During this time, market prices might be less than that needed to fully recover all the costs of those generators that have higher short-run marginal costs than wind and solar.”

And so on. All this is lost to view in tabloid media screeching (whether in newspapers or on radio or TV) about “gouging” and other sins.

In a time of soaring power prices, it is entirely understandable that sellers of electricity should be asked to account for the make-up of the bills they despatch – and I think their explanations fall short of the “pub test” of comprehension quite a lot of the time – but to assume they are guilty of rorting etcetera without knowledge of the market issues they have to manage is another example of community energy illiteracy, which is fuelled by what politicians (and others on the make) have to say in the media.

All this is tossed together with the separate, but related, issue of energy poverty, which was a problem a decade ago when bills were half the level they are today. It does not diminish the pain those in financial difficulty are suffering to point out that they are a tiny minority of the mass market but this does not suit the rant du jour, so the travail of the few becomes a symbol of all that is perceived to be wrong with the system.

The larger issue (in terms of how energy prices bite politicians) is the big number of so-called middle class Australians struggling to deal with rents or mortgages and the other routine costs of family life. In their world, where the need to cut money corners intrudes increasingly on living the good life, yet another power bill rise (let alone the one they incurred recently from seeking to be comfortable in a torrid summer) is quite a large psychological irritant (even if the actual latest increase is only the equivalent of a cup of café coffee a week).

Another issue for this substantial cohort of the community is participation in the retail market and the problems encountered in wrestling with the process. As the AEMC points out, “in NEM jurisdictions where consumers have an active choice of retailer, 47 per cent of residential and 54 per cent of small business (customers) have not switched retailer or plan in the past five years.”  It would be fascinating to have someone calculate what this represents in aggregate savings foregone – billions of dollars is my guess.

Sims, I note from his talk, wants to focus on the level of the standing or default prices these consumers choose to pay (‘which for a range of reasons are not being competed away”). Retailer risk surely is one ingredient.

That the present situation dissatisfies the mass market, and that Australians want action to ameliorate both the actual prices we are now paying and the upward trend we fear will continue, is beyond argument. But we will not get real solutions – that is, ones that work for us over time in delivering affordable, reliable power while continuing to reduce carbon emissions – out of an environment where policymakers are in a funk brought on to an extent by confected outrage over prices and their own lack of adequate appreciation of a complex marketplace.

Getting a real public handle on the nature of risk in the NEM would be a good thing.

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