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Network tariff reform: a test of political will Annual EUAA Conference Tony Wood Grattan Institute 14 October 2014 Network regulation is a major area for reform • Australians are paying too much for electricity because the regulation of distribution networks is broken. • Allowed profits exceed reasonable levels for low-risk businesses • Costs have been incurred to meet unjustified reliability standards • Ownership matters • The regulatory process is unresponsive to changing markets • Electricity prices have been rising even while consumption has been falling. • Tariff structures are leading to bad decisions • Australians are paying for assets they no longer need or want • Tariff structures lead to some consumers subsidising others in a way that is unfair and provide little incentive for efficient investment. P 1 Network spending and rising power prices Rapid increases in network spending have been driving retail power prices Network costs grew by 64% between 2006 and 2013... $ million (real $2012-13) Index 900 100,000 90,000 800 80,000 700 600 70,000 Electricity price 60,000 500 50,000 400 40,000 300 CPI, All groups 30,000 200 20,000 100 100 = September 1980 10,000 0 - 2006 2007 2008 2009 2010 2011 2012 2013 ...and electricity prices grew by 75%. P 2 Putting the customer back in front How to make electricity cheaper Recommendations Address clear regulatory flaws . Align rates of return with the risks involved and the cost of managing those risks . Establish a consistent, national approach to setting reliability standards . Address governance concerns with government ownership or privatise . Review capital expenditure against updated forecasts P 3 Shock to the system Strategies to reduce network costs in a time of falling demand Recommendations Address overinvestment and make prices more cost-reflective . Ensure that investments better match future needs . Begin the hard task of reforming network tariffs to reflect costs incurred . Review the value of network assets – who pays? P 4 Fair pricing for power Strategies to make prices fairer and cheaper Recommendations Make prices more cost-reflective . A capacity charge better reflects the cost of building and operating the network. It would remove unfair subsidies . Critical peak pricing would reduce peak demand and ultimately, lower prices P 5 Electricity demand rarely approaches the peak In 2013, demand came within 5 per cent of the peak for only 6 hours MW MW 12,000 10,000 Peak demand 9,000 10,000 95% of peak 8,000 8,000 7,000 6,000 6,000 5,000 4,000 4,000 3,000 2,000 2,000 1,000 - 0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Frequency P 6 The problem with networks For the AFL grand final, MCG ticket prices are higher and sales are limited Source: Sheko, Alexander (2010), ‘The Melbourne Cricket Ground during the 2010 AFL Grand Final’ Under the regulated model, more infrastructure drives higher prices P 7 Peak demand expectations drive growth Actual growth capex over 5 years since 2009 reflect peak demand forecast $ million MW 7,000 3,500 5 year growth capex (LHS) 6,000 3,000 5,000 2,500 4,000 2,000 Forecast peak growth (RHS) 3,000 1,500 2,000 1,000 1,000 500 - - Qld NSW Vic SA Tas WA P 8 Why look at households? Households are large contributors to peak demand… 60% 50% 40% 30% 20% 10% 0% New South Victoria Queensland South Tasmania Wales Australia ...and many large businesses already have more efficient traiffs. P 9 The solution: charge more at peak times Wholesale electricity is sold into a pool market…. $/MWh 5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 - (500) Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec ... prices rise dramatically at constrained times. P 10 Charge for capacity, rather than energy Customers would be charged based on their maximum annual use kW 0.42 1.50.3 0.21 Maximum capacity 0.50.1 Energy use 0 0:00 1:00 2:00 3:00 4:00 5:00 6:00 7:00 8:00 9:00 10:00 11:00 12:00 13:00 14:00 15:00 16:00 17:00 18:00 19:00 20:00 21:00 22:00 23:00 Time of day . Encourages customers to become aware of their maximum use. No change in the total amount paid by customers under a revenue cap. P 11 Capacity charges better reflect peaks Capacity has a stronger correlation with peak demand than energy use . Capacity charge from 6am to 11pm on weekdays . Results modelled using the top half hour of demand per year. P 12 Capacity charges make power prices fairer Energy charges mean some households pay too much, others pay too little . Now in Victoria, efficient users of the network subsidise others by an average of $150 a year. P 13 Critical peak pricing to be used in some locations Alongside capacity charges, CPP can be designed to be revenue neutral $/kWh demand profile 2.00 2.50 High peak price 1.50 2.00 Household demand 1.00 1.50 0.50 1.00 0.00 0.50 ‘Discount’ during off peak -0.50 0.00 1-Jan 2-Jan 3-Jan 4-Jan 5-Jan 6-Jan 7-Jan 8-Jan • CPP operates as a ‘non-network’ solution to a capacity constraint. • Only applies in constrained areas • Cost-benefit cost to justify metering investment P 14 CPP has proven effective in reducing peak demand Where a network is under strain, a sharper price signal is warranted 40% 35% 30% 25% 20% 15% 10% 5% 0% TOU TOU Peak CPP CPP w/ tech rebate w/ tech Source: Faruqui, A., and Sergici, S. (2010) . CPP results in a 17% decline in peak demand, or 36% with technology. Results may be lower without voluntary participation. P 15 Key advantages of the proposed solution More cost reflective The price each customer pays reflects pressure they put on the system. Customers can respond Customers that reduce their maximum consumption pay less (unlike, say, with fixed charges). Networks recover regulated revenue Allows a way to recover the cost of building the network, even with falling energy demand. Resilient to future technologies A design that is not technology specific allows for future changes (eg, introduction of electric vehicles). Considers metering availability Capacity can be billed on estimates where interval meters are not available. Pricing design would support a staged metering rollout. P 16 Barriers to implementation Retail price regulation Network solutions will work best where retailers have flexibility to help manage the transition. Smarter metering Smart meters are available in Victoria, but not in other states. Regulatory process The regulated model means changes occur slowly and may need to fall within 5 year regulatory periods. Consumer backlash Many customers find change challenging and a fairer system will mean some customers pay more. Transitional arrangements and engagement are critical – the Victorian ‘moratorium’ on time of use pricing is an example of the potential backlash. P 17 Political will needs structural support Energy Green Paper Pursue tariff reform and improved consumer access to energy use data, including electricity network tariff reform to limit cross-subsidies AEMC Draft rule determination: National Electricity Amendment (Distribution Network Pricing Arrangements) Rule 2014 Losers have louder voices Customers tend to value losses more highly than they value gains. Clear outcomes and process are necessary Selling the benefits across all stakeholders and by all stakeholders makes this a hard reform to implement. P 18 Network tariff reform: a test of political will Annual EUAA Conference Tony Wood Grattan Institute 14 October 2014 .

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