Monday, December 24, 2012

Heavy hand of regulators promises pain on power

In the week before Christmas, three events reiterated the increasing degree to which Australia's once market-driven electricity industry dances to a tune of government regulation.

On December 19, the Climate Change Authority issued a final report on its review of the Renewable Energy Target.  Originally set to supply 20 per cent of the market by 2020 with high-cost non-commercial renewable energy, lobbying and tinkerings have caused the RET share to blow out so that it will now be at least 26 per cent.

The renewables are divided into large scale (LRET), mainly wind farms, and small scale (SRES), largely photovoltaics.  The latter are uncapped and are far more expensive even than wind farms, which themselves cost twice as much as conventional coal or gas generation.  Nobody could claim the authority offers a clear path to extricating consumers and taxpayers from the costs that these subsidies impose;  and its report doesn't provide regulatory simplicity either.

Dropping all pretence that the renewable program is in place to combat global warming, the authority recommends that the LRET stay as it is and suggests a galaxy of options for changing SRES.

Options offered on SRES include trying to ensure that commonwealth-mandated payments from other consumers to photovoltaic installations be limited to households (as opposed to businesses).  Other canvassed possibilities include reducing the upfront payments for 15 years of deemed generation that offset the installation costs.  These commonwealth subsidies are in addition to state-based regulations which oblige other electricity consumers to finance the costs of the ultra-generous feed-in prices retailers have to offer those with rooftop panels.

Yet while the RET pushes prices up, state governments are forcing unsustainable price reductions on retailers.  On December 19 the Queensland Supreme Court upheld the right of the Queensland government to fix electricity prices at a level that had forced the leading retailer, Origin Energy, to announce a profit downgrade to the ASX.

The Queensland government determined standard electricity tariffs had previously been set at levels that created a floor price that had made it difficult for other retailers to win market share and 60 per cent of household customers remained on the standard tariff, but the Newman government's decision earlier in the year had made supply even less profitable.  Populist price settings are not confined to Queensland.

Until recently, South Australia had a retail regulatory regime that was a genuine fail-safe system.  Its price-fixing was a floor price designed to prevent a grossly exploitative tariff on the part of the dominant retailer (AGL).

As a result there was lots of customer churn and a market that experienced competitiveness rivalling the almost fully deregulated Victorian market.  Only 25 per cent of household customers have remained on the standard tariff.

But in October, the Premier decided that the previous fail-safe tariff should be transformed into one with a floor price, which was carefully sculpted in order to engineer a price reduction.

The default tariff, in the face of increased costs, was reduced by 8.1 per cent and the Premier was calling for this reduced tariff to be made available to all customers.

After much activity and a legal threat, on December 18 the price reduction was modified.  AGL agreed to set the households' standard tariff for those at present on that tariff at fully 9.1 per cent below that previously prevailing.  In return, the government agreed to allow cost impositions from its own and from commonwealth regulations to be passed on to customers.  Those customers on non-standard tariffs are now allowed to rejoin the regulated tariff but with a 4.5 per cent price reduction.  Small business customers' standing offer tariffs are also reduced by 4.5 per cent.

The Premier says in two years' time the market will no longer be regulated as long as prices fall and numerous new suppliers enter the market.  Remarkably, Wayne Swan and Martin Ferguson have welcomed this as deregulation, as have the retail businesses.

Electricity suppliers are all too aware of the damage that government price-fixing and regulatory measures can wreak on their balance sheets.  Businesses have contracts locked in and, as evidenced by the Origin profit downgrade announcement, are hostage to populist government price controls.

The immediate impact of political price-squeezing is unlikely to bring a serious immediate fall in supply availability, since its effects are longer term.  But politicians rarely have a time horizon longer than three years.

The mix of carbon taxes, renewable requirements and other market interventions combined with government-determined increased spending levels on electricity networks have raised electricity costs and the all-important profile of electricity to consumers.  This lays the ground for exercising political muscle on the cheap.

The various interventions are forcing up the cost of electricity to consumers by requiring retailers to use high-cost green power, and incur a variety of management expenses thus reducing their profitability.  The bitter harvest is one for the future.

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