Julia Gillard has finally fingered the real problem with electricity prices -- inefficient markets in need of reform. Tristan Edis of Climate Spectator lists five steps to fix the situation.

Julia Gillard has finally acknowledged the real problem behind rising electricity prices — the unfinished business of market reform in electricity networks. But I’m not convinced she’s got much of a clue what to do about it.

She’s certainly on the wrong track when she praises News Limited for its “Big Electricity Switch” campaign (which a former senior Labor adviser is behind), which is tinkering at the edges at best.

Gillard’s praise of looming reviews by the Australian Energy Market Commission is similarly misguided — the AEMC is captured by the industry it seeks to govern. Alarm bells also rang when she started talking about gee whiz government-funded technological trials like the Smart Grid, Smart City program. Julia, this stuff is a distraction, not a solution.

Also if the government focuses solely on headline prices without thinking about overall long-term costs, they will muck this up. In some cases electricity prices need to rise, but savings will come in other areas that outweigh these price rises.

So here are five things Gillard needs to do if she wants to get serious about containing electricity costs. The challenge is that, contrary to Tony Abbott’s ignorant assertions yesterday, the federal government doesn’t hold all the regulatory strings, as the constitution vests the power to regulate power with the states. But not to worry, just take a lesson from the Hilmer competition reforms and make some payments to states contingent on them cooperating on implementation of these five reforms …

1. Mandate that networks charge electricity retailers cost-reflective time and location variable network charges, and remove retail price controls

The economics of electricity networks is not dissimilar to roads, as Gillard correctly noted — the costs are largely driven by the need to handle peak demand loads (the number of lanes on the road) and by the distances of the power lines. Yet for the vast majority of residential consumers these costs are recovered through charges to electricity retailers that are smeared averages across time and location. Transport of electrons carries the same charge whether consumed on a very hot day in the afternoon or at 2am, and whether consumed in Melbourne or Mildura.

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This means electricity retailers have very little incentive to help customers control their peak demand. Also, existing electricity generators pay absolutely no fees for use of the network that delivers their electricity to customers’ doors. In combination with subsidies for rural consumers this distorts locational decisions around where to put these generators.

2. Inject competition into the electricity supply industry through establishing a market for the acquisition of electricity demand reductions

It is possible to inject competition to discipline the monopoly electricity network businesses. If you reduce electricity demand, you avoid the need for very expensive and poorly utilised upgrades in network capacity.

The problem we have at present is that while electricity consumers like to whinge a lot about electricity price rises, they lack the time and capability to do something about it. As outlined by Greg Guthridge, Managing Director of Accenture’s global utility practice, the key to reducing demand is not to hit end consumers over the head with price shocks. Rather it is to provide incentives direct to businesses who are knowledgeable in energy demand management. They have the capability to help consumers reduce peak demand. This market can be funded through a levy on electricity which will ultimately yield savings that exceed the additional costs.

This is not contrary to point 1, which is to ensure electricity retailers, not necessarily end customers, see cost-reflective price signals. The electricity retailer is then free to determine how they’d like to manage this cost exposure and whether to pass it on.

3. Remove the cost of capital “free kick” for state-owned electricity networks

Electricity networks are monopolies that are regulated by government in terms of what costs they can incur and pass onto customer to deliver reliable electricity supply. Network businesses are allowed to recover all their direct costs plus a margin thought to be necessary to raise finance from equity and debt markets. This cost of capital margin has to date been set with a view to what would be required for a private sector business to raise finance.

However state government-owned networks can borrow money at much lower rates via government bonds. This means their owner, the state government, receives a much higher dividend for each unit of expenditure the regulator allows them to spend. The end result has been that state-government-owned networks have a very strong incentive to undertake more expenditure than necessary to maintain a reliable electricity supply, which is exactly what they’ve done.

4. Privatise electricity networks

State governments with shrinking tax bases that are desperate for new revenue cannot be trusted to efficiently regulate businesses that they also happen to own. These network businesses should be privatised to avoid conflicts of interest where the state government is the poacher and the game keeper.

5. Make energy consumption data freely available (with privacy safeguards)

One of the major problems hindering effective energy policy in this country is that the only people with access to high resolution data on energy consumption are the electricity companies themselves.

The energy market operators have a database which automatically collects all the data on what is happening with energy consumption down to individual customers and even down to 30 minute intervals in some cases. Yet policy analysts within government as well as independent research institutions are living in an information vacuum without an ability to access and analyse this data. Instead they have to make do with macro market-wide data which is completely insufficient to truly understand what’s going on and evaluate the effectiveness of policy changes.

This data should be uploaded to a publicly accessible database but with data anonymised to avoid linking it to the identity of a particular individual or small business.

*This story was first published at Climate Spectator