The Victorian Government finds itself between a rock and a hard place on electricity prices. Either it must allow price increases to households of up to 20 per cent or it will oversee a version of the Californian electricity debacle with retailers like TXU and CitiPower going to the wall.
Until recently, inflation adjusted electricity prices had been steadily falling. This followed five years of reforms and privatisations in electricity supply which brought vast improvements in the industry's productivity. For electricity generation, productivity improvements effectively increased capacity bringing lower wholesale prices. Electricity lines have also been more intensively used also lowering average costs in this part of the industry.
For larger users competition translated the lower wholesale prices into lower bills. For households they followed from pre-arranged regulated reductions that anticipated the supply glut and lower average costs.
All of this is eventually planned to be placed on autopilot -- competition in production and for consumers would leave only a residual role for Government. Whether or not this will take place, we are not there yet. A real market for smaller consumers cannot operate properly without cheap metering facilities that allow retailers to tailor their price offerings to customers' time of day consumption. But within the next year we will have the long-awaited systems in place to allow customers to switch between rival retailers. At that time competition will be able to do the job of ensuring electricity businesses are unable to exploit a captive consumer base. In the meantime, some Government intervention in prices to the household market is inevitable.
In this respect, in January the Government required cuts in final customer prices following the Regulator-General last year mandating a 15 per cent cut in lines charges. Since the beginning of this year, however the energy component of prices (which accounts for about 40 per cent of total costs) have risen by a half. Although forward contracting allows retailers to cushion some of these costs, the long term effect of this is minor. Essentially, unless prices suddenly fall, household increases of up to 20 per cent will be necessary over the coming year. This is a matter of simple arithmetic.
Last month the Government received the first retailer applications for price increases. These averaged only 5 per cent. But the Government either did not realise or turned a blind eye to the fact that the applications were only round one. When a third retailer came up with a 15 per cent increase, the Minister, Candy Broad reacted with horror. She said the company, TXU, "has overstepped the mark with price rise proposals of this magnitude".
Her press release, talked as if the price reductions following the review of distribution lines had not taken place. In fact, in January TXU's prices were reduced by over 20 per cent for small businesses and between one and two per cent for households. It seems price changes in response to cost decreases are legitimate but those in response to cost increases are not!
In California, governmental refusal to allow prices to reflect market conditions contributed to supply shortages and brought bankruptcy to of most of the state's retailers. This is a much worse nightmare than the government copping criticism, even if ill-deserved, for price increases.
To avoid it the government has to allow prices to consumers to move up and stop meddling with prices once retail competition is in place. Not only are higher prices important in encouraging new capacity, but without them there will be no retail competition, as new retailers will be priced out of the market, and the financial viability of the existing retailers will come under threat.
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