What price should consumers be asked to pay for competition?

11 Aug 2016

A global conversation is underway about how the transformed energy system should be regulated, including in the UK, Europe and North America. Some of the key questions relate to energy network regulation, promoting innovation throughout the supply chain, and how the full benefits of distributed energy resources can be secured for customers.

It’s a hot topic in Australia. Not only retailers, but energy networks are undertaking diverse trials in energy storage, including large scale and behind-the-meter deployments, to deliver lower cost outcomes for customers.

Will ring-fencing and other restrictions on networks actually lower costs to customers or just promote the philosophy of competition? The Australian Energy Regulator (AER) is soon to release its Draft Ring-fencing Guideline for Distribution Network Service Providers as part of a process to replace disparate State and Territory guidelines. The Australian Energy Market Commission (AEMC) also recently indicated it expects to receive a rule change request from Ministers regarding “…how the rules create separation between what is a regulated service and what is a contestable service.”

These issues came to the fore at the Energy Networks Association Regulation Seminar and the ACCC/AER Regulatory Conference last week as speakers debated whether constraints on the use of new technologies by networks were justified by customer benefits, or potential competition. Some network businesses are investing in behind the meter storage to avoid costly network upgrades and lower the cost of network services. In a South Australian case, individual customers can gain discounted access to storage, which is called on by the network a few times per year to provide grid benefits to all network customers.

The AEMC indicated that, while network-controlled storage could result in more efficient network services, it was concerned that it could impact on competition in energy services.

"Our concern is that network-controlled storage is likely to act as a barrier to the other models. For example, how could a retailer or energy service company compete on price if the network can smear some or all of the costs across all consumers in the state but the retailer or ESCO has to recover the full cost from the individual consumer?... Although networks may rightly argue that using storage in this way enables them to operate the network more efficiently, this model would damage the development of a competitive energy services sector, which gives consumers the best opportunity to decide which product or service best suits them."[1]

The AEMC’s logic was directly challenged the following day at the AER/ACCC Conference by Euan Morton, Principal of Synergies Economic Consulting. Mr Morton described the AEMC approach as “a bet on behalf of customers” that the cost to customers of paying higher network charges in the short term would be offset by future dynamic efficiencies in competitive energy services markets. Mr Morton acknowledged the difficult trade-offs involved in this assessment. Faced with uncertain market outcomes, he said regulatory constraints imposed on network efficiency should be as limited as possible. This is consistent with protecting competitive markets, which advance the efficiency objective embodied in the 'Long-term Interest of Consumers' test.

Everyone agrees (including energy network companies) that a regulated network provider should not be permitted to undertake anti-competitive behaviour, whether by discriminatory treatment of market participants or cross-subsidising competitive activities through the regulated asset base. There are already a wide range of existing controls in competition law and energy regulation addressing these risks.

However, the AEMC’s position goes beyond preventing anti-competitive behaviour. It seems to promote the development of a particular business – retailing of energy storage – even at the cost of higher network charges to customers. The AEMC should welcome, rather than express concern, that new technologies like storage could be used to provide more efficient network services to customers. It is not the role of competition policy or regulation to ensure that some market providers can “compete on price” with an efficient network service which is not discriminatory or cross-subsidised. 

Should customers be asked to pay more than necessary for network services to support the development of new markets for energy services?

Energy networks have a significant role to play in establishing a platform for competition, on a level playing field, by downstream or upstream customers in competitive markets. However, that objective is not the same as compromising network efficiency to promote competitive markets.

In the forthcoming policy debates on ring-fencing and the boundaries of competition, the real focus should be on the long-term interests of customers, as per the National Electricity Objective. Policy makers should consider:

  • Where is the evidence that an investment by network service providers in the use of storage would compromise efficient outcomes in competitive markets? Australia should consider a precautionary approach and observe market outcomes before regulatory intervention. This has been the approach taken by the AEMC in electricity metering reforms.  In that case, it recognised the market power risks of a retailer-appointed Metering Coordinator, but elected to observe market outcomes after 3 years. In California, utilities are required to invest in storage, but are also subject to a cap to avoid market domination.
  • Where is the evidence that the costs imposed on customers by constraining network efficiency are outweighed by the incremental benefits in other markets? It might be possible to demonstrate that dynamic efficiency in storage markets is promoted by constraining the efficient use of storage by energy networks, however, it should not be assumed. Under best practice regulation, the onus should be on those proposing regulatory intervention to demonstrate this approach provides a net public benefit.

It is worth adopting an empirical approach – as even in markets with high churn, the realised benefits of competition can remain contested. As the Chairperson of the Victorian Essential Services Commission said of the Victorian retail electricity market in 2015:

"The paper contends that energy retailers are sheltered from the disciplines of genuine competition because their customers are ‘trapped’ in the market. This muted level of competition may explain how ‘signs’ of competition can be observed despite the lack of competitive and efficient outcomes."

Since the Hilmer report, Australian economic policy has had a strong focus on promoting potentially competitive markets, including by providing access to monopoly infrastructure, removing bottlenecks and addressing anti-competitive behaviour such as discrimination. The Hilmer Report focussed on the ends (customer outcomes) rather than the means (competition policy) stating:

“Competition policy is not about the pursuit of competition for its own sake. Rather, it seeks to facilitate effective competition in the interests of economic efficiency while accommodating situations where competition does not achieve economic efficiency….” [2]

 

[1] AEMC Address: “Redrawing the boundaries between regulation and competition in new energy services markets”, ENA Regulation Seminar, 3 August 2016