Efficient Pricing in an Uncertain Energy Market

Australians are once again focused on electricity prices. When consumers are under pressure with the increasing cost of living, that is entirely understandable. When household budgets face pressure, there is a natural expectation that regulators will do everything possible to ensure prices are fair, disciplined and grounded in reality.

In the context of the energy sector, a current wave of reform raises a more difficult question: how do we protect customers from high prices without undermining the conditions that keep the system stable, competitive and investable over time?

This question sits at the centre of evolving reforms to the Victorian Default Offer (VDO) and the Default Market Offer (DMO), two regulatory mechanisms that act as safety nets for customers who are unable or unwilling to engage actively in the retail electricity market.

In Victoria, the VDO establishes a regulated price for standing offers, providing a reliable safety net for households on standard plans. Similarly, the DMO across the National Electricity Market acts as an anchor point, ensuring that even customers who haven't yet moved to a market deal receive a fair, regulated rate while making it simpler for them to compare and find higher-value offers.

In practice, both frameworks now function as benchmarks for the broader market, shaping pricing behaviour as well as protecting disengaged customers. Both are now subject to regulatory review.

A key feature of current reform discussions is a shift toward more rigid pricing methodologies. In particular, there is a growing emphasis on anchoring default offer prices to a narrow definition of “efficient costs”.

While the objective of transparent and fair pricing for households is a shared priority (particularly as a safeguard for those on standard offers) the practical application of these “efficiency” benchmarks can be challenging. A formulaic approach to pricing risks overlooking the fact that our energy system is not static.

Retailers are managing an environment of heightened volatility, where wholesale price swings are driven by global fuel markets and unpredictable weather patterns. Furthermore, the retail landscape is growing in complexity as we integrate rooftop solar, batteries, and EVs. In this context, pricing should remain flexible enough to account for these shifting consumption patterns and the sophisticated risk-management strategies retailers must adopt in order to protect customers from market shocks.

Retailers are also operating within an expanding set of obligations. Expectations around customer support, particularly for those in vulnerable circumstances, are increasing. Retailers are no longer just energy providers; they are at times being treated as the primary delivery vehicle for complex social and systemic policy. From managing sophisticated hardship programs, to coordinating decentralised energy resources, the operational footprint required to meet these expanding mandates has scaled well beyond the traditional scope of energy retailing.

To accompany this expanded ambit, regulatory frameworks are becoming more and more detailed, coupled with the energy transition (which in and of itself is introducing new layers of investment uncertainty and coordination). Taken together, these factors mean that supplying electricity is not a simple, stable activity. It is a dynamic and evolving task that requires managing variability as much as minimising cost.

In this environment, supplying electricity is no longer a simple, stable utility function. Rather, it is a sophisticated exercise in managing market volatility. We cannot therefore treat “efficient costs” as a static benchmark. Modelling costs inherently require the exercise of subjective judgment regarding risk and uncertainty. The validity of any regulated price depends entirely on which real-world costs are captured within the regulatory boundary and more importantly, which critical market variables are left unaddressed by the model.

As frameworks shift toward narrower definitions of efficiency, they increasingly rely on average cost projections rather than the full range of potential market outcomes. This move toward centralised estimates does not fully account for the frequency or impact of high-cost events.

This is most critical in the wholesale market. By anchoring regulated prices to mid-point outcomes, reform discussions are systematically stripping away the financial buffers required to absorb extreme price spikes. While this may create the appearance of a leaner price, it leaves retailers, and the broader system, exposed to volatility that a “central” model simply cannot account for. That volatility, however, does not disappear. The system continues to experience shocks, whether from extreme weather events, supply disruptions or demand fluctuations. What changes is where that risk is borne. When it is less visible within regulated prices, it is instead absorbed elsewhere within the system.

A similar dynamic can be observed across other cost components. Retail operating environments are becoming more complex, compliance requirements are expanding, and the capabilities required to support customers are becoming more sophisticated. These are structural features of a transitioning energy system, not temporary anomalies. Within this environment, retail margins take on a role that is often underappreciated in regulatory discussions. While they are typically treated as a discrete component to be constrained, they also provide flexibility. They enable retailers to manage variability, absorb short-term shocks and invest in the systems and services required to operate effectively.

As pricing frameworks become more tightly calibrated around a narrow view of efficient cost, and as buffers are reduced across multiple inputs, that flexibility inevitably contracts. The risk is not immediate or dramatic. It is more gradual: a system that becomes less able to absorb shocks, less able to sustain competitive dynamics over time, and less able to support the level of innovation and investment that the transition demands.

This is where the policy trade-offs at the heart of the VDO and DMO frameworks come into sharper focus. Both are designed to protect disengaged customers from unreasonably high prices, while also maintaining incentives for retailers to compete, innovate and invest. These objectives are not independent. A framework that is highly efficient in a static sense may, if calibrated too tightly, weaken the very conditions that deliver efficiency over time.

None of this is an argument against reform, nor against the concept of efficient pricing. Rather, it is a reminder that precision has limits, particularly in systems characterised by uncertainty and change. In these contexts, buffers are not always inefficiencies. In some cases, they are what allow the system to function smoothly under stress.

The goal of default offer regulation is not simply cheaper electricity today, but a system that remains competitive, resilient and investable tomorrow. Getting that balance right is the real task of reform.