Retail prices: IPART sounds note of caution

The recent draft review of New South Wales power bills by the state’s Independent Pricing and Regulatory Tribunal (IPART) supports the view that competition should be left to deliver the best outcomes for consumers, if supported by a stable and predictable energy market framework.

It has also provided a note of caution in seeking to rush to introduce a default electricity price.

The IPART review found that while electricity prices are higher than a decade ago, the bulk of the price increase in this period occurred when prices were regulated. The 2018-2019 electricity prices have remained steady compared to 2017-2018 and continue to reflect the underlying costs of supply.

It also notes that while the average bill remains close to 2013 levels in real terms, what has been seen is a widening in the spread between the cheapest and most expensive offers over time.

Customers who do not shop around, therefore will tend to pay more over time, although IPART also records that more customers are now active in the market with 83 per cent on market offers (up from 78 per cent in the previous year) and last year 19 per cent of customers switched electricity retailers.

Default Pricing

The spread between the lowest and highest offers (market and standing offers) are considered too high for some retailers, which is why the Australian Competition and Consumer Commission (ACCC) recommended a default price to government.

Both the Federal Government and the Opposition have supported the ACCC’s recommendation.

IPART cautions that “re-introducing price regulation or a ‘default tariff’ is likely to lead to lower levels of competition and higher prices”. It notes that while in the short term a default tariff could help customers who are not active in the market and therefore are paying more than they would if they shopped around (in the case of NSW this represents 17 per cent of all customers). Over time, however, it is likely to lead to less customers shopping around as the benefits from switching retailers falls and “this would lead to less vigorous competition and innovation, with fewer retailers competing in this market”.  (See Figure 1).

Figure 1: Impact of Price Regulation

Source: IPART

IPART has reiterated what the global evidence shows to be the outcome of retail price regulation. While there may be a short-term price reduction for disengaged consumers, this group grows as customers are tacitly encouraged to move onto the regulated rate, or forego engagement.  In price regulated jurisdictions internationally, a significantly higher proportion of customers pay the higher regulated rates, and only the most price sensitive customers engage in the market.[1]

The vast majority of customers are now on market offers, so would not benefit from a default offer, while the risk is that that tariff is likely to create the impression that it is a fair price resulting in customers moving away from seeking market offers.

With a default tariff the challenge also remains that regulators – in the case of the ACCC recommendation this would be the Australian Energy Regulator – need to accurately set prices to reflect the cost of supply. Getting it wrong risks either undermining the financial viability of retailers or customers paying more than they otherwise should.  To illustrate the risks, IPART notes that the biggest electricity price increases in NSW over a sustained period occurred between 2007-08 and 2013-14 when prices more than doubled and when they were actually regulated.

Alternative Mechanism

IPART’s report offers another mechanism that would allow customers to assess different offers – a non-binding benchmark tariff that it argues could be less problematic and would not reduce levels of customer engagement or create greater risk for retailers.

The idea would find some support among retailers who are worried about the current political instability and knee-jerk regulation that could further stifle competition. While the broad view of the industry is there is a greater need for transparency for customers around standing offers and discounts, the introduction of a default rate will de-incentivise providers to offer cheaper details and will therefore reduce competition.

The IPART draft review reinforces this viewpoint.

“A non-binding benchmark could provide customers with a tool to assess how an offer compares with the benchmark to help them to determine whether it is a ‘good’ deal. The benchmark tariff would need to be set for each network and would be used to estimate bills for different consumption levels.

“It would make it easier for customers to engage in the market, maintaining competitive pressure on retailers. This would deliver increased customer engagement, without creating additional risks for retailers.” Regardless IPART considered that even a benchmark tariff would not “appear to be warranted at this time, given the additional measures to assist customers that have been implemented”.  These include new requirements from 31 August this year of how retailers must present offers including an annual bill comparison table as part of the basic plan information.

A reference bill and the discounting limitations in the ACCC’s recommendation 33, are also an alternative and do not require price regulation to be implemented to achieve the benefits.

AEC members across the industry share concerns that the ACCC “fair” price for energy will create an incentive for consumers to opt out of the market, a move that will see them paying more for their energy usage.  A clear reference point, such as the mechanism outlined by ACCC, could be implemented quickly with a much lesser risk of unintended outcomes than the default tariff.

Conclusion

IPART’s draft report of its review of the performance and competitiveness of NSW’s retail energy market has flagged potential issues with a default tariff.  The energy industry is keen to engage to ensure any default tariff does not  kill off any incentive to switch to a competitive market offer.  And as we have seen in the debate in Victoria around the Andrews Government’s proposed Basic Service Offer, the impact would be less competition and a reduction in more innovative energy providers.

While the government remains determined to drive down electricity prices before the Federal election, it remains important that any mechanism can be carefully considered.

[1] KPMG, Energy retail markets, An international review, April 2017, pp 7-8.