Perspectives on regulation in a changing environment

13 October 2014

In a speech at the 2014 Annual Energy Users Association of Australia Conference in Melbourne, AER CEO Michelle Groves, discussed both how energy users are having a greater say on the network services they receive and the cost of those services, and how consumers will become integrated into electricity markets in the future.

Transcript

Thank you for the opportunity to talk to you today.

I was asked to talk about perspectives on regulation in a changing environment. This is a 'big-picture' topic, so I decided to look at it through the lens of the changing role of energy users—both large and small. I was hoping this would filter down the issues around regulation and change. I was wrong.

The role of users in energy markets is one of the primary drivers of the changing environment, and the need for the regulatory framework, the regulated businesses and the regulators to realise this and respond to it, is crucial.

Traditionally users such as small business and residential households would consume electricity, receive a bill every so often, they would pay the bill, and that was about it.

This is changing. Users are no longer passive. They are increasingly responding to higher energy prices. Users want to have a say on the services they receive and the cost of those services. Further, technology such as roof-top solar PV has allowed consumers to become producers of electricity too.

The word you will hear me say a lot today is 'integration'.

The first part of my talk will highlight how the 'consumer voice' has become integrated into our regulatory processes more than ever before. Bottom line: AER decisions must and will better reflect the interests of all users.

Second, looking forward, will the current regulatory framework enable efficient change in technology and market preferences—so customers can be actively integrated into electricity markets—and what reforms are necessary, if any?

Giving end-users a say

In the past, some network businesses have consulted with some of their customers, some of the time, but there hasn't seemed to be much in the way of comprehensive engagement. Perhaps they didn’t think there was much need for it. For many of their customers they essentially provided only one service—transport of electricity in one direction. Further, they were the only businesses able to provide the vast majority of users with a delivered energy service.

This is clearly changing. Networks are capable of (and do) provide a range of services that users might want and also, perhaps more significantly, they are beginning to face some competition in the delivered energy market. This should create the ultimate incentive for businesses to engage with their customers.

Recent reforms to the regulatory regime support consumer involvement in the regulatory process, and enable the AER to engage more productively with energy users and businesses.

Most significantly, the new rules framework requires us to take account of network businesses’ consultation with their customers in considering their regulatory proposals. This is also a powerful incentive for the businesses to engage with end-users.

To assist with this, we developed a consumer engagement guideline for network service providers. It sets out our expectations for consumer engagement by network businesses. It aims to assist network businesses to engage systematically, consistently and strategically with end-users on significant issues, to better align the provision of services with the long term interests of consumers.

The guideline specifies that the network businesses must understand their consumer base including large industry. They need to demonstrate that they have listened to their customers, and that this is reflected in their proposals. We expect the network businesses to demonstrate a commitment to ongoing and genuine consumer engagement on a broad range of issues relevant to end-users. We want to see businesses being more accountable to their consumers. It needs to become part of 'business-as-usual'—integrated into all parts of their operations—not just being 'dusted off' at regulatory proposal time.

The AER is also doing more to integrate users into the regulatory process. For example, our newly formed Consumer Challenge Panel (CCP) injects another direct 'consumer voice' into our decision making by challenging our analysis, our assumptions and our ways of engaging. The panel is comprised of members who have significant experience representing the interests of all energy consumers, including large energy users. The panel advises us on the issues that are important to consumers to make sure that consumer perspectives are being properly considered throughout these technical and complex regulatory processes.

We have established jurisdictional groups of consumer representatives for each of our network pricing reviews. Large energy user representatives are participating in these groups, such as the EUAA, Major Energy Users and National Irrigators and Cotton Australia to name a few. This more targeted approach to engagement makes it easier for user and consumer representatives to have input into our processes. We are trying to make our processes respond to the needs of stakeholders, rather than have stakeholders constrained by the needs of our processes.

Let's be clear, we are not pushing customer engagement because it is happens to be the flavour of the month. We consider better customer engagement is essential to the regulatory process: to achieving better customer understanding, and better customer buy-in and ownership of the regulatory outcomes, more focused regulatory decisions, and overall better regulatory outcomes. Perhaps not surprisingly, we see better customer engagement as an essential part to achieving the fundamental objective of promoting the long term interests of end-users.

Networks to be held accountable for the services they offer users

But even the most motivated customers struggle to hold their network businesses to account without accurate, relevant information. The AER has a critical role in collecting, verifying and processing key information. Customers need to know whether they are getting value for money.

A very important way to achieve this is to look at how each of the network businesses is performing in comparison to the others—as well as itself overtime. Benchmarking allows us to shed some light on which businesses are operating most efficiently. Which businesses are able to achieve the greatest output for a given set of inputs?

Recent reforms in the rules and our guidelines increase and improve the AER’s use of benchmarking. The rules require we publish an annual benchmarking report, which we must consider when assessing expenditure forecasts during a determination. We will be able to use benchmarking to consider whether network expenditure proposals as a whole are reasonable.

Comparative analysis can create an incentive for network businesses to improve their performance, not only on existing performance, but on the performance of their peers.

And the results are in (and soon to be published on a website near you).

We are finding that the most efficient distributors are those located in South Australia and Victoria. Under most of the performance measures we use, the Victorian and South Australian distributors appear more productive in their use of operating and asset costs. The 'productivity gap' is not even that close.

Detailed analysis of our assessment of the efficiency of the network businesses in New South Wales and the ACT will be available when our draft decisions on their pricing proposals are released at the end of November this year. You will all be able to see how benchmarking can be used as an effective regulatory tool within the framework.

We will publish annual benchmarking reports from this year. They will be a useful source of information for consumers and other stakeholders to engage in the regulatory process, and to provide better information about the relative performance of regulated networks. They also provide a very useful conversation starter for customers and their businesses—it empowers customers to challenge businesses about their operations and costs.

Customer integration into the electricity market

Allowing consumers a greater say on the services they receive and cost of those services is timely given the networks are entering a period of fundamental change. Drivers such as network cost pressures, the need to integrate renewable generation and electric vehicles, and the disruption brought about by new technologies will impact the way energy is delivered to and by consumers in the future.

The electricity industry in Australia has undergone a number of transformations in the past two decades, and we are on the cusp of a further fundamental shift in the way electricity is produced and consumed.

The network is no longer only about transporting energy from 'A to B'. The network is becoming a platform for the two-way trade of electricity.

The convergence of communications and energy transport and the uptake of new network technologies, smart meters and other household devices bring opportunities for innovation and competition. It has become feasible for customers to be actively integrated into the electricity market. New and existing industry participants will be able to offer services that assist users to better manage and understand the cost drivers of their consumption.

The vision is for end-users to become integrated into the market

With improvements in IT and communications, customers are also potentially generators, consumers or providers of other products such as ancillary services. The term ‘prosumers’ reflects that consumers of electricity can also be producers of electricity, and may switch from net consumption to net production in response to changes in market signals.

For example, we have seen over a million households install roof-top solar PV in the last few years. Further, customer investment in smart appliances and battery storage could substantially shift the amount customers withdraw from or inject into the network from one moment to the next.

Ideally, ‘prosumers’ would be willing and able to directly or indirectly respond to local market conditions, so that they make efficient decisions as to the best time to use their electric appliances, charge and discharge their electric vehicles or have knowledge of their local conditions inform their investment decisions.

There are several potential benefits from the increasing penetration of small scale generation, smart devices, and demand management and storage, and the integration of these services into the electricity market. The integration of even small players into the market:

  • facilitates the integration of small-scale renewable generation such as solar PV
  • increases the resilience of the electricity network
  • increases the utilisation of the network
  • allows customer choice when it comes to managing their electricity consumption
  • helps customers make informed decisions regarding investment in appliances, energy efficiency, and local generation and storage.

Perhaps the most significant benefit from increasing the integration of small customers into the electricity market is that it will lead to a range of new services. In fact, it may mean a host of yet unknown services that will deliver real value to consumers and society more generally.

Does the regulatory regime enable competition from new services?

The full benefits of these developments will only be achieved if the appropriate regulatory arrangements are in place. We cannot regulate for innovation. We can however create an environment in which innovation may flourish.

It is good regulatory practice to take a principles-based approach rather than a 'destination-based' approach. In this era of rapid development in technology and the high rates of change, it is a 'courageous' regulator or policy maker who predicts the future dominant technology.

Regulation should not be about 'picking winners' or rewarding network businesses with guaranteed returns when competing with other services. It is better to allow the market to 'decide' than for the regulator or the policy maker to favour a particular technology or solution and have customers carry the risk.

Regulation should establish a base for access to the network to support competition of services. Indeed, competition principles have been at the heart of early energy market reforms since the mid-90's. The idea of these reforms was to introduce competition wherever feasible. These early reforms included:

  • structural reform—separating potentially competitive functions from monopoly infrastructure, and establishing a competitive industry structure for commercial functions
  • competitive neutrality—establishing corporatised governance structures for significant government businesses
  • access—enabling regulated access to monopoly infrastructure, with independent authorities to oversee prices
  • market design—establishing a national electricity market, with associated institutions to oversee the rules and manage the market.

The electricity market design and regulatory framework has proven effective at delivering a reliable, stable supply of electricity, and on-going investment in a competitive, efficient generation sector. The market-based framework has proven robust to changes in government policies, consumer preferences and technology. The design of the market has also proven robust to challenges including changes in comparative costs of generation (such as for renewables), periods of scarcity and periods of excess generation capacity. Further, when there was the need, generators responded to market signals for investment in peak demand capacity without the need for any central authority to direct or to purchase capacity.

Competition in generation and retail has delivered benefits to the Australian community and has ultimately meant more efficient electricity prices for consumers.

Of course, the energy networks are monopoly businesses. Currently there is limited competition for the core service of transporting energy between suppliers and the majority of consumers through the 'poles and wires' (both large and small)—so we need to regulate their prices and services.

However, some services provided by a network business, can be subject to competition or are potentially contestable and the current regulatory framework allows for these services to be treated differently. This aspect of the framework will become increasingly important as more of the network's core services become contestable.

Clearly the competition principles on which the framework is founded will be relevant going forward. Those competition principles have proven their worth in the past and can continue to provide a guide in the future. Competition is the 'marker in the ground' that should orientate us. It is just as important to separate potentially competitive functions from, and enable access to, monopoly infrastructure.

That said, some important work needs to be done for the framework to continue to enable competition from new services. For customers and suppliers, large and small, to be efficiently integrated with and respond to local market conditions, we need better price signals, 'smarter' infrastructure and adaptive policy frameworks.

Priority energy reforms

Although the current regulatory framework is fundamentally sound, there are important further reforms being considered by the Australian Energy Market Commission (AEMC) following decisions by the COAG Energy Council. These reforms can be readily adopted by the regime and will enable the transformation of the industry towards a 'smart grid future'.

The AEMC's Power of Choice reforms endorsed by the COAG Energy Council, are necessary to keep the regulatory framework 'future ready', and should remain high on the sector's reform agenda.

As a priority, the AER considers reforms to the way distribution businesses set and structure network prices are required. First, cost-reflective pricing is an efficient way of responding to changes in peak demand. Second, as long as customers face tariffs that do not reflect local network congestion, they will not face the correct incentives for investment in and use of local generation and smart devices.

Metering is another important area of reform and is a good example of a potentially contestable service. To date, regulated network businesses have exclusively provided, maintained and owned the majority of electricity meters installed on residential premises.

Most electricity metering services have involved basic tasks of installing and maintaining assets, and manually relaying basic consumption data to reconcile market systems. As highlighted in the Power of Choice review, advances in metering technologies have the potential to fundamentally change the traditional role of metering in the market and expand the range of products and services available to consumers, including enabling greater consumer involvement.

For example, advanced metering with communication capability (smart meters) are capable of recording consumption on a near real time basis, and differentiating consumption at different times of the day. This can provide consumers with better information about their consumption and more control over how they manage their use. In so doing, advanced metering can support greater consumer participation and choice in the market. Better consumption information can also help consumers weigh-up competing retail price offers, such as whether to switch to a flexible retail offer or take-up different demand-side participation products, which could also be provided competitively.

However, the current rules around the provision of metering services have not kept pace with these advances in metering technologies. The existing arrangements inhibit investment in the provision of metering technology that can support the uptake of a range of new and innovative energy products and services.

There is currently a degree of exclusivity in who can provide metering services in the National Electricity Market. The rules still mandate that regulated networks are exclusively responsible for provision of the meters that the majority of residential customers have on their premises.

The AEMC is currently considering proposed changes to the rules that would allow competition in the provision of metering services, including open access to meter functionality and information. These changes are important in promoting greater consumer participation and choice, thereby permitting the potential benefits of advanced metering to be realised.

Perspectives on regulation in a changing environment

To conclude: the electricity industry certainly is changing. In fact it is not much of a stretch to say that the next couple of decades will witness something of a revolution in the way small customers interact with the electricity industry.

Revolutions can seem threatening at first, but they also present opportunities.

There will need to be change. I have talked about two different roles for customers: first, as participants in the regulatory process and, second, as active customers seeking out the best packages from retailers, and responding to changing network conditions.

I encourage you all to get actively involved as participants in the regulatory process, testing and challenging the claims of the network businesses and negotiating outcomes that are mutually beneficial to all. You may choose to either get involved directly, or indirectly supporting your customer representatives. Either way, the end result will be better outcomes for everyone, and greater confidence and credibility in the regulatory regime.

I also encourage you to take up the opportunities presented by new metering technologies and new pricing arrangements. Many of you—especially the largest users—already actively manage your electricity use, responding to wholesale market conditions, and perhaps even participating in the forward or hedge markets.

But in the future there will be more scope for even the smallest energy users to become active participants in the energy market. We recognise that for some customers, the changes ahead will be challenging.

The AER will need to play our part in working with customers to facilitate this transition as effectively as possible, to ensure that the transition occurs in a measured way and that the benefits are spread equitably.

Our work in network regulation and retail and wholesale markets helps ensure the integrity of energy markets, so that end-users can trust that they are receiving a service that meets their needs and are paying no more than necessary.

It is also important for the network businesses to embrace the changes underway in the energy sector. If the networks attempt to create barriers to new, competing technologies by limiting access to their 'platform', there is a risk that a significant number of consumers will 'walk away' from the network. This would have major consequences for many consumers and for the efficient operation of energy markets. The hope is that network businesses re-define the services they provide to adapt to the new market, which will benefit end-users and transform the industry.

Thank you.