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Select Committee on Electricity Prices
25/09/2012
Electricity price increases in Australia

O'REILLY, Mr Cameron, Chief Executive Officer, Energy Retailers Association of Australia

[11:08]

CHAIR: Welcome. Do you have an opening statement?

Mr O'Reilly : I do. First of all, I would like to thank the committee for the opportunity to provide further evidence on ERAA's written submission to the Senate inquiry. Energy retailers are very aware that electricity prices have risen significantly in recent years throughout Australia. We also understand that Australia's electricity system and markets are not well understood by most consumers and people are looking for explanations for their higher electricity bills. As retailers are the billing agent for the entire electricity industry value chain, we bear much of the consumer backlash over rising electricity prices while the retail component of the price rises has been very low. We welcome the committee's efforts to examine the reasons for recent price increases as retailers support transparency. In fact, we would welcome better public understanding of the cost drivers for recent price rises.

The Australian Energy Regulator graph included in our submission shows the components of a retail price. It clearly indicates that network charges are the biggest component of the bill and in most cases the fastest growing. Green costs have also been increasing and will continue to do so. From the graph you can clearly see that retail margins are not high and retail operating costs are just 10 per cent of the bill. Wholesale electricity costs around 30 per cent the bill but until the introduction of the carbon price this year these costs have been stable in nominal terms and declining in real terms over the last decade. Retailers who in many cases also invest in generation play a key role in ironing out the volatility of the wholesale market for consumers. Wholesale market prices change in half-hour increments and can vary in price anywhere from zero, or even a negative price, to $12½ thousand a megawatt hour. Retailers must sell at regulated or their notified prices so it is retailers, not consumers, who bear the risk in a volatile wholesale market. Retailers also package products from customers and provide a range of customer service functions while complying with comprehensive regulatory obligations, including the provision of hardship programs to customers struggling with payment difficulties.

In spite of commitments to a national non-price regulatory framework for the National Energy Customer Framework, this move was halted by some states at the 11th hour. We urge state governments to implement these measures as soon as possible to ensure a harmonised and effective framework that will provide consistency for industry and consumers. Inconsistency and overregulation add substantially to the costs and risks of doing business for energy retailers.

This regulatory burden exists in spite of there being a highly competitive retail market in which the vast majority of customers on the east coast can switch providers. In the case of Victoria, one in every four do so every year, making it the most competitive and retail energy market in the world as shown in the covering letter to our submission. Customers have no doubt begun to think more about switching in the environment of rising prices but, as virtually all submissions to the inquiry have shown, it is not the retail or wholesale electricity component prices that have caused recent price rises but network charges and green schemes such as the LRET, SRES and feed-in tariffs. While retailers have not driven the price rises, we have to deal with the customer backlash and with the increased customer payment difficulties they cause while carrying the credit risk for the entire industry as we must meet our payments to the market generators and networks. Retailers also believe they have been targeted by the political and regulatory bodies in response to rising prices even though we have not caused them.

CHAIR: How much longer have you got to go?

Mr O'Reilly : Two pages. As an industry we supported a deregulated pricing market which allows for competition. This means better outcomes for consumers. Some recent regulator pricing decisions, most notably in Queensland, have totally underestimated the retail cost base and in turn this has squeezed margins and stifled competition. Some governments have attacked the energy contracts which are used to try and attract new customers in a competitive market and the national regulator, the ACCC, has singled out the energy retail sector on door-to-door sales without acknowledging the fact that the industry spent a million dollars on self-regulation, creating a scheme called Energy Assured, which always addresses any instances of proven mis-selling and successfully transfers almost two million customers each year. The door-to-door sales channel, which I understand is not on face value popular, is a symptom of a price based competition for customers in Australia's energy retail markets. It has proven to be the only reliable channel through which new entrants to the market can build market share and therefore provide more options to consumers. In the UK market increased regulation of this marketing channel has led to retailers withdrawing from these door-to-door sales. This has in turn led to reduced levels of customer switching and discounting in the market. I have a report from VaassaETT that underlines this and I am happy to provide that to the committee.

Going forward, the product options for consumers and the way they are approached by retailers may well change but should do so through a competitive market, not one characterised by heavy-handed price and non-price regulation. Smart meters, if implemented with a consumer focus, something our submission comments on, could well play a role in helping consumers manage rising electricity bills. What will not change is the need to ensure that retail price deregulation, the stand-out incomplete reform in Australia's energy markets, has to be implemented as soon a possible. Victoria has proven retail price deregulation can be effective. Its consumers are the most empowered to deal with the pressure of rising electricity bills. Thank you for the opportunity to address the committee.

CHAIR: Thank you, Mr O'Reilly.

Senator CORMANN: I will start with the same question I have asked others. I have got some data in front of me from the Australian Energy Regulator which indicates that electricity prices in South Australia and Tasmania are higher by a large margin than they are in the other states that are part of the NEM. Would you care to provide an explanation as to why you think that may be the case?

Mr O'Reilly : I will comment in broad terms but I do not discuss the pricing strategies or approaches of my members within the association as that would be a breach of competition laws. Both of those states have had a higher cost form of generation traditionally. In the more recent case of South Australia, obviously the introduction of higher cost forms of renewable energy generation, which are intermittent and have to be supported or backed up by peaking generators and backup generators, means that overall it is logical that their wholesale component of electricity would be higher. As the Australian Energy Markets Commission just indicated, there are also increasing issues in relation to the impact of renewables on the network sector.

Tasmania obviously has hydro traditionally, a higher cost form of generation than coal, which has underpinned electricity generation on the east coast in states like Victoria, New South Wales and Queensland, but it could obviously become more competitive over time depending on the size and future of the carbon price.

Senator CORMANN: How do you think the carbon tax and the renewable energy targets will impact on electricity prices moving forwards?

Mr O'Reilly : It is undeniable that they will contribute to an increase in them. Obviously if you start to price the carbon emissions of our traditionally low cost coal generators then the wholesale cost of energy goes up and we have to pay that higher wholesale cost of energy. With the impact of the renewable energy target at the moment, we still have a long way to go to reach 20 per cent, and that is preserving a percentage of generation for higher cost forms of generation which, as I said, also require backup generation because they are largely intermittent. In recent times the driver for increases has been networks and some of the renewable schemes and fee- in tariffs. But, going forward, clearly the carbon price will have an impact on the wholesale cost of electricity. It should be pointed out, however, that we do acknowledge that the federal government has attempted to compensate a lot of consumers for the impact of the recent increases due to the carbon price.

Senator CORMANN: Have you assessed at the retail end what the combined impact of the carbon tax and the renewable energy target has been so far and what it is likely to be into the future?

Mr O'Reilly : Again, it is complex across individual consumers, but regulators have been making estimates, where there are regulated tariffs, of the impact of the carbon schemes on retail electricity bills this year. In the case of New South Wales, I believe they estimated that, for the regulated tariff, it would be around $316. That is a New South Wales government estimate that we have been required to put on our electricity bills. It can vary across customers and it will vary across states. But, at the end of the day, it obviously means higher retail bills for higher cost forms of generation. The government has obviously seen that it will have an impact on consumers and has sought to provide them with some compensation. Although we still have concerns that some of the compensation being provided through fortnightly tax cuts and pension increases may well be forgotten or spent by the time higher quarterly utility bills come through, so we still believe there may be some increase in hardship for retailers and will have to help our customers with temporary payment difficulties through our hardship policies, which we are happy to do.

CHAIR: That requirement to detail those costs on billing includes the feed-in tariff scheme and other state based schemes as well as the carbon price, doesn't it?

Mr O'Reilly : Yes, it wrapped in a broad range of schemes, and I make clear that it was not a decision of retailers to put that estimate in the bill. We made it clear that it is very complex for us to estimate the impact of all of these schemes on an individual's bill, and highly costly to do so. But the regulator made these estimates and covered a range of schemes, and we cooperated with the government on how it would be presented in the bills.

Senator CORMANN: What is the level of cross-ownership between retailers and generators in the industry?

Mr O'Reilly : In no state is cross-ownership at such a level that the ACCC has indicated any concerns about market concentration to date.

Senator CORMANN: You are drawing a conclusion about what you think I am asking the question about. What is the level of cross-ownership?

Mr O'Reilly : I will explain why there is cross-ownership. It comes down to those risks. When you have a wholesale electricity market that varies in price anywhere from a negative price to $12,500 a megawatt hour in half-hour increments, it is a highly risky business. When you have a large retail customer base where your opportunity to vary your retail prices in line with movements in the wholesale price is very restricted by price regulation, then obviously one of the things you do as a natural hedge management strategy, a risk management strategy, is to have your own forms of generation in case they are required in peak periods.

CHAIR: Senator Cormann, we have to move on and I now turn to Senator McEwen.

Senator CORMANN: Perhaps I can put further questions on notice, about ownership between retailers and generators in the industry at present.

CHAIR: We will take that on notice. We have to cut you off there, Senator Cormann.

Senator McEWEN: With regard to the issue of comparative prices of electricity between states, could it be a factor that some states like Western Australia are actually in catch-up mode, and their prices are artificially low, and they also exist in Queensland and New South Wales?

Mr O'Reilly : As we know from this inquiry, electricity prices are always a contentious issue—and, yes, Western Australia is playing a very big catch-up on a tariff freeze that existed there for some 10 years. Western Australia has a high dependence on gas-fired generation, and wholesale gas prices in that state are much higher than on the east coast. So, yes, a decade-long unwise regulatory intervention by way of a tariff freeze means that a large proportion of the Western Australian taxpayer's budget has to go into subsidies for the industry, because the retail price is not reflective of costs there. I think the current government understands that and has attempted to address that. It is a reflection that, if you try to hold retail electricity prices long term below the cost of supply, then inevitably the public pays, just by a different way, and in this case it is through higher taxes to pay for those energy subsidies.

Senator McEWEN: And in the Northern Territory, for example, which is also a comparator in this, and we know that the prices there are totally artificial because electricity generation and supply is subsidised by the Territory government, is that correct?

Mr O'Reilly : Sure. The reality is that the Northern Territory is obviously an island market, as is Western Australia—it is not part of the National Electricity Market. While we do have a National Electricity Market, the reality is that in many respects we still have a number of regions within that National Electricity Market where there are different influences on prices. There are obviously interconnections amongst the generation market, but still a lot of the trade between generators and retailers occurs on a state-specific basis.

Senator McEWEN: And in Queensland and New South Wales, the market is having to provide or replace ancient infrastructure, and that will increase prices in time, in those states, we presume.

Mr O'Reilly : Obviously in the debate about network prices we are coming to two extremes. Peak demand is a real issue, and network demand has traditionally been lumpy. However, as is now being recognised by the Standing Council on Energy and Resources and a number of the regulators you are hearing from, the rules and the regulation probably provided too much incentive for overbuild, and we are paying the price for that now. But there seems to be processing traced back to look at those issues now. The reality is that the legacy of that is that for a retail electricity bill, at least in New South Wales and Queensland, the network component is about 50 per cent of the bill.

Senator McEWEN: So it is not just a matter of saying electricity prices are higher in two states as opposed to the rest of the country—there are a lot of factors involved.

Mr O'Reilly : Sure, and we develop the electricity industry in this country on the basis of state governments and state markets, and the whole notion of a national industry is a fairly recent concept and it is still not implemented in full.

Senator McEWEN: If I could go to another issue and that is smart meters: do you find there is a demand from consumers for smart meters? Are people beginning to understand that technology and the benefits it could deliver to them?

Mr O'Reilly : Not really understand as such. Obviously, it became a high-profile issue in Victoria and, in some ways, the way it was done without much consumer involvement, information or consultation, and they got the cost of the meter upfront without getting any of the benefits has poisoned the environment around them. They have a role to play. The major benefits are captured all along the energy value chain but the major benefits from a customer's point of view going forward is a lot greater understanding of data on energy use patterns, and more information means better decision making, remote connection and disconnection.

From a retailer's point of view, it negates the need for often estimated bills when a meter reader cannot get over a fence or there is a dog. A lot of the time those estimated bills end up being wrong or being the subject of some revisions. More data, more accuracy, should help for better decision making but, at the end of the day, they rely on consumer uptake, so you will see in our submission why we have recommended to other states not to try the Victorian mandated rollout route and look at a market-driven rollout. When some consumers start to see the benefits of flexible pricing, time of use pricing, accurate bills and more data, then I think uptake will happen by osmosis for those who see the benefits in it. Victoria will become the test case for the country in terms of smart meters as they are going down the path of flexible pricing on an opt-in opt-out basis.

Senator McEWEN: Will a smart meter facilitate the implementation of monthly bills? I find in my state that the three-monthly bills are a big obstacle for vulnerable consumers, lower-income consumers.

Mr O'Reilly : I think that is an accurate observation, Senator McEwen. Yes, that will provide for more flexible billing options and more flexible products and that is a good thing. You are quite right: three-monthly lags—the process in this country of where you are using something, you get a bill three months later and you had no price signal at the time. It is no wonder sometimes people get a bit of shock when they get their bill because they do not remember certain things they have done three months before but it is recorded by a meter that can provide more accurate pricing and data use, and data about usage patterns more often will be a good thing for the market, consumers and for retailers.

Senator McEWEN: You made some comments—I think you have called it door-to-door face channel; is that what you mean?

Mr O'Reilly : Door-to-door sales channel.

Senator McEWEN: So this is when people come and knock on the door of a householder and say—demand in some instances—'Show me your AGL bill, and I'll tell you how you can save money.'

Mr O'Reilly : It is a highly regulated practice within the energy retail space, and we have added to that through having a registry of all door-to-door salesmen. We also have a range of common training, recruitment procedures and, if there are any behavioural issues regarding a particular doorknocker, then the whole industry will know about it now and particular doorknockers can be deregistered.

The industry, on top of Australian consumer law, and the traditional regulation that existed for this practice within the state marketing codes is that it added a whole new layer of self-regulation. We are leading any other industry that does door-to-door in this regard. I will emphasise this to you: in many respects, retailers are doorknocking because each particular house is potentially a customer. A politician doorknocks each house because each potential house has a voter in it, but our doorknocking is regulated in hours and so on, so the people who often get doorknocked are the ones that are at home within the prescribed hours. At the end of the day, this was the way a lot of new entrants to the market could build their market share. Huge numbers of transactions have occurred, and regulators and ombudsmen never hear from satisfied customers or people who are happy with the decision they made; they only hear from the unhappy ones. We get a skewed perspective on this. I think having more players in the market is a good thing for consumers, and the way that they have been able to build market share is through this channel. If you attempt to shut it down, you are making it harder for new entrants into the retail market.

Senator McEWEN: My experience of the process has been quite unpleasant, and a number of my constituents complained to me about it—but we only hear the bad stories; that is true. My last question: do you have an average figure that a consumer entering into an arrangement with one of those door-to-door salespeople could save as a result of changing supplier?

Mr O'Reilly : Decisions in relation to electricity by the consumer when you think that they cannot differentiate between providers or the product are generally based on price. So the level of discounting is—

Senator McEWEN: Is it $10 a month or $20 month? How much is it?

Mr O'Reilly : It depends on the state. In Victoria the discounts are often greater against what I have termed the notified prices. Generally, the rule of thumb is that you need to offer them something around the 10 per cent discount in the regulated states to get them interested in it. The consumers have 10 days to consider the decision that they have made. Often there will be strategies by their existing retailer to try to win them back, which is again a good thing. Exercising choice, shopping around, understanding your usage patterns and using the official regulator's comparison sites are good things for the consumers to do. There is no doubt that the more active consumer in the future will do better than the passive one.

Senator XENOPHON: Further to Senator McEwen's line of questioning, could you take on notice and provide us details of the form of self-regulation practices that you have, how you deal with disputes, the number of complaints you have had and whether you pass on some of the more egregious disputes on to regulators for formal action? Like Senator McEwen, I have had a number of constituents who have complained about practices with respect to this.

My first substantive question goes to your submission. On behalf of your members, the energy retailers, you have basically cried victim. You have said that it is important that senators understand that the retailers are the billing agent for the entire electricity industry and the value chain—meaning that they bear much of the consumer backlash over rising electricity prices. To what extent do you think that consumer backlash is in part due to AGL boss Michael Fraser's pay going up 85 per cent from $3.4 million to $6.3 million and that Origin Energy's managing director Grant King's package is now $8.348 million—a rise of $600,000 in one year?

Mr O'Reilly : I would say to you that we are fortunate that the two largest energy companies in this country—which are in the top 20 ASX listed companies—have performed very well in recent years in a very challenging climate for shareholders.

Senator XENOPHON: That is not my question. I am asking about the consumer backlash. Do you acknowledge that some of these massive pay rises by members of your association have caused a degree of that consumer backlash?

Mr O'Reilly : I would say that they are held to account by their boards, and as the federal government has introduced further powers for shareholders to look at executive pay, in this case it appears that the board and shareholders of those companies are happy. These things come to light because of transparency and reporting of executive salaries, which is a good thing.

Senator XENOPHON: That is not my question. You made an assertion in your submission that the retailers bear much of the consumer backlash over rising electricity prices—and you do not consider that the hefty pay rises given to AGL boss Mr Fraser and Origin's Grant King have anything to do with that consumer backlash?

Mr O'Reilly : Executive salaries is an issue which is something that is held to account by boards and by the opportunity for shareholders to now vote on remuneration reports. These companies are billion dollar companies upon which we rely to build our future generation and to provide an essential service. If they are doing a good job then I do not think that encouraging envy is necessarily a good way to be dealing with the issue of our rising electricity prices.

Senator XENOPHON: I am not encouraging envy; I am just asking you whether you acknowledge that when consumers are facing rising power prices and they see that an energy retailer gets an 85 per cent pay rise—up to $6.3 million—that could fuel part of that consumer backlash.

Mr O'Reilly : I am not accountable for how much my respective member CEOs get paid. The boards of those companies are and they seem to be happy with the job they are doing. What I would say is that these companies are going to play a critical role in building the future generation of this country and delivering reliable electricity, and I hope they are run by the best people available who are getting paid appropriate dollars.

Senator XENOPHON: Last month Mr Fraser threatened to stop selling electricity in New South Wales if the government set 'unrealistically low power prices'. Do you support those statements?

Mr O'Reilly : What he was referring to was the reality that the risk is that you use energy price regulation to actually suppress the important issue of the proper retail margin because you are trying to deal with the backlash caused by network prices and green schemes, which companies like Origin and AGL are not responsible for.

Senator XENOPHON: Hang on a second. Further to Senator Cormann's line of questioning, there is an interplay between cross-ownership and retailers and generators, isn't there?

Mr O'Reilly : Yes, and if a company in response to a government policy seeks to diversify to take advantage of that government policy, I do not think the company that is doing the logical thing for its shareholders should be blamed for the policy in the first place.

Senator XENOPHON: But you acknowledge that one of the causes of power price rises, particularly in South Australia, where it seems to be a bit higher than in the rest of the country, is that we have a heavy reliance on intermittent wind energy?

Mr O'Reilly : Sure. And if in the interests of the shareholders of AGL, because this is a policy of the government, Michael Fraser decides to get into the wind industry, that is a good thing from his shareholders' point of view. It does not necessarily mean that you hold Michael Fraser responsible for the renewable energy target.

Senator XENOPHON: You have made reference to the states blocking some reforms and that there are inconsistencies. Would your members support a national approach in terms of having just one set of laws at a federal level so there is that level of consistency?

Mr O'Reilly : Senator, I note that you referred in your press release today to the objectives of the former Keating government. I am very familiar with that, having worked as a ministerial adviser to a cabinet minister.

Senator XENOPHON: I thought they were good objectives.

Mr O'Reilly : What I and the whole industry would like to see is the sort of federal-state cooperative environment that existed when those reforms were initiated across party lines between levels of government. We have to remember that a lot of these initial reforms were achieved in an environment where the states also received some financial incentives for those reforms, so we had a good period of reform. At the moment that reform has stalled between the current state and federal governments. The atmosphere is fairly uncooperative, but that does not mean that we throw out the baby with the bathwater here. We want to see the current market that we have work better. The Australian energy market operators would like to see more of a cooperative arrangement between the states and the federal government. The reality is that electricity is still in many respects governed by issues that are state based. The legacy of state involvement in the industry is great so, therefore, I think we do not necessarily need to have a handover of state powers to the federal government. What I think we need to see is the existing federation and cooperation between the governments work better.

Senator XENOPHON: You can see that that has not been happening.

Mr O'Reilly : We are hoping that this is not indicative of the long term.

Senator XENOPHON: On notice, Mr O'Reilly, could you provide the view of your association on the review of the limited merits review regime—that is, the interim stage 2 report by Professor Yarrow, Mr Egan and Dr Tamblyn and the serious concerns they have raised about the way the rules are structured?

Mr O'Reilly : I did provide evidence to that and, yes, we do believe it has been skewed far too much in the interests of the—

Senator XENOPHON: If you could provide some more details on notice, I would appreciate that.

Mr O'Reilly : We will.

Senator EDWARDS: Mr O'Reilly, what is the relative market share of the major energy retailers in the different markets in Australia?

Mr O'Reilly : I can give you some broad terms, and we can follow up with a bit more analysis.

Senator EDWARDS: Yes.

Mr O'Reilly : Victoria, which has a deregulated market, is the least concentrated. It has roughly 25 per cent AGL Origin and TRUenergy/EnergyAustralia, and 25 per cent of the market is held by another eight or so retailers who are all fairly recent entrants into the market. That is a reflection of the greater competition you get in a deregulated market. In New South Wales, the largest retailer for electricity is Origin and the second largest is TRU, which is branded Energy Australia here, and AGL is a Sydney competitor. But a lot of the smaller retailers have a minuscule share—about two per cent. In Queensland the largest retailer is Origin and the second largest is AGL. Because of recent tariff decisions a lot of the small new entrant retailers will probably exit that market, but they have a small, five per cent, share at the moment. In South Australia, the biggest electricity retailer is AGL. Origin is a significant competitor and TRUenergy and Simply Energy have some market share, and a small market share is held by Red Energy.

So, in broad terms, clearly the most competitive market and the least concentrated market in this country—and remember that Tasmania does not have full retail competition yet—is Victoria, which does not have retail price regulation, which is a risk that deters new entrants into the market.

Senator EDWARDS: You are an advocate of deregulation across the country. By how much would you expect electricity to increase or decrease for consumers if that were adopted?

Mr O'Reilly : What it takes away is the risk of artificial interventions like in Victoria, or tariff freezes in Queensland. If you assume that we would have regulated tariffs that would reflect costs—and remember that the majority of the costs will always be regulated because the network component will always be regulated—the wholesale market pressures would still be the same whether they were deregulated or regulated.

Senator EDWARDS: My question is: how much would those prices vary?

Mr O'Reilly : I am not going to make any particular promises. The range of product offers and the range of variation in offers between individual retailers would be vastly different, and therefore consumers who are active would make a lot more savings. The reality is that we have had three years of experience with a deregulated market in Victoria and the price movements there have not been out of whack, and in some cases have been lower than the other states which have regulated tariff increases. But a lot of that is the influence of the network factors.

Senator EDWARDS: So you cannot tell me whether there will be an increase or a decrease in electricity prices?

Mr O'Reilly : The evidence in Victoria is that as long as there is a high level of competition it makes no material difference to the cost basis of the retail industry. What it means is that there is a vastly different array of outcomes for consumers and a vastly different array of products.

Senator EDWARDS: In the interests of time, if smart meters are such a good thing why do we not give consumers an option to have them?

Mr O'Reilly : That is what we are suggesting in our paper. At the end of the day it should be driven by the market and, therefore, retailers coming to consumers and trying to sell them as part of a particular offer. Then the consumers who are getting into this demand response and using these meters have had a say in it. The problem in Victoria is that they never had a say.

Senator EDWARDS: Are there any other devices that have been offered apart from smart meters?

Mr O'Reilly : In Victoria there are things called 'in-home displays' being distributed which help to give information inside about pricing at particular times of the day. I think this whole area of technology, if you see how the digital economy has revolutionised so many industries, puts us on the cusp of the digital industry really changing the range of product offers and options for consumers in the electricity game.

Senator EDWARDS: In those regions of Victoria where those other products are available, what has been the take-up?

Mr O'Reilly : Essentially, because a lot of these in-home displays are being provided by the white certificate energy efficiency scheme, a lot of people are happy to have them because they are not being charged for them.

Senator EDWARDS: They are being subsidised.

Mr O'Reilly : Yes.

CHAIR: Thank you, Mr O'Reilly, for your evidence this morning.