One of the perennial gripes of the incumbent suppliers when market reforms are proposed is the cost of upgrading their systems for the new rules. However, this qualitative grumbling is rarely backed up by quantitative evidence of the actual costs. A new report from consultants Deloitte sheds some light on this, in the context of the AEMC’s consideration of whether to delay implementation of the five minute settlement and global settlement rule changes (see below for more information on these changes).
Deloitte assessed the likely cost of a major systems change such as preparing for five minute settlement for the electricity supply industry. The regulated revenue framework for networks largely insulates them from cost shocks such as these by allowing them to recover costs from customers, but market facing businesses such as generators and retailers are not guaranteed to be able to recover these costs. These are fixed costs, so in a competitive market they wouldn’t expect to be able to recover them. In practice neither the wholesale nor retail markets are perfectly competitive, and so businesses may be able to increase their prices to recover a portion of their costs.
Looking specifically at retailers, Deloitte lists 36 retail businesses in its report, and classifies them as large (>10% market share), medium (1-10%) and small (<1%). It then gives a cost range for each category of retailer. We can compare this to the average margin each type of retailer earns, using AER data for customer numbers and ACCC data for (pre-COVID) margins. These data only cover households.
|Retailer category||Low costs ($m)||High costs ($m)||No. of retailers||Average customers||Average margin ($m)||Months’ profit to cover costs (high-low)|
As the table shows, it is clear why retailers and other suppliers groan at the cost impost of system changes arising from rule or law changes. While large retailers can take it in their stride, with the implementation costs of the settlement rules wiping out only 2-3 months’ profit, medium retailers take a much bigger hit. And while small retailers appear to get off lightly, this assumes they can earn the industry average margin of 4 per cent. In practice, economies of scale mean smaller retailers tend to have higher costs per customer served then large retailers and consequently smaller margins. So, at the high cost end, the implementation could be wiping out around a full year’s profits for all but the big 3 retailers. This is before accounting for the impact of COVID-19.
Sceptics might suspect that the limits to competition for small customers mean retailers can actually claw some or most of these costs back from customers. But that just means customers are picking up the tab for the industry’s costs. For retailers alone, the figures above suggest a total cost of $180-320m, or $18-32 per household. Then add networks and possibly some generator costs on top. Systems changes aren’t just about the costs either. In years past as each of the big 3 updated their billing systems, their customer complaints skyrocketed as teething problems led to incorrect bills being sent out. Of course, if the rule changes work as intended, then customers should save more than this as the benefits of the rule changes flow through to them through lower wholesale and retail costs.
If this was a one-off, then it might not be such an issue. But the pace of rule changes has increased and there are a number of other very significant changes to the market being mooted that would likely each be at least as costly, such as day ahead market and nodal wholesale pricing. Systems changes are also going to be required for the new demand response mechanism, the application of the consumer data right to the sector, the likelihood of new security services markets and keeping up with the ever-changing retail reliability obligation.
Intriguingly, one of the signatories to a letter from the Australia Institute opposing the delay to implementation was US-based tech billionaire Mike Cannon-Brookes who has taken an interest in the electricity sector. Perhaps the best thing Mr Cannon-Brookes could do for the sector would be to help them find ways to implement systems upgrades more efficiently.
Settlement rule changes
Five minute settlement is the change from settling the spot market every 30 minutes using an average of the six five minute dispatch intervals to settling each individual dispatch interval. The rule change is expected to prevent a certain form of “gaming” of the spot market that many believe occurred to take advantage of this quirk. It’s also argued that the change will be beneficial to fast-acting storage such as batteries and to demand response providers.
Global settlement is the practice of spreading unaccounted for energy around all retailers in an area proportionally rather than attributing it all to the incumbent local retailer. Unaccounted for energy can include electrical losses, theft and metering errors as it is essentially the difference between the total energy supplied to the system and the sum of metered energy at customer connection points.