Retail stress: An emerging COVID challenge

Australia remains in a two-pronged crisis caused by COVID-19. As providers of an essential service, energy retailers will play a key role in both the economic crisis likely to impact Australia for years to come, and the health crisis – for which access to energy at a household level is vital.

In this environment governments and regulators are keen to be seen to be in front of the issue and have consequently placed higher expectations on retailers who are at the pointy end of assisting households and businesses.

An emerging and growing challenge will be how to manage the sheer volume of customers vulnerable to payment difficulties and the increasing debt levels carried by retailers as the health and economic crisis continues.  Measures like this week’s announcement that the Federal Government’s JobSeeker and JobKeeper measures will be maintained in some form for at least the rest of 2020 will help.  But retailers, who carry all the risks of non-payment in the market, currently have limited scope to recover costs.

The question is how best to ensure retailers and other providers of essential services can continue to assist customers given the emerging risks? We look at the market dynamics and possible responses.

The role of retailers in the energy market

Energy retailers by design carry all the risk of the non-payment and cash-flow in the National Electricity Market (NEM). Whilst recent reviews have focused on trying to understand why retail costs are high, little attention has been placed on the role of retailers, and why an effective and functioning retail market is critical for the long-term interests of consumers.

Recent reviews - Thwaites in Victoria and the Australian Competition and Consumer Commission (ACCC) - have posited that retailer costs are higher than they need to be; recommending approaches to trim down the retailers slice of the pie without any real consideration of why retail is necessary in the first place.

The Independent Review of the Electricity and Gas Retail Markets in Victoria described the energy market as one where the costs of competition, the structure of the market, and the practices of industry were disadvantaging consumers.[i] There was barely a mention in the entire review of the risks retailers faced, or the functions they performed for the rest of the electricity supply chain.

The ACCC provided a significantly more in-depth consideration of the role of retailers in managing risks for the market. The commission highlighted that a retailer’s EBITDA margin reflects a level of return on its operations and should in theory reflect the risks faced by retailers due to their operating and regulatory environment.[ii] Yet, it too made recommendations that sought to reduce retailer costs, without any consideration as to how retailers might be efficiently compensated for the cover they provided other participants. 

Since these reports were finalised in 2017 and 2018 respectively, the operating and regulatory environment for retailers has changed dramatically. As the impact of the COVID-19 pandemic continues to impact the Australian economy and broader social environment, the stakes have never been higher for retailers.

Coronavirus impacts on retailers and customers

To date, it has been difficult to quantitatively identify the impacts of the pandemic on retailer operations. Data provided voluntarily by retailers to the Australian Energy Regulator (AER) and Essential Services Commission (ESC) is showing that retailers and customers are doing the best they can to remain engaged in challenging circumstances. In Victoria, customer contacts are increasing, yet the number of customers receiving assistance under the payment difficulties framework is declining. A decline in the number of customers receiving assistance at this time might point to an increase in hidden debts. The AER presents a similar picture in the other jurisdictions, with call numbers growing, and customer debt levels increasing.

What is not clear is the percentage of customers not engaging at all with their retailer and the impacts this is having on the overall levels of debt held by retailers. The regulatory framework, practical limitations, and proactive retailer commitments have meant between March and July, next to no disconnections for non-payment were undertaken in the NEM.

Retailers are anticipating the disconnection moratorium will have significant flow on impacts in the coming months on bad debt write-offs, and ultimately their EBITDA. This risk cannot be underestimated.

While the effective unemployment rate remains high, retailers will continue to be challenged by the sheer volume of customers vulnerable to payment difficulty. Earlier this month Origin announced to the market that they were anticipating a $25-35 million increase in bad debt provision up to June 2021. Other large retailers would likely be anticipating similar impacts, and the smallest retailers may face existential challenges.

What has been the response of policy makers?

Since the AER released its Statement of Expectations[iii], retailers have been required to provide hardship assistance and avoid disconnections for both residential and small business customers – vastly greater obligations than the existing regulatory framework envisages.

Energy Networks Australia released its Network Relief Package almost immediately as a means to assisting retailers during this period – a positive step – but in hindsight, strict eligibility requirements and the development of other macroeconomic stimulus has meant that the quantum of the relief is smaller than might have been expected.

Noting this, the AER proposed a rule change to the Australian Energy Market Commission (AEMC) that sought to avoid the regulatory imposts in the Statement of Expectations resulting in retailers defaulting on their obligations to meet their upstream costs, irrespective of customer payment.

The AER proposal would enable retailers to defer network payments for a period of 6 months to allow those retailers more time to recover debts from their customers. The AER was concerned that with customer payment not forthcoming, retailers – particularly smaller retailers – would fail, triggering retailer of last resort (RoLR) events in the market. A RoLR event results in the customers of the failed retailer being transferred immediately to the registered RoLR in each network patch (usually the incumbent retailer). If multiple smaller retailers failed, vastly greater pressures would be placed on other retailers in the market, risking financial contagion. The AEMC now proposes to make this rule, albeit limiting its application to smaller retailers and those not owned by Australian Governments. It is important to note that for customers who do not pay during the deferral period, the rule change merely defers the crunch point for retailers.

In Victoria, the ESC proposes to require retailers to expand their payment difficulty programs to provide up to two years of support to small business customers. The AER’s rule change will not apply in Victoria, so in an environment where retailers are inhibited from recovering their customer debts, retailers will continue to be required to pay network businesses as per the usual NEM timeframes.

The ESC is now considering alternative approaches to mitigate the impacts caused by their own proposed regulatory changes. While the ESC has not imposed a disconnection moratorium in Victoria, network businesses have to date refused to action requests from retailers to perform the service even in instances where customers are not receiving assistance under the Payment Difficulties Framework. This might appear altruistic – but it is important to remember that retailers remain liable for network charges incurred at sites the network has refused to disconnect. In effect, retailers are unable to mitigate their own costs, yet remain indebted to the party who is making that mitigation impossible.

To date, no regulator or government has made any recommendations of policy responses that would allow retailers to be effectively compensated for the risks they are facing in the COVID-19 economy.

Instead, regulators such as the AEMC in its 2020 Retail Competition Inquiry final report suggested that in an increasingly volatile environment for retailers, changes needed to be made to the RoLR scheme to make the experience for impacted customers more streamlined. In practice, the AEMC is seeking to mitigate the impacts of retailer failure, rather than attempting to solve the market conditions that led to that failure in the first place. If the RoLR scheme is not delivering for consumers, then potential reforms deserve comprehensive analysis – not ad hoc changes during a time of crisis.

What needs to be done?

The COVID-19 pandemic has been described as a once in 100-year event. If that is the case, there is no need to fundamentally restructure the makeup of the NEM to mitigate what is hopefully a relatively short-term problem. That being said, retailers have faced increasing regulatory obligations in recent years which have been predominantly designed to enhance protections for vulnerable consumers and minimise retailer margins. It could be said that in the coming years, there may need to be a rethink about what is in fact the most efficient means of delivering energy to consumers, and where the risks of non-payment should lie. That is a discussion for another day.

The immediate concern for retailers is the increasing bad debt risks that will inevitably hit the sector. It is unreasonable to expect that the limitations on collections placed on retailers during this time will have no effect, so the question is, what is the best way to minimise these effects on Australian energy consumers.

The first step would be to ensure retailers are able to recover their costs in price regulated markets. In unregulated markets, when costs increased, retailers would be able to price their products in a manner that allowed them to recover those costs (albeit subject to the pressures of competition). Given the reintroduction price regulation via the Default Market Offer (DMO) and the Victorian Default Offer (VDO) in recent years, retailers have been limited in their ability to recover costs not anticipated when the frameworks were developed. This is of particular concern in Victoria where the VDO is intended to act akin to a market offer price expressly without any allowance for headroom or risk, rather than the approach of the DMO which intends to allow competition to flourish beneath the ‘fair’ price cap.

While a “coronavirus allowance” in the regulated prices would enable retailers the opportunity to recover their efficient costs in time, the timing of the impacts of the pandemic is affecting retailers today and neither the VDO or the DMO includes a true-up mechanism that would allow retailers to recover costs incurred in previous years.  

For the current year, the AEC hopes the extension of JobKeeper and JobSeeker will provide a buffer between retailers expected to manage customer non-payment and the affordability problems that will no doubt come with a doubling of the unemployment rate amid an ongoing recession.

State governments have a role to play and could be doing more – particularly in Victoria and South Australia that to date have not increased their emergency relief payments. Queensland acted quickly, placing a $200 credit onto the electricity accounts of all residential consumers, and NSW has enhanced its own emergency assistance payment scheme to target bill relief for those doing it tough.

As the pandemic moves into its second phase, jurisdictions need to ensure their customers are adequately supported.

But primarily, retailers need to be confident that if the worst case occurs, they won’t be left carrying the can for the whole sector.

This will require policy makers and regulators to develop approaches that deliver optionality in the coming months – as the data published by the regulators shows, debt trends are slow to present themselves – positive steps to protect the sector and energy consumers are necessary now – if we wait it will be too late.

In the meantime, retailers will continue to help their customers who are having trouble paying their bills.

[i] Thwaites final report, pg. ix

[ii] ACCC REPI, pg. 5

[iii] Australian Energy Regulator Statement of Expectations of energy businesses: Protecting consumers and the market during COVID-19, 9 April 2020