Power to the People

On 13 January of this year, the Victorian Government introduced Full Retail Competition for electricity.  Household customers became free to seek better deals from retailers.  But at the end of last week there were only 3,600 Victorian applications to change retailer (even this was better than in the NSW government owned system where hardly any applications were made).

Why are so few people are seeking better electricity supply deals when electricity retailing has lots of scope for competition?

One reason is that the competitors are less keen to win new business during the summer months when energy costs are high.

But the most important reason is price controls.  Soon after its election, the Bracks Government decided that households' electricity supply was too politically sensitive to be left to the cut and thrust of the market and foreshadowed competition accompanied by price caps.  Such policies were not adopted for business customers groups, which were progressively allowed choice of retailer over the past half a dozen years.  Nor were they needed -- competition ensured that most business customers saw lower prices.

Recent rising energy costs have increased Government fears of a backlash from higher electricity prices to household consumers.  These developments led electricity retailers to seek average price increases of between 15 and 21 per cent.  On the advice of the Essential Services Commission, the Government pared these back to between 2.5 and 15.5 per cent.

Though this price dampening offers a short term benefit to many consumers, price controls risk undermining business economics.  At the extreme, holding customer prices down puts retailers at risk of the Californian nightmare, crushed between the hammer of rising costs and the anvil of fixed prices.

In addition to caps on overall prices, electricity retailers are required to keep price increases for each customer class to less than 3 per cent of the benchmark.  This cements-in distortions, making it easier for new retailers to avoid those customer classes whose tariffs have become highly unprofitable -- for example those with off-peak water heating.  The danger is that the host retailers will gradually be left servicing the highest cost customers.

This distortion will be intensified by the lack of "smart" household meters, which means all household customers are treated as having the same daily electricity use profile.  Such treatment may be unavoidable but encourages firms to cross-subsidise high volume customers, even those with air conditioning units that cut in just when the energy costs are highest.

The Victorian Clayton's form of Full Retail Competition was introduced during the same week as the UK announced a total deregulation of electricity prices.  Previously, the UK had Victorian-style price caps to phase-in full price deregulation.  This worked, because the price caps were introduced when energy costs were falling and therefore did not bite.

Victoria is unlikely to have such luck.

Price caps that hold down average prices and prevent them adjusting to shifting costs sap business innovation, deny customer choice and increase firms' risks of incurring huge losses.  Victoria must therefore avoid further delays to Full Retail Competition and allow competition its rightful role as the price regulator.

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