Cost reflective network prices – will the power of choice be enough?

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Emerging Issue: As part of the Power of Choice reforms, a change to the National Electricity Rules has been approved by the Australian Electricity Market Commission in April 2015 by which electricity networks in the National Electricity Market are required to implement more cost reflective network tariffs, starting in 2017. The rationale behind this rule change is the need for adequate price signals to drive efficient network investment and reduce network costs, putting downward pressure on electricity prices. So, if implemented well, this should make grid energy more competitive compared to its emerging substitutes and prevent nasty scenarios of excessive customers going off-grid.

Network costs are typically related to the network capacity. Hence, to be reflective of actual costs, network tariffs are expected to be based on maximum customer demand instead of overall consumption. However, the network operators’ ability to implement accurate demand-based tariffs is limited by the availability of interval meters (typically remotely read “smart meters”) that can register customers’ load profile, i.e. how much electricity is being used at any given time.

So, we have the metering rule changes – also part of the Power of Choice reforms. The proposed metering rule changes effectively rely on retailers discretionally offering smart meter products to their customers, apart from instances requiring a new or replacement meter (for at least the first three years of the contestable market, an independent metering services provider cannot go direct to the customer).

Retailers will only offer smart meter products if the business case is beneficial to them. But with a smart meter comes a new cost reflective network tariff, and this can impact the retailer’s business case in a number of aspects:

  • Cost reflective prices are aimed at reducing peak electricity demand yet retailers may earn better margins for peak periods than for non-peak periods, or they may own generation assets that rely on peak energy demand for their viability
  • Price incentives to reduce maximum demand could also have the impact of reducing overall electricity consumption by promoting energy efficiency products and services, reducing retail revenue
  • The customer could be significantly worse off under a cost reflective tariff. For example, solar PV customers currently on simple accumulation meters.

In the long run, customers should benefit from successful implementation of cost reflective network pricing as it drives efficient network usage and investment, resulting in lower network charges in customers’ electricity bills. But, many customers will not be able to move to a truly cost reflective tariff unless they are offered a smart meter product by a retailer and they can clearly see value in the product offering.

Distributors are looking to achieve higher penetration of more cost reflective network tariffs, but with the retailers (at least initially) with control of smart meter offerings, how do distributors convince retailers to convince customers to take them up?

Two main factors will be key to the effective implementation of cost reflective network tariffs:

  • Availability of supporting technology (e.g. automated demand management devices) that:
    • supports the creation of customer value from the introduction of demand based tariffs by shifting load away from peak periods
    • simplifies customer behavioural change by automating and optimising decision making, and
    • allows multiple stakeholders to derive value from the customer relationship (e.g. network support functionality and data for distributors, profit margins for technology providers, and reduced churn for retailers)
  • Collaboration between distributors, retailers and technology service providers to combine their interests and create customer offerings that bundle the smart meter, demand tariff and demand management product to optimise the value for all stakeholders and smooth the transition for customers. (Or, if they can’t all get along, an effective aggregator who can broker the deal.)

The combination of these two factors would likely result in a win-win-win-win situation where:

  • Network costs are reduced as the result of reduced peak demand and increased data for effective network management, preserving the long-term value of the grid
  • Customers pay reduced network charges in their electricity bills
  • Retailers not only retain existing customers but grow their market share and gain access to back office benefits of smart metering, and
  • Demand management technology providers get an effective and profitable channel to market.

However if the ‘Power of Choice’ regulations are not effective in creating enticing customer products to foster the successful implementation of cost reflective pricing, the alternative may be strict, imposed regulation to deal with the current system inefficiencies or the dreaded death spiral.

Will Australian distributors and retailers be up to the challenge?