Price ceilings on electricity need to go

Last week marked the first ever retailer failure in the Australian electricity market.

Energy One, a retailer serving customers mainly in Queensland and NSW, closed its doors.

Its customers were taken over by other retailers and now find themselves with higher prices (up to 10 per cent above the maximum price in the case of Victorian customers and more than this for larger customers in other states).

Though painful for the Energy One shareholders and somewhat costly for its customers, the episode represents a triumph for the electricity market and its institutional settings.

The process unravelled quickly, there were no "knock-on" effects on other companies within the industry and no customer was cut off.

The intrinsic nature of electricity means that most customers' prices are fixed.  But because demand is highly variable and supply cannot be stored, prices from generators are extremely volatile.

This requires considerable contracting care to avoid situations where insolvency becomes infectious.

Central to ensuring confidence is a requirement that energy retailers are fully insured.  To cover their energy purchases they must either have cash or bank guarantees.

All new business ventures face inherent disadvantages, simply because their suppliers don't know them and they have no track record.

The industry is looking at ways for new start-up companies to overcome these by better facilitating credit and swapping of contracts.

But these improvements might not have helped Energy One.

It got caught because its prices did not incorporate higher energy costs caused by the Queensland Government's water-saving regulations reducing power stations' output.

Unlike other businesses it did not have enough pre-arranged swaps at agreed prices.

While the resilience of the energy market in the face of a bankruptcy is good news, this does not mean there is no room for improvement.

There is increased uncertainty as a result of caution on the part of new investors worrying about the risk of greenhouse-inspired charges.

This would be a major consideration in the Victorian system, dominated as it is by brown coal.

Government statements about impending new greenhouse measures will need to be tempered by other measures to ensure an energy supply vacuum does not result.

The increased energy uncertainty raises the importance of other policy reforms.

The energy retailers want higher maximum prices that small businesses and households can be charged.

Most customers in Victoria are benefiting from prices below the maximum.  This has been a factor in Victoria having the highest proportion of consumers who have switched retailers, an outcome that arguably makes this state's market the most competitive in the world.

Understandably there is resistance to fairer, cost-reflective prices from those benefiting from artificially low prices.  Everybody likes low prices.  But the problem with regulated price ceilings is that they lead to unprofitability.

Price caps also deter the roll-out of smart metering that allows people better control over their electricity usage.  In the end they bring business failure and inadequate investment to assure future supplies.

We don't have price ceilings on petrol, beer or bread.

They were put on electricity as part of the process of weaning people off the old inefficient socialist industry.

But they need to be phased out.

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