Issues Paper. Retail Electricity Price Regulation in Regional Queensland

Transcription

1 Issues Paper Retail Electricity Price Regulation in Regional Queensland December 2013

2 How to Participate HOW TO PARTICIPATE Closing date for feedback: 28 February 2014 Public involvement is an important part of the decision making processes of the Queensland Competition Authority (QCA). Therefore, we invite interested people and organisations to provide written feedback (known as Submissions) on Retail Electricity Price Regulation in Regional Queensland. Submissions can range from a short outlining your views on a particular topic to a more substantial format (ideally in Microsoft Word or PDF format). As this is a public review, the QCA prefers to make submissions publicly available on our website. We do this in the interests of transparency and to promote informed discussions. Confidentiality In the interests of transparency and to promote informed discussion, the QCA would prefer submissions to be made publicly available wherever this is reasonable. However, if a person making a submission does not want that submission to be public, that person should claim confidentiality in respect of the document (or any part of the document). Claims for confidentiality should be clearly noted on the front page of the submission and the relevant sections of the submission should be marked as confidential, so that the remainder of the document can be made publicly available. It would also be appreciated if two copies of each version of these submissions (i.e. the complete version and another excising confidential information) could be provided. Again, it would be appreciated if each version could be provided on disk. Where it is unclear why a submission has been marked 'confidential', the status of the submission will be discussed with the person making the submission. While the QCA will endeavour to identify and protect material claimed as confidential as well as exempt information and information disclosure of which would be contrary to the public interest (within the meaning of the Right to Information Act 2009 (RTI)), it cannot guarantee that submissions will not be made publicly available. As stated in s 239 of the Queensland Competition Authority Act 1997, the Authority must take all reasonable steps to ensure the information is not disclosed without the person s consent, provided the Authority believes that disclosure of the information would be likely to damage the person s commercial activities and that the disclosure of the information would not be in the public interest. Notwithstanding this, there is a possibility that the Authority may be required to reveal confidential information as a result of a RTI request. Submitting your feedback Submissions, comments or inquiries regarding this paper should be directed to: Queensland Competition Authority GPO Box 2257, Brisbane Q 4001 Tel (07) Fax (07) electricity@qca.org.au ii

3 TABLE OF CONTENTS TABLE OF CONTENTS HOW TO PARTICIPATE Closing date for feedback: 28 February 2014 II ii 1 INTRODUCTION Background to electricity sector reforms Direction to the QCA Review process 3 2 ASSESSMENT OF THE CURRENT UTP ARRANGEMENTS Background Effectiveness of UTP Efficiency of UTP 8 3 OPTIONS FOR RETAIL PRICE REGULATION Options that maintain a UTP Options that target subsidies 18 GLOSSARY OF ACRONYMS, TERMS AND CONDITIONS 20 APPENDIX A : DIRECTION NOTICE 22 i

4 Introduction 1 INTRODUCTION The Queensland Government (the Government) is in the process of reforming the electricity sector. A key reform is the removal of retail electricity price regulation (retail price regulation) and introduction of retail price monitoring in south east Queensland by 1 July 2015, if competition is deemed to be sufficient and certain conditions relating to customer protection and engagement are met 1. However, retail prices will continue to be regulated in regional Queensland, where competition is extremely limited. One of the major impediments to competition in regional Queensland is the provision of subsidies to Ergon Energy Queensland (EEQ or Ergon Retail) to maintain the uniform tariff policy (UTP). Under the UTP, non market customers of the same class generally have access to the same regulated retail prices (notified prices) throughout Queensland, even though the costs of supply are considerably higher in regional areas than in the more densely populated south east of the state. This cost difference is largely due to the high costs of transporting electricity over long distances to a sparsely located customer base. The Government has announced that it will examine options to improve competition in regional areas, including the development of more effective subsidy arrangements. It has also signalled that it will consider whether subsidies could be better targeted to those most in need 2. Related to this, the Minister for Energy and Water Supply (the Minister) has directed the Queensland Competition Authority (QCA) to investigate and report on matters relating to the UTP and retail price regulation in regional Queensland. 1.1 Background to electricity sector reforms In May 2012, an Interdepartmental Committee on Electricity Sector Reform (IDC) was established to examine cost pressures on electricity prices specifically network costs, electricity supply and retail competition. The IDC's recommendations form the basis of the Government's electricity reforms, which have been established with the objectives of ensuring 3 : (a) (b) (c) electricity in Queensland is delivered in a cost effective manner for consumers Queensland has a viable, sustainable and competitive electricity industry electricity is delivered in a financially sustainable manner from the Government's perspective The IDC's recommendations In May 2013, the IDC made a series of recommendations to establish a pathway to reform the electricity sector. These recommendations included 4 : (a) removing retail price regulation in south east Queensland by 1 July 2015, if certain conditions are met 1 Department of Energy and Water Supply (DEWS), The 30 year Electricity Strategy, Discussion Paper, September 2013, p Queensland Government, Response to the Interdepartmental Committee on Electricity Sector Reform (IDC), 16 June 2013, p Ibid., p Interdepartmental Committee on Electricity Sector Reform (IDC), Report to Government, May 2013, p. 88 &

5 Introduction (b) (c) reviewing the UTP arrangements to develop more efficient subsidy arrangements for regional Queensland, including whether there is scope to better target the subsidy addressing barriers to the growth of retail competition in regional Queensland, including moving towards a network based subsidy within three years in conjunction with the structural reform of Ergon Retail. The Government largely accepted these recommendations 5 and is in the process of developing many of the IDC's recommendations further through the 30 year electricity strategy and the Commission of Audit Taskforce The 30 year electricity strategy The Government began the process of developing a 30 year strategy for Queensland's electricity sector with the release of a directions paper in December This was followed by a discussion paper in September 2013 which seeks feedback from interested parties on a number of proposals 6. The discussion paper highlighted that improving retail competition in regional Queensland was an immediate challenge and noted the Government's intention to examine options to improve competition, including the network based subsidy option proposed by the IDC 7. The final 30 year electricity strategy is expected to be published in early Commission of Audit Taskforce The Commission of Audit Taskforce 8 is examining recommendations to better target community service obligation (CSO) payments to those in need, including the IDC's recommendations to transition very large electricity customers to cost reflective retail prices and consider removing their access to notified prices. The Commission of Audit Taskforce will also examine recommendations to improve the transparency of the subsidy. 1.2 Direction to the QCA On 14 October 2013, the Minister directed the QCA to investigate and report on matters relating to the UTP and retail price regulation in regional Queensland. In undertaking its investigation, the QCA is to: (a) (b) consider the efficiency and effectiveness of the current UTP arrangements, including the policy's scope and the applicability of the regulated retail prices for south east Queensland to regional Queensland noting the Government's intention to implement a price monitoring regime for southeast Queensland by 1 July 2015: (i) (ii) identify options for maintaining a UTP and related options for retail price regulation in regional Queensland consider alternative options for setting regulated prices in regional Queensland that target the Government's CSO payments to areas of greatest need 5 Queensland Government, Response to the IDC, 16 June 2013, p. 7, p. 9 & p DEWS, The 30 year Electricity Strategy, Discussion paper, September Ibid., p Queensland Government, Response to the IDC, 16 June 2013, p. 7 & p

6 Introduction (c) consider the extent to which options for determining notified prices will support a competitive retail electricity market in regional Queensland. The direction was issued under section 253AA of the Electricity Act 1994 (Electricity Act) and is provided in Appendix A. We must provide our final report to the Minister no later than 30 April Review process We are releasing this Issues Paper as the first step in the review process. In early February we will be holding workshops in Brisbane and regional centres to discuss this review and our Draft Determination of regulated retail prices for Details of the workshops, including how to register to attend, will be available from our web site ( in early January Submissions are invited in response to this Issues Paper and are due no later than 28 February Stakeholders may respond to questions raised in this paper or raise other issues they consider are relevant to the review. Given the short timeframe for the review, this will be the only opportunity for stakeholders to make submissions. We will consider all submissions received by the due date. Table 1 sets out the timetable for this review. Table 1 Timetable Task Date Release Issues Paper 19 December 2013 Regional and Brisbane workshops February 2014 Submissions on Issues Paper close 28 February 2014 Submit report to Minister 30 April

7 Assessment of the Current UTP Arrangements 2 ASSESSMENT OF THE CURRENT UTP ARRANGEMENTS The first part of the Minister's Direction requires that we consider the efficiency and effectiveness of the current UTP arrangements, including the policy's scope and the applicability of regulated retail prices for south east Queensland to regional Queensland. 2.1 Background We have determined regulated retail prices (notified prices) under delegation from the relevant Minister since the introduction of full retail contestability (FRC) in mid The introduction of FRC allowed most customers to enter into a market contract with the retailer of their choice. However, most customers in regional Queensland (Ergon Energy's distribution area) remain on non market or standard contracts and pay notified prices. Until the framework for setting notified prices changed in late 2011, we were not required to explicitly consider the UTP when making our determinations because we were limited to adjusting the notified prices applying to existing regulated retail tariffs (retail tariffs) by our estimate of the percentage change in the Benchmark Retail Cost Index (BRCI). The UTP applied because there were no geographical limitations on the ability of customers to access retail tariffs. The changes to the regulatory framework 9 provided more scope to introduce and remove retail tariffs and to establish tariffs that were more cost reflective. We first applied the new framework to make our Determination. This was also the first determination that did not apply to large customers in south east Queensland, because the Government decided to remove their access to notified prices. For each determination made under the new framework, the delegation has required that we take the UTP into account and we have set notified prices to be consistent with the UTP as follows: (a) (b) Notified prices for residential and small business customers are based on the costs faced by a retailer in south east Queensland, including a network cost component that reflects Energex's network charges. Notified prices for large business customers are based on the costs faced by a retailer in regional Queensland, including a network cost component that reflects the lowest of Ergon Energy Corporation Limited's (EECL's or Ergon Distribution's) network charges. We adopted this approach because large business customers in Energex's network area no longer had access to notified prices. Ergon Retail charges the notified prices we set and receives a CSO payment or subsidy from the Government to compensate for the shortfall between the revenue it earns and the costs it incurs to supply customers Customers in Essential Energy's distribution area A UTP also applies to around 5,700 customers in the Goondiwindi, Texas and Inglewood areas of southern Queensland who are connected to Essential Energy's New South Wales distribution network. While notified prices do not apply to these customers, the Government provides a 9 Through amendments to the Electricity Act and Electricity Regulation

8 Assessment of the Current UTP Arrangements subsidy to Origin Energy of around $5 million per year to ensure that non market customers pay no more than similar customers that have access to notified prices 10. We have been directed to consider options for maintaining a UTP in the context of setting notified prices. We consider that the pricing arrangements applying to customers in Essential Energy's distribution area are outside the scope of this review because they do not have access to notified prices Uniform tariff policies in other jurisdictions In addition to Queensland, three other Australian jurisdictions have retail electricity UTPs: South Australia, Western Australia and the Northern Territory. A summary of the key elements of the policies that apply in each jurisdiction is provided in Table Queensland Government Gazette, 24 June 2013, Vol. 363, No. 39, p. 515; Queensland Government, State Budget , Concessions Statement, June 2013, p. 4 & p

9 Assessment of the Current UTP Arrangements Table 2 Retail electricity uniform tariff policies in Australia FRC? Retail price regulation? Who has access to UTP? Who funds subsidy? Who receives subsidy? Queensland (QLD) a Yes Yes All customers accessing regulated prices Regulated prices not available to large business customers consuming more than 100MWh/yr in south east Queensland QLD Government Ergon Retail (Government owned, supplies customers outside south east Queensland) South Australia (SA) Yes No Removed in February 2013 Residential and small business customers Cross subsidy in network tariffs (Government requires distributor to set uniform network tariffs) All retailers SA Government (if network cross subsidy insufficient) Western Australia (WA) No Customers <50MWh/yr in SWIS b not contestable Yes All customers accessing regulated prices Regulated prices not available to customers consuming more than: 160 MWh/yr in SWIS 4 GWh/yr outside SWIS Tariff equalisation contribution (TEC) determined annually by WA Government TEC recovered through network charges paid by customers in SWIS Horizon Power (Government owned, supplies customers outside SWIS) Northern Territory (NT) Yes Yes All customers accessing regulated prices Regulated prices not available to customers consuming more than: NT Government funded PWC c (Government owned, supplies customers throughout NT) 2 GWh/yr 750 MWh/yr (once regulated price reaches cost reflective level) (a) A UTP also applies to Queensland customers connected to the Essential Energy distribution network (see above). (b) SWIS is the South West Interconnected System, which covers the south west corner of WA. (c) PWC is Power and Water Corporation. 6

10 Assessment of the Current UTP Arrangements 2.2 Effectiveness of UTP An effective policy is one that is successful at achieving its intended result. Assessing the effectiveness of the UTP is difficult because it has not been clearly defined and does not have a clearly specified objective Defining the UTP The UTP provides that, wherever possible, non market customers of the same class (for example, residential or small business) should have access to uniform retail tariffs and pay the same notified price for their electricity supply, regardless of their geographic location 11. However, the UTP is open to interpretation in a few areas. In particular, the UTP does not specify whether notified prices should be based on: (a) (b) the lowest costs of supplying customers in Queensland (i.e., south east Queensland); or the lowest costs of supplying customers that have access to notified prices. In our determinations, we have adopted the latter interpretation. As discussed above, following the removal of access to notified prices for large business customers in south east Queensland, we set notified prices for large business customers based on the costs faced by a retailer in the lowest cost area of regional Queensland. The Minister appeared to endorse our interpretation the following year, when we were explicitly required to consider basing retail tariffs for large business customers on Ergon Distribution's network charges 12. The Commission of Audit also noted that, when retail prices are deregulated in south east Queensland, consideration could be given to the adoption of a different cost reference point for setting notified prices in regional Queensland 13. The definition of the UTP also recognises that there may be situations where it is not possible to set uniform retail tariffs because it requires uniformity 'wherever possible'. There are reasons why it may be valid to place restrictions on customers of the same class accessing certain retail tariffs. For example, some retail tariffs are only available to customers that have more advanced meters and some are closed to new customers (i.e., obsolete retail tariffs) Objective of the UTP Although the objective of the UTP has not been clearly defined, such policies are generally justified on equity or fairness grounds. There is often a view that access to essential services, such as electricity, should be available at uniform prices regardless of location 14. This appears to be the objective that has been adopted to date because access to uniform retail tariffs has not been restricted based on need or any other criteria. UTPs have been more targeted in other jurisdictions, (see Table 2 above). It appears that the Government is now considering whether the objective of the UTP should be refined. For instance, the Government has noted its support for targeting subsidies to customers that are most in need and we have been asked to consider options that improve targeting. The Commission of Audit Taskforce has also been asked to examine 11 Ministerial Delegation to QCA to Determine Regulated Retail Electricity Prices from 1 July 2013 to 30 June 2016, 12 February 2013, p Ibid., p Queensland Commission of Audit, Final Report, February 2013, Vol 2, p QCA, Statement of Regulatory Pricing Principles, August 2013, p

11 Assessment of the Current UTP Arrangements recommendations to better target subsidies. At the same time, the Government has stressed that it is committed to maintaining the UTP 15. If the objective of the UTP was to ensure that all customers have access to affordable electricity to meet their basic needs, the scope of the UTP might be too broad because it is also available to business customers, including very large commercial businesses. In fact, the biggest customers of electricity receive some of the greatest benefits. Our analysis suggests that some very large customers received individual subsidies worth more than $1 million each during As set out in Table 2 above, Queensland is the only state to allow very large business customers access to uniform retail tariffs. It is also the only state in the National Electricity Market (NEM) to allow large customers access to uniform retail tariffs. Alternatively, if the objective of the UTP was for low income and disadvantaged customers to access electricity at an affordable price, an approach that provides assistance in a more targeted way may be more appropriate. The Government provides various targeted rebates and concessions to customers that meet certain eligibility criteria. For instance, pensioners and seniors are entitled to an annual rebate to reduce their energy bills 17 and low income earners are entitled to short term assistance if they experience a crisis or emergency 18. A more targeted approach is also likely to be more effective if the objective was to meet certain economic objectives, for example, promoting regional development. We consider that it is the Government's role to establish a policy objective and we welcome further guidance from the Government on this matter. This would help to better assess the effectiveness of the current arrangements relative to alternative options. Questions 2.1 Should other interpretations of the UTP be considered? 2.2 Have we correctly applied the UTP when setting notified prices? 2.3 What are the policy objectives of the current UTP? 2.4 How effective is the current UTP in achieving these objectives? 2.5 What other factors should we consider when assessing the effectiveness of the current UTP in achieving its objectives? 2.3 Efficiency of UTP An outcome is economically efficient when the benefits to society are maximised given available resources. As pointed out by the Commission of Audit and IDC, the current UTP arrangements are likely to be an inefficient means of subsidising electricity prices Covering Letter to the Minister's Direction Notice, 14 October 2013, p. 1; Queensland Government, Response to the Independent Commission of Audit Final Report, April 2013, p. 6; Queensland Government, Response to the IDC, 16 June 2013, p QCA, Advice to the Minister for Energy and Water Supply, Retail electricity prices for Ergon Energy Queensland's very large customers, November 2012, pp The Queensland Government is reviewing the eligibility criteria and structure of this rebate to better target assistance to those in need. See: DEWS, The 30 year Electricity Strategy, Discussion paper, September 2013, p See: water home/electricity/rebates. 19 Queensland Commission of Audit, Final Report, February 2013, Vol 2, p ; IDC, Report to Government, May 2013, pp

12 Assessment of the Current UTP Arrangements Incentives for efficient demand for, and supply of, electricity The UTP has resulted in notified prices that are lower than the costs of supply for most regional customers. Setting prices below the costs of supply has provided incentives for customers to make inefficient consumption and investment decisions and likely resulted in excessive investment in the distribution network and, potentially, in generation capacity Incentives for Ergon Retail to improve its efficiency The incentives for Ergon Retail to reduce its costs and improve its efficiency are limited because it receives a subsidy to compensate for the difference between its actual costs and revenues 20. It is also not exposed to competitive pressures from other retailers because they do not receive a subsidy. As pointed out by the IDC 21, it is difficult to differentiate between the efficient cost of providing uniform retail tariffs (which should largely reflect the difference between Energex and Ergon Energy network prices) from any possible inefficiencies in Ergon Retail Impact on retail competition Competitive markets generally provide the best means of achieving efficient outcomes. The benefits of competitive markets are many and include, incentivising businesses to reduce costs, prices that reflect efficient costs over time, and a choice of products and services that customers demand. As Ergon Retail is the only retailer to receive a subsidy, this provides a significant barrier to the development of competition in regional Queensland and effectively entrenches Ergon Retail's monopoly position. Despite the legislative barriers to competition being removed more than six years ago, less than 1% of regional customers are supplied under a market contract with another retailer. The proportion of large customers is higher, at around 27%. This compares to south east Queensland where more than 70% of customers are supplied under a market contract 22. The Government is a party to the Australian Energy Market Agreement (AEMA), under which it has committed to FRC in retail energy markets in accordance with the National Competition Policy Agreements. It has also agreed (among other things) to meet social welfare and equity objectives through clearly specified and transparently funded CSOs that do not materially impede competition 23. The current subsidy arrangements appear to be inconsistent with this obligation Cost of providing the subsidy As pointed out by the Commission of Audit, the current arrangements to fund the UTP "give rise to an increasing and somewhat unpredictable requirement for subsidisation of energy costs by taxpayers." 24 The cost of the subsidy is estimated to be $615 million in and is projected to increase in future 26. There are opportunity costs of providing this subsidy. In other 20 Queensland Commission of Audit, Final Report, February 2013, Vol 2, p IDC, Report to Government, May 2013, p QCA, Draft Determination, Regulated Retail Electricity Prices , December 2013, Chapter Australian Energy Market Agreement, as amended, 2 October 2011, clauses & 14.11(b). 24 Queensland Commission of Audit, Final Report, February 2013, Vol 2, p Queensland Government, State Budget , Concessions Statement, June 2013, p Queensland Commission of Audit, Final Report, February 2013, Vol 2, p

13 Assessment of the Current UTP Arrangements words, the money spent to ensure retail tariff uniformity cannot be spent on other Government priorities, which could include providing more targeted assistance to those in need. There are also efficiency costs of raising revenue through taxation to provide subsidies. Taxes impose efficiency costs because they distort behaviour. For instance, a tax imposed on labour income distorts the decision people make between work and leisure, while a tax on house purchases (stamp duty) discourages people from moving to a house that better suits their needs. The administration costs of providing the subsidy should also be considered. As pointed out by the IDC, a key benefit of the current UTP arrangements is that they are relatively simple to administer 27. Questions 2.6 How efficient is the UTP? 2.7 What factors should we consider when assessing the efficiency of the current UTP? 27 IDC, Report to Government, May 2013, p

14 Options for Retail Price Regulation 3 OPTIONS FOR RETAIL PRICE REGULATION While retail price regulation is expected to be removed in south east Queensland by 1 July 2015, we will continue to determine notified prices for most customers in regional Queensland. Given that notified prices for residential and small business customers are based on notified prices in south east Queensland, removal of notified prices means that an alternative method of setting retail prices in regional Queensland will be required. The Minister's direction requires that we consider options for retail price regulation that: (a) (b) maintain a UTP target the Government's CSO payments or subsidies to areas of greatest need. The direction also requires that we consider the extent to which options for determining notified prices will support a competitive retail electricity market in regional Queensland. 3.1 Options that maintain a UTP There are two key issues to consider when looking at options that maintain a UTP: the method of delivering the subsidy and how notified prices should be set Delivery of the subsidy We have identified two broad options for the future delivery of subsidies required to maintain a UTP: (a) (b) Retail level subsidy applied at the retail level, potentially expanded to all retailers subsidy applied at the network level. The first option is to continue to pay a subsidy to Ergon Retail. However, this arrangement has a number of failings, as discussed in Chapter 2. Most notably, it creates a significant barrier to retail competition in regional Queensland and provides ineffective incentives to Ergon Retail to operate efficiently. One possible solution to these problems is to retain a retail subsidy but make it available to all retailers, not just Ergon Retail. We understand that such an arrangement exists in South Australia where retailers are able to access compensation to provide uniform retail tariffs to customers with higher costs to supply (see Table 2 in Chapter 2) 28. Extending the provision of the subsidy to all retailers would promote retail competition and encourage Ergon Retail to become more efficient, but would likely introduce additional complexity and administrative costs. This approach would also require that compensation payments be linked strictly to the key drivers of cost differences (i.e., network costs and energy losses) to ensure that taxpayers do not subsidise other controllable costs of retailers in a competitive market. 28 However, we understand that the South Australian Government also imposes a requirement on SA Power Networks to maintain state wide pricing for small customers, which means that distribution tariffs are averaged. As this eliminates the main cause of disparity between the costs of supplying urban and regional customers, we understand that retailers have not typically required the compensation available to them. 11

15 Options for Retail Price Regulation Network level If a subsidy was paid to Ergon Distribution, retailers other than Ergon Retail could access subsidised network charges, which would remove a key barrier to competition in regional Queensland. However, there may be residual barriers to competition, as set out in Figure 1 below. A network subsidy would also continue to prevent customers from facing cost reflective retail prices and could continue to result in inefficient investment in electricity supply infrastructure and inefficient investment by consumers. We have identified a number of other issues that would need to be considered before implementing a network subsidy, as outlined below. Ability of Ergon Retail to compete The IDC recommended that moving to retail contestability should be accompanied by structural reform of Ergon Retail, so that it has the capacity to operate as a competitive retailer 29. We understand that Ergon Retail would not immediately be able to compete effectively on a large scale without significant investment in systems and capabilities. Aside from internal capabilities, there are legislative instruments restricting Ergon Retail's commercial activities. The IDC pointed out that introducing a network subsidy while Ergon Retail remains precluded from competing would put the value of the company at risk through an immediate and significant loss of customers 30. While Ergon Retail would be expected to lose customers to other retailers, this may not occur to a significant extent if customers do not actively participate in the competitive market. There may be a need to consider amending the Electricity Act to remove the competitive restrictions imposed on Ergon Retail. It may also be appropriate to amend the restrictions that preclude customers from returning to Ergon Retail after accepting a market offer from an alternative retailer. Retaining this restriction could limit customer choice and may be an impediment to competition if customers are wary of moving to alternative retailers if they are precluded from returning to Ergon Retail in future. 29 IDC, Report to Government, May 2013, p Ibid. 12

16 Options for Retail Price Regulation Figure 1 Residual Barriers to Competition Even if the barriers to competition inherent in the current UTP arrangements are removed by introducing a network subsidy, a number of other barriers to competition are likely to remain, including: Price regulation. Retailers are likely to perceive markets that have price regulation as more risky and less attractive than markets that do not. Recent government intervention in the regulatory price setting process may also have increased the perceived risk of retailing in Queensland compared to other markets. For instance, retailers have previously argued that the Government s decision to freeze tariff 11 in increased uncertainty and the risk of retailing in Queensland. The Government also intervened in the price setting process in by capping increases in the obsolete and transitional retail tariffs at 10%. Requirement for all retailers to offer notified prices. If the requirement for all retailers to allow customers to revert to notified prices is retained, this may have implications for the attractiveness of the market to prospective new entrants due to the perceived regulatory risk involved. One option might be for the requirement to apply to Ergon Retail only. No reversion to notified prices for large business customers. Once a large business customer accepts a market contract they cannot revert to a non market contract (paying notified prices), which may discourage them from accepting a market offer. This restriction also applies to any future occupants of that premises (for example, if the premises is sold or occupied by a new tenant). Limited metering functionality. This can negatively impact competition by inhibiting product innovation and limiting the choice of products retailers can offer customers. The Government has recently announced its support for a customer driven rollout of advanced meters 31. Poor customer engagement and participation. A lack of customer engagement is a recognised issue in retail electricity markets. Well informed customers that actively participate in the competitive market put pressure on retailers to price competitively and provide products and services that meet their needs 32. The Government is establishing a working group to develop a strategy to improve customer engagement 33. Limitations on door to door selling. Door to door selling may not be a viable marketing tool in more remote areas. While the major retailers have announced that they will no longer be selling door to door, smaller retailers have tended to use this technique as a key way of building market share and overcoming a lack of customer engagement. As pointed out by one retailer 34, "the vast majority of people only switch energy retailers when a cheaper proposition is put to them, normally at the door." 31 DEWS, The 30 year electricity strategy, Discussion paper, September 2013, p Australian Energy Market Commission, Review of Competition in the Retail Electricity and Natural Gas Markets in New South Wales, Final Report, 3 October 2013, Chapter DEWS, The 30 year electricity strategy, Discussion paper, September 2013, p Australian Power and Gas, Investor Day Presentation, 6 December

17 Options for Retail Price Regulation Adjustment of Ergon Distribution's network tariffs Applying the subsidy to Ergon Distribution would require its approved network charges to be reduced by an amount sufficient to provide uniformity between retail prices in regional Queensland and the chosen benchmark price under the UTP. From a practical and process perspective, consideration should be given to how these adjustments would be applied. One option is to reduce Ergon Distribution's network charges to a level that would deliver uniform retail prices. Any reduction would also likely need to account for differences in energy losses. This would likely require a direction from the shareholding Minister under the Government Owned Corporations Act 1993 to act in the public interest or give effect to a particular public policy, even if it is not in the distributors' commercial interests 35. There have been a number of precedents for this, including the directions to Energex and Ergon Distribution to not recover allowed revenue bonuses associated with the Australian Energy Regulator's (AER's) service target performance incentive scheme. The distributors have also been directed to reduce their network revenues to give effect to the recommendations of the electricity network capital program (ENCAP) review. Furthermore, to ensure that retailers were compensated for the Government's decision to freeze tariff 11 in , Energex was directed to make a one off reduction to the fixed component of the underlying network charge. Alternatively, legislative provisions could be developed to achieve a similar outcome. An example of this is the provision in the Electricity Regulation 2006 that prevents the distributors from charging customers for disconnection services 36. In this case, the AER still approves charges for these services, however the provisions of the Regulations effectively over rule this by setting the maximum prices that can be charged for this service at nil. A similar provision might be implemented to adjust network charges under a network based CSO arrangement. Customers in isolated communities While most customers are connected to the national electricity grid, a small number of customers located in remote areas are supplied by isolated systems. As noted by the IDC, there is no independent assessment of the distribution costs for isolated systems (except the Mt Isa system) as there is for Ergon Distribution's grid connected systems 37. Customers in isolated communities are excluded by legislation from choosing their retailer. If the Government does not intend to remove this restriction or there are other barriers to retailers offering to supply isolated communities, the benefits of providing a network subsidy for this group of customers may be limited. 35 See sections 114 & 115 of the Government Owned Corporations Act Electricity Regulation 2006, Schedule 8, Part 2 (1). 37 IDC, Report to Government, May 2013, p

18 Options for Retail Price Regulation Questions 3.1 Is a network based subsidy the best way of supporting a UTP and promoting competition in the future? If not, what other approaches should be considered and why? 3.2 Should Ergon Retail continue to be precluded from competing if a network based subsidy is implemented? If not, what issues need to be addressed to allow Ergon Retail to compete effectively? 3.3 What role should notified prices play if competition is established in regional Queensland? Should all competing retailers be required to offer notified prices, or just Ergon Retail? 3.4 What other impediments to competition in regional Queensland exist? How should these be addressed? 3.5 What other matters need to be resolved to implement a network based subsidy? How should these matters be addressed? Options for setting notified prices We have identified two broad approaches for setting notified prices that maintain a UTP: (a) (b) base notified prices on the lowest costs of supply in Queensland (i.e., south east Queensland) base notified prices on the lowest costs of supply in regional Queensland. The approaches will have different impacts on the size of the subsidy and the extent to which customers face more cost reflective retail prices. Lowest costs of supply in Queensland (south east Queensland costs) We have identified two options that would broadly maintain the current approach to basing notified prices for residential and small customers on the costs faced by a retailer in south east Queensland. However, this approach would be inconsistent with our interpretation of the UTP because it would not reflect the lowest costs of supplying customers that have access to notified prices (see Chapter 2). Benchmark against south east Queensland market prices Under this approach, notified prices would be based on a benchmark south east Queensland retail market price, for example, the simple average of retail market prices observed in southeast Queensland. Small customers throughout Queensland have access to notified prices. This means that those customers in regional Queensland on a standard contract (around 99% of regional customers) are paying the same retail price as those customers in south east Queensland who are on a standard contract (only around 30% of south east Queensland customers). Assuming market customers in south east Queensland are paying less than the notified price, small customers in regional Queensland are paying more than the majority of customers in south east Queensland. While this approach might seem to produce an accurate estimate of the efficient cost of supply in south east Queensland (providing competition is driving retailers to reveal their efficient costs), it is based on observations of retail prices at a point in time rather than expectations of market prices over the prospective year. As a result, any alignment between an estimated south east Queensland benchmark price and the actual average market outcome realised 15

19 Options for Retail Price Regulation during any prospective year, is unlikely. Other observations could be used, such as taking a rolling average of recent historical south east Queensland market prices, however this is unlikely to improve the accuracy of the estimate as a proxy for future south east Queensland prices. Benchmarking also requires comparisons between 'like for like' products. Market retail electricity offers are often composed of varied components of value, which would make developing a meaningful benchmark difficult. Given the potential diversity in market offerings, a possible alternative is to benchmark to retailers' 'standing offers'. The Government has indicated that all electricity retailers would be required to publish a 'standing offer' to apply to customers that do not enter into a market contract once retail prices are deregulated 38. If the intent of the UTP is to ensure regional customers have access to the retail price that most south east Queensland customers face, setting notified prices for regional Queensland based on observed market prices in south east Queensland is probably the closest way to deliver pricing uniformity between south east Queensland and regional Queensland. However it would be a step backwards in the effort to improve cost reflectivity in regional Queensland and would increase the subsidy in the process, other things being equal. Bottom up estimation of an efficient south east Queensland cost of supply Another option would be to calculate notified prices based on south east Queensland costs using a bottom up assessment of efficient costs for the year in prospect, in much the same way as we currently do. Unlike a point in time market observation, a bottom up approach would offer a more robust forecast of the expected costs of supply over the prospective year. This is because a bottom up analysis could consider movements in underlying cost drivers such as energy costs, as well as expected network, retail and other costs. Lowest costs of supply in regional Queensland Another option, which would deliver more cost reflective pricing outcomes in regional Queensland, would be to set notified prices based on the costs of supplying electricity to regional Queensland, rather than south east Queensland. Consistent with the approach we have adopted to setting notified prices for large customers, notified prices for small customers could be set based on the lowest of Ergon Distribution's costreflective network charges. These are the network charges for small volume customers that apply in the east pricing zone, transmission region 1. This approach would be consistent with our interpretation of the UTP as it would provide pricing uniformity for all customers who have access to notified prices. The Commission of Audit suggested that an alternative option might be to establish a band of allowable prices around the notified price to provide limited price differentiation, which would improve cost reflectivity 39. However, this approach implies different notified prices for customers depending on their location, so is unlikely to be consistent with the UTP. Figure 2 shows what a typical tariff 11 residential customer in each Ergon Energy network pricing zone would have paid in if they paid a cost reflective notified price, instead of the uniform notified price. It shows that a typical customer in the east pricing zone 38 DEWS, The 30 year Electricity Strategy, Discussion Paper, September 2013, p Queensland Commission of Audit, Final Report, February 2013, Vol 2, p

20 Options for Retail Price Regulation (transmission region 1) would have paid around 30% more, while a typical customer in the west pricing zone (transmission region 1) would have paid around 140% more. It is important to note that these differences will vary from year to year based on changes in underlying costs. Figure 2 Theoretical tariff 11 cost reflective customer bills ( ) $4,000 $3,500 $3,000 Annual bill ($) $2,500 $2,000 $1,500 $1,000 $500 $ Geographical pricing zone Note: Annual bills are calculated based on a typical tariff 11 customer that consumes 4,250 kwh/yr. The cost reflective notified prices in each Ergon Energy pricing zone are estimated by applying the approach we used to set notified prices in , but using Ergon Energy's underlying network charges for each pricing zone (instead of Energex's underlying network charge) and our energy cost estimate for the Ergon Energy net system load profile (NSLP) instead of the Energex NSLP. T1, T2 and T3 refer to the transmission pricing regions set by Ergon Energy as a means of allocating transmission charges to customers. T1 is the closest to the regional reference node and carries the lowest transmission charges. T3 is the furthest north of the regional reference node and carries the highest charges. While a move to more cost reflective prices may reduce the cost of the subsidy, consideration also needs to be given to the impact of higher prices on the utilisation of existing supply assets, which are sunk. If prices are set too high, customers are likely to reduce their demand and some may even disconnect from the network. This would leave existing customers or taxpayers to make up the resulting shortfall in costs. Consideration should also be given to the impact on consumers and the sunk investments they have made in response to subsidised prices. These issues might suggest that a transition period is appropriate. However, moving towards greater cost reflectivity will provide incentives to customers about the costs of maintaining and expanding supply infrastructure and reduce inefficient investment in the future. Furthermore, as pointed out by Ergon Energy 40 : Customers will be making future decisions in terms of how they invest in embedded generation, energy storage, energy efficiency, electric vehicles, premise (sic) automation and other emergent technologies. Customers will need transparent cost reflective prices against which to optimise these decisions. We also acknowledge that Ergon Distribution is reviewing its network tariff strategy and considering a range of network tariff options to better reflect the cost of supplying electricity. The restructuring of network tariffs may have additional impacts that need to be considered Ergon Energy Corporation Limited, Network Tariff Strategy Review, Consultation Paper, July 2013, p See: 17

21 Options for Retail Price Regulation Questions 3.6 What is the best approach for setting notified prices in regional Queensland that will maintain a UTP when south east Queensland retail prices are de regulated? 3.7 What factors should be considered when evaluating alternative approaches that maintain a UTP? 3.2 Options that target subsidies We have been asked to consider other options for delivering subsidies in ways that more effectively target areas of greatest need. The Government's direction suggests that options other than maintaining uniform retail tariffs should be considered. Ultimately, decisions about how the subsidies should be targeted will involve complex and often sensitive issues of equity and welfare. These issues would need to be considered by the Government in the context of its own social and economic policy objectives Limiting access to uniform retail tariffs One option is to limit access to uniform retail tariffs for certain customer groups. The most obvious group to start with would be very large customers. Access to uniform retail tariffs by very large customers in Queensland is unique among UTPs in Australia. The IDC noted that very large customers, including mining companies, receive subsidised electricity supply at an estimated cost of around $50 million per year 42. As noted above, our analysis suggests that some very large customers received individual subsidies of more than $1 million each during We have previously recommended that very large customers should be transitioned to cost reflective charges over time. This idea was endorsed by the IDC and Commission of Audit. An alternative approach put forward by the Commission of Audit is to allow large customers to remain on their subsidised retail tariffs for a fixed period before becoming ineligible to access those tariffs at some point in the future. The Government has not yet accepted these recommendations and has referred them to the Commission of Audit Taskforce for further consideration 44. There may also be reasons to consider removing access for other customer groups. For instance, the IDC raised concerns about notified prices being made available to Australian and Queensland government customers, which it estimated represented $35 million of subsidies during If the Government wants to target the subsidy more precisely, alternative mechanisms may be more effective and efficient Direct transfer payments or subsidies A better approach might be to transition all customers to their cost reflective retail tariffs over time and provide direct transfer payments to those customers identified as most in need of support. Direct transfers are generally considered to be the most efficient means of providing support because they do not distort price signals. Applying direct transfer payments would 42 IDC, Report to Government, May 2013, p QCA, Advice to the Minister for Energy and Water Supply, Retail Electricity Prices for Ergon Energy Queensland's Very Large Customers, November Queensland Government, Response to the IDC, 16 June 2013, p IDC, Report to Government, May 2013, p