The dark side of electricity price capping

Welcome to Furious Friday!

I recently saw a news article about Australians being “promised new laws to slash up to $832 from their annual electricity bills”

This article outlines;

1. This is a “federal government move to toughen rules for big energy companies and demonstrate action on household costs”.
2. Outline new laws “to set a default offer price for millions of consumers…response to calls from regulators …to put pressure on suppliers”.
3. The Government “promises the default offer will ensure customers are not being “exploited” because they stay on the standing offer from their suppliers rather than shopping around for a better deal”.
4. “Opposition Leader Bill Shorten revealed plans in August for simpler bills with “capped” prices under a Labor government, at the same time former prime minister Malcolm Turnbull outlined similar measures”.
5. “Returning to the table to negotiate with Labor a bipartisan energy policy that will support the growth of renewable energy, bring down carbon pollution and bring down electricity prices for Australian households and businesses is in the national interest,” Mr Butler said.
6. “The “standing offers” used by companies such as AGL, Energy Australia and Origin have been criticised for years because loyal customers miss out on discounts and are punished for not shifting to different suppliers”.

How will this work?

1. ACCC’s “reference bill” says that, in each region, it makes it easier for customers to compare offers from different suppliers, which is great because this increases competition
2. Where it gets bad – Default pricing or capped pricing forces sellers/suppliers to limit their prices. When you break this down, whilst it SEEMS like a good idea, it isn’t actually that great.

Let’s look at the stats, and the claims that there will be price savings on electricity

1. Government says the price premium to be saved could be $652 in Victoria, $411 in NSW, $369 in Queensland and $273 in the ACT
2. ACCC’s estimate of annual savings from the default tariff measure is much lower, at $105-$165.
3. Either way, both the Government and the ACCC have said that it will lower prices.

What price capping actually does, comes back to my favourite thing – The Supply vs Demand equation

1. When capping the price at which goods and services are supplied, it reduces supply, and this lowers infrastructure in the long term.
   • Especially when renewable energy is being forced upon suppliers as well, pressuring them to cut their emissions etc
   • These things increase costs to suppliers… so how will they pay for it?
2. Demand – With lower prices, demand goes up, people use more when something is cheaper.
3. This is a bad situation – Reduced supply along with increased demand = Not enough power

Lack of power – Rolling blackouts

1. A rolling blackout – an intentionally engineered electrical power shutdown
   • Electricity delivery is stopped for non-overlapping periods of time over different parts of the distribution region.
   • Rolling blackouts are a last-resort measure used by an electric utility company to avoid a total blackout of the power system.
   • They generally result from two causes: insufficient generation capacity or inadequate transmission infrastructure to deliver sufficient power to the area where it is needed.
2. Rolling blackouts – common or even a normal daily event in many developing countries where electricity generation capacity is underfunded or infrastructure is poorly managed.

Long term effects of price ceilings

• When companies have price-ceilings enforced by regulation and are what they can charge for a service is limited, this effects profits.
• Their incentive to invest in the infrastructure and the grid goes down because level of investment can only come from profits
• If profits are going down because prices are capped, as publicly listed companies they’re still obligate to maintain profits – otherwise investors dump their shares and the company can go out of business. A lot of individuals lose their jobs in the end.
• This results in a decrease in overall supply to the market.

Pakistan

1. In Pakistan there are shortages day in and day out. This highlights the chronic underinvestment into infrastructure, long-term planning sacrificed to short-term expediency, lack of leadership, cronyism and corruption.
   • Capped prices meant the companies had no funds to build infrastructure
2. The dual effect of the government setting low electricity prices PLUS the customers failing to pay for it meant state utilities lost money, and couldn’t pay private power generating companies, which in turn could not pay the oil and gas suppliers… who cut off the supply.
3. Infrastructure investment comes from revenues – if revenues drop, there is less money to maintain the power grid.

Rolling blackouts in developed countries sometimes occur due to economic forces at the expense of system reliability (such as in the California electricity crisis of 2000-2001).

Okay, lets look to a developed nation, and specifically, California in 2000-200.

California had a shortage of electricity supply caused by market manipulations, and a capped retail electricity prices was one major factor

• The state suffered from multiple large-scale blackouts, one of the state’s largest energy companies collapsed, and the economic fall-out greatly harmed Governor Gray Davis’ standing.
• There were delays in producing some power due to weather
• By keeping the consumer price of electricity artificially low, the California government discouraged citizens from practicing conservation.
• When the electricity demand in California rose, utilities had no financial incentive to expand production, as long-term prices were capped.
• In February 2001, California governor Gray Davis stated, “Believe me, if I wanted to raise rates I could have solved this problem in 20 minutes”.

There are many other examples of asset pricing, like New York housing (which lead to it becoming derelict), gas shortages in the USA, and many others… (if you are interested, let me know)

How do we solve this?

The average bill is $1576 p.a. in Australia, where as in France it is $1178 pa (731 Euros) – 34% lower

• How they do this? Nuclear power – it is a viable, clean, option.
• Where it goes wrong:
  • Poor construction – Chernobyl
  • Building on a fault line – Fukashima

If it is done well it is the best solution to the electricity price issues. Either cap prices = No power for anyone, or increase supply through more power with no environmental pollution

As always, thanks for listening!