Will pricing reforms satisfy customer trends to take up new technologies in the electricity market and will customers respond in the way the authorities expect. Lynne Taylor, energy sector leader, PwC.
THE 2016 YEAR saw a strong focus on pricing reform from regulators and energy companies alike. There have been significant developments for electricity network pricing and an emergence of new retailers with innovative price offerings.
Some of the pricing debate has been stimulated by the ongoing evolution of new technologies such as solar PV, batteries and electric vehicles. International trends show falling costs and growing uptake of these technologies and they are having significant impacts in some countries. Uptake in New Zealand remains below that seen in Australia, the United States and parts of Europe – but is growing fast.
Network companies, encouraged by regulators, are increasingly thinking about making sure their prices send ‘efficient price signals’ that convey the cost of using the networks.
A consensus seems to be building that current prices, which are based largely on the amount of electricity used, are inefficient, outdated and could encourage customers to make poor investment decisions (eg, the Electricity Authority thinks current price structures encourage customers to install solar PV to save on energy bills, even though using solar generally does not reduce the cost of electricity supply).
Prices that signal the cost of supply, potentially based on peak demand or customer capacity, are increasingly being seen as the preferred way forward.
A risk with this emerging consensus is that it may not be well connected to what customers want and may impede other socially desirable outcomes. Cost-reflective charges are likely to see customers paying more for electricity at precisely the times they want to use it most. This is unlikely to be popular.
Some customers will use the electricity anyway and pay more for it, others will take steps to avoid the higher costs. This could mean people using less heating during the coldest times of the year, choosing to cook their main meal during the day or changing their routine so appliances are turned on at non-peak times. It could also mean some customers invest in additional sources of energy such as gas hot water heating or diesel generation.
The higher cost challenge
These decisions may all be economically rational. But what shouldn’t be missed is that actions people take to avoid higher electricity prices will themselves have a cost. And, crucially, there is a risk that these actions do not successfully avoid the higher prices due to confusion and complexity.
All parties acknowledge that the energy industry is complex. What is less often discussed is how this complexity will affect customers’ responses to price signals. If customers do not fully understand the concept of peak congestion and what the price signal is, they are less likely to respond in the way that is expected.
In other words, there is a risk that the behaviour change caused by the new prices does not really reduce costs for the energy company, but still imposes costs on the customer.
In general, across all sorts of products and services, customers generally want prices that are simple, predictable, affordable, understandable and that are seen to be fair. Cost-reflective prices may not meet any of these goals. Prices that seek to deliver efficient price signals are likely to be complex, more difficult to predict and cause affordability problems for some customers. Where prices are high, complex and/or unpredictable they are at risk of being seen as unfair.
The challenge for energy companies and regulators alike is finding a way to deliver efficient prices that send the right price signals and retain popular support, or at least acceptance.
If customers strongly oppose pricing reform the industry runs the risk of political intervention. For example, South Australia is currently going through a move to demand-based pricing that has become controversial. The resulting political attention led to restrictions on how this form of pricing could be applied.
Energy retailers are likely to find themselves increasingly in the middle; between distributors that seek to implement more cost-reflective prices and customers that value stability and simplicity. As the parties in the electricity supply chain that are closest to the customers, retailers have an important role to ensure that debates and decisions on pricing reform take account of what customers want.
Smart meters and pricing reform implementation
Implementing more cost-reflective pricing is reliant on the necessary systems and technologies being in place. In particular, to successfully set prices based on how much each customer uses the network at peak times ‘time of use’ information is needed. This can be delivered by smart meters. More than 1.5 million smart meters have now been deployed across the country (out of two million customer connections).
Delivering cost-reflective tariffs to areas without smart meters, or to areas where a lack of communications infrastructure means that smart meters cannot communicate in real time with the metering providers, will be much more challenging.
The smart meters deployed to date have generally achieved their core aims – to improve billing accuracy and reduce meter reading costs for retailers. As yet, usage of smart meter data to provide additional services or innovative tariffs has been limited here. Part of this may simply be because it would involve working with half-hourly (or, in some cases, more frequent) data from 1.5 million connections. The challenge of gathering, storing, collating and interrogating such a large volume of information should not be underestimated.
Electric vehicles and energy pricing
In 2016 the government announced a package of measures designed to increase the uptake of electric vehicles (EVs). These included: an extended exemption from road user charges for EVs, an investigation of government bulk purchasing of EVs, funding for promotion of EVs and low-emission vehicle projects and a review of relevant tax rules.
The number of electric vehicles here is growing, but remains very low (just over 2000 vehicles registered by late 2016). With continued government support and increasing international uptake, the number of EVs deployed will become increasingly significant.
This is both a benefit and a challenge to the electricity sector. It is a benefit because EVs will be significant users of electricity, offsetting reductions in demand that are expected from increased local generation and improved energy efficiency of devices.
EV uptake is also a challenge due to the stresses that could be placed on electricity systems from multiple EVs on a network charging at the same time. The industry, understandably, is concerned about the impact of simultaneous charging of many vehicles on the same line.
Pricing seems like a positive solution to this problem – sending signals that encourage people to charge their electric vehicles off peak so it will be cheaper. However, we see a risk in relying too much on a price signal to achieve this outcome. Charging an electric vehicle is likely to be much cheaper than filling a car with petrol so customers may see it as affordable to charge their vehicle even with peak charges.
In the retail sector there are now over 30 active electricity retail brands in this country, more than the number of network businesses. Switching continues to be at a high level, with nearly 420,000 switches occurring in the year to October 2016. The growing competitive pressures are increasing pressure on operating costs and energy retail margins.
The challenge for retailers is in developing new niche pricing products to engage with customers while retaining stable, high-margin customers on whom profitability largely depends.
The question of how much retailers can or should deliver network-focused, pricing signals through to customers needs to be seen in this context.