Regulation that supports innovation, demand and consumers - Presentation to Disruption & the Energy Industry Conference - Sydney - 7 September 2017

Good morning ladies and gentlemen, and thank you for the opportunity to speak to you today on a topic which occupies a lot of minds, and not just for those working in the energy sector.

For decades, energy supply in Australia was a sleeper issue because it was all so simple.

Coal was dug up.

Coal was burned.

Power was produced.

How the world has changed.

Another market in Australia which has undergone comparable change is broadband – itself facing an interesting clash of old and new technologies.

In both sectors, new products, services and technologies are emerging, not only changing the way we consume the product, but the way we think fundamentally about it.

In preparation for today I reflected on the AER’s first State of the Energy Market Report. It was published in 2007 – one year after the creation of the AER as the national regulator and nine years after the formation of the National Energy Market.

This report commented on an energy market which was undergoing significant change.

It celebrated an energy market which was “barely recognisable from that which operated in the 1990s”.

It described the creation of the NEM as a resounding success which came about by the removal of “regulatory barriers to interstate trade”.

It stated that the framework envisages that all jurisdictions will work collaboratively to accelerate the development and take-up of renewable and other low-emission technologies.

That was 2007. The more things change …

The Energy market is changing

The energy market is changing — it is moving toward renewables and greater use of decentralised energy production.

This shift that we are seeing in the market is being driven by consumers.

Consumers are demanding an energy market which allows them to:

  • have a say in how energy is generated
  • generate electricity themselves
  • manage their own energy demand
  • assist networks in managing demand
  • choose a retailer who meets their needs.

The energy market today has characteristics which are unique among markets in our economy. The typical market we learnt about in Introduction to Microeconomics was made up of a producer, a separate consumer and a good or service.

However, energy consumers may also be producers.

Recently, we have heard suggestions that with such significant change, the market structure itself is not working and that we should re-regulate competitive energy markets

We consider that competitive markets with low barriers to entry are best placed to deliver new products and services to consumers, so we seek to drive effective competition wherever it is feasible.

Markets drive innovation because they provide incentives to do things more efficiently and produce an economic reward.

The energy market is no different — participants have sought out innovative ways of producing energy and the energy market itself is changing to accommodate innovation.

Effectively competitive markets will ensure that customers can capture the value of their choices. But as regulators, we must be as innovative as the sector we regulate.

Innovation is driving down the cost of technologies, in particular renewables. Legacy providers, such as Hazelwood, are being retired, replaced by large-scale solar and wind.

To accommodate intermittency, pumped hydro is being considered as an option to provide support for these intermittent technologies.

Battery storage is becoming more efficient and is being trialled to support renewables.

Smart meters, smart grids, electric vehicles and distributed energy resources (DER), are creating a huge range of opportunities for consumers to use data to better manage consumption of energy.

This includes making decisions, for example, about when to store, sell and buy electricity.

We are also seeing investment in research into other technologies such as tidal and wave generation.

As the regulator, we welcome innovative ideas and the potential benefits to consumers.

We seek to empower consumers to make informed decisions about their energy use and encourage them to engage in the market and for the market to respond to consumer demand – including the demand for cleaner, renewable energy.

This has driven innovation. Remember, it wasn’t that long ago that some of these technologies were not considered to be cost effective. Some barely existed at all, such as solar battery storage.

As we meet today, we can see that these technologies are starting to stand on their own two feet and compete in the market.

With new technologies come new challenges. For the NEM, this means the challenges of decentralisation, and intermittent supply.

As coal generators are being retired, significant capacity is being removed from the market and leaving a tighter supply–demand balance.

Traditional thermal energy generators still have advantages in the market over intermittent generators and the energy market has experienced significant loss-of-supply events.

Unlike previous periods when prices were the primary concern, South Australia’s state-wide blackout in September 2016 has drawn attention to the importance of ensuring security of supply.

Price is still as much a concern. Wholesale electricity prices are well above the long term average. In part, high gas fuel costs are contributing to higher electricity prices. Retail electricity prices have doubled over the past ten years and are continuing to increase.

The energy market must include technologies which can provide secure reliable and affordable supply.

The medium and long-term challenge for new technologies is to become. As secure, reliable and affordable as the supply they are replacing.

This outcome was identified in the Finkel Review, along with lower emissions and rewards for consumers who manage their supply.

The challenge for traditional generators, such as coal and other thermal technologies, is to respond to the new competitors in the market as their market advantages are being eroded.

Responding to the changing energy market

The AER has several schemes and guidelines which support innovation in the energy market

Some of the AER’s recent work in ring-fencing, demand management scheme and cost reflective pricing has demonstrated that we can use regulation to support innovation and respond to a changing energy market.

A good example is the electricity distribution ring-fencing guideline which we consulted on and published last year.

Ring-fencing guideline

Ring fencing will prevent businesses from shifting costs into their regulated business or taking unfair advantage of their regulated position in the energy market.

Instead, businesses will need to separate unregulated services, such as solar PV and battery installations from their monopoly services. These new energy services will need to be provided through a separate entity that provides services in a competitive market.

This will support the development of competitive markets for energy services and efficient investment in network and customer services which will, in turn, encourage the development of innovative services that will give consumers better energy choices.

The services these technologies provide will enable households and businesses to manage how much electricity they use and ultimately help manage electricity bills.

AEMC draft rule determination on the Contestability of energy services

Last week, the AEMC made a draft rule that facilitates competition in the emerging energy services market

New technologies such as battery storage – which are able to provide multiple services – make it more difficult to draw the line between monopoly services that arely regulated and services provided by contestable markets.

The draft rule introduces restrictions on businesses earning a regulated return on assets located “behind the meter”.

Demand management incentive scheme and innovation allowance mechanism

After limited growth for several years, peak demand is rising again, particularly in Queensland where demand reached a record level in January 2017, and also in NSW.

Managing demand can assist in addressing both energy supply issues and network capacity issues.

There are opportunities here for the regulatory framework to encourage innovation to address demand issues.

Last week, we published our draft decision on the new demand management incentive scheme and innovation allowance.

The scheme provides electricity distribution businesses with an incentive to undertake efficient expenditure on non-network options relating to demand management.

These projects address network congestion by reducing or shifting demand or by altering the drivers of network demand in other ways.

The scheme is designed to ensure that non-network options are sufficiently incentivised, relative to network options.

This should result in distributors investing more on the merit of efficiency than the prospective rate of return.

To glimpse the potential applications of demand management projects, you can look at the actions of United Energy and Greensync. They have recently entered into a demand management project on the Mornington Peninsula.

Greensync announced in February that a decentralised energy exchange, or deX for short will be implemented on the United Energy network.

The deX will open the door for individuals with solar panels and battery packs to trade their electricity on the market with the consumers of the electricity directly at a fair price.

The innovation allowance on the other hand, will reduce the risk distributors face with research and development costs in demand management projects that could reduce long-term network costs.

It will allow distributors to be more experimental, the prerequisite of innovation. 

TasNetworks is currently trialling demand management solution at Bruny Island. It has been subsidising customers with solar panels to install batteries that will support the network during periods of network constraint.

These trials are still underway but if they are successful they may see TasNetworks using this technology to replace diesel generators during these periods, a benefit in economic and environmental terms.

Now, obviously not every trial is going to result in greater efficiency but there is value in the process.

We have a requirement that businesses publish their findings after each trial, so each result will drip into the collective pool of knowledge.

The allowance and the scheme are designed as complements to provide an industry incentive for innovation.

The scheme rewards businesses for embracing non-network demand management technologies. The allowance gives distributors a chance to experiment to find most effective way to integrate these technologies.

Network tariff reform (TSS)

We recently approved the first round of tariff structure statements, or TSS, for all distribution businesses.

The purpose of the reform is to transition to cost-reflective pricing, which provide better signals of distribution businesses’ cost drivers than traditional tariff structures.

A distributor’s costs are highest when the network becomes congested. So, customers using electricity at peak times impose greater costs on the network than at other times.

It is not necessarily how much electricity you use, but when you use it that determines network costs.

Most large customers in the NEM already face cost-reflective network tariffs. On the other hand, most residential and small business customers face tariffs that send no signal of network congestion.

These customers may be paying more or less than the costs they impose on the network. Customers with air-conditioners or rooftop solar PV, for example, may not be paying the full costs they impose on the network under traditional tariff structures.

Cost-reflective tariffs will signal the costs of using electricity when demand on the network is highest.

These tariffs will empower customers to decide whether they value electricity enough to pay costs they impose on the network. If not, they will adjust their behaviour accordingly.

A family might delay using other appliances when they crank the air-conditioner on a hot summer afternoon…or they might decide to invest in a more efficient air-con.

These are the type of informed choices consumers should be making.

Cost-reflective tariffs will ensure customers use electricity in the way they value it most.

In combination with other instruments like demand management, we think cost-reflective tariffs will contribute to slowing down growth in peak demand and network congestion. 

This would reduce the need for costly network augmentations and replacement.

In our view, extending cost-reflective tariffs to more consumers will benefit the entire system by ultimately lowering network prices.

Extension of RIT to include replacement investment

Last year, we proposed a rule change to the AEMC around the network planning frameworks to ensure they keep pace with new technologies and other developments in energy markets.

Currently, network businesses are required to undertake a cost benefit assessment, known as the regulatory investment test, when they wish to augment the network.

This process is designed to find out whether a network augmentation is the best way of meeting a need (such as a reliability issue) or whether a non-network option is more efficient.

However, businesses are not currently required to conduct this assessment for replacement projects.

These proposed reforms will require network businesses to undertake a thorough analysis of all options before replacing existing electricity assets in order to consider whether new technologies or demand-side options offer a better deal for consumers.

We are part of a managed transition with continuing focus on consumers, costs and affordability

As a result of many of these challenges, energy, price, supply and investment have been brought to the forefront of public debate in Australia.

The AER is committed to using our expertise to inform the debate about Australia’s energy future, the long-term interests of consumers and the regulatory landscape.

As I noted at the outset, many of the changes that we are seeing in the market are being driven by consumers.

We need to ensure that the regulatory framework allows consumers to take advantage of opportunities that new energy technologies present, while maintaining appropriate protections.

The AER has an important role to play in managing the transition to greater use of renewable and decentralised energy but continuing the focus on costs and affordability.

One significant reform which will remove upward pressure on prices is the removal of Limited Merits Review, or LMR.

Appeals to the Competition Tribunal have only ever resulted in increased revenues for energy businesses and higher bills for consumers.

LMR has seen consumers pay $6.5 billion more in energy bills than would have been the case if the AER’s decisions had been upheld.

Just let that sink in for a moment …

That $6.5 billion has been spread across energy users. No wonder energy prices over the past decade have risen at twice the rate of inflation.

The Commonwealth Government has recently introduced legislation to abolish the LMR, from AER decisions setting network revenues.

We welcome this.

Governments have initiated a number of inquiries into these perpetual price rises, such as the Finkel Review and the ACCC’s Electricity Affordability Inquiry.

In a recent speech, ACCC Chairman Rod Sims highlighted six issues which have put upward pressure on prices:

  • the loosening by government of the regulation of the poles and wires monopolies — this was done largely to maintain or boost government revenues
  • changes to network reliability standards that could be seen as an overreaction to specific outage incidents
  • increasing concentration in electricity generation
  • considerable concentration in the retailing of electricity, with the three vertically integrated players having the lion’s share of the market
  • generous green schemes
  • very high gas prices.

It’s quite a list—an intricate web of stakeholders, competing interests and policy drivers.

But at its heart is recognition that affordability is a policy objective in its own right and needs to be considered in making policy decisions as well as security, reliability and emissions reduction.

An important first step is equipping consumers to participate effectively in the marketplace, and to protect those who are unable to safeguard their own interests

We are continually encouraging consumer engagement in the reset process and use our Customer Consultative Group and Consumer Challenge Panel as additional consumer voices.

For the AER, consultation is not a ‘tick the box’ exercise.

It is foundational to our ethos, and the new playing field we are all about to step on to means we’re all going to have to do a whole lot more of it.

At the AER we recognise that the decisions we make and the actions we take in performing our roles and activities affect a wide range of individuals, businesses and organisations. Effective and meaningful engagement with all our stakeholders across the range of our functions is therefore essential to fulfilling our role.

With the removal of LMR, stakeholder engagement becomes even more significant.

We are about to publish our final version of our stakeholder engagement review.

Our revised Stakeholder Engagement Framework will provide a clear and transparent model as to how we can all have a more meaningful conversation in a less adversarial environment.

Participants in the energy industry need to consider more collaborative and innovative ways of working together, as well as with stakeholders.

An example of innovative stakeholder engagement is the AER, ENA and ECA collaborative project.

These three organisations have come together to develop an ‘alternative path’ for network businesses to take in building their regulatory proposals, and for the AER in approving those proposals.

The aim is to explore ways to improve sector engagement and to identify opportunities for regulatory innovation.

This project is also about shifting the cultural mindset of the AER and network businesses to be increasingly focussed on consumer views and preferences.

Such an approach is expected to increase confidence in the legitimacy of the business’ proposal, allowing the AER to streamline or expedite its formal revenue determination if the proposal clearly promotes the long term interests of consumers.

The goal is to undertake trials of this proposed new regulatory approach and ‘learn by doing’.

This process of exploration may identify reform opportunities, including possible changes to the Rules.

Beyond the obvious need to have consumer buy-in is the commercial reality of the industry we work in: the decisions we make today last for decades.

I’ll remind you that construction on the Hazelwood Power Station commenced in 1964 – the year The Beatles touched down in Australia. By the time it was finished in 1971, so were The Beatles!

And even after its closure Hazelwood’s still affecting energy policy almost 50 years later – and its shadow may loom over policy for a decade more.

Unfortunately, the truth is that with rising prices and the SA blackouts, the confidence the consumer needs to have in energy markets has been tested.

Confidence is essential when new technologies are being rolled out.

And, it is essential that we foster confidence among stakeholders that the energy markets are working well for them, as levels of public trust now can have a long-term impact on consumer engagement and the effectiveness of competition.

Our energy markets, networks and frameworks need to be fit for the future—regardless of what that future may look like.

Outside of renewables, private investment in new plant has stalled while governments have announced plans to invest in gas, pumped hydro and energy storage.

The Finkel Report made recommendations that the Commonwealth, State and Territory Governments work together on various aspects of energy policy.

The challenge for the AER is to ensure consumers are protected, network prices are no higher than they need to be and the market is able to meet their needs.

Thank you.

Conference: 
Renew Energy
Issued date: 
7 September 2017
AER reference: 
AS 02/17