Major reforms needed to cut electricity and gas costs

Tuesday, 30 June 2015

A University of Adelaide economics expert has proposed radical reforms to the regulatory system in Australia, which he says would lead to cuts in electricity and gas bills for consumers.

In the lead article in the Australian Competition and Consumer Commission’s (ACCC’s) journal Network due out today, Professor and Head of the University of Adelaide’s School of Economics, Paul Kerin, identifies major problems in Australia’s regulatory systems and proposes fundamental reforms.

“The issue of why electricity and gas prices are too high is always of critical importance to the general public, especially to those doing it tough on a tight budget. People often wonder why the costs keep spiralling upwards year on year. This article identifies the most important reason for overly high costs – regulators use something called ‘Regulated Asset Bases’ to set their prices,” Professor Kerin says.

A Regulated Asset Base is the value assigned to the assets of a regulated business. Regulators use this value to set maximum revenue allowances. About 70% of the “costs” that regulators use to set maximum revenue allowances are directly driven by this value.

“The Regulated Asset Base model is widely used in Australia and overseas. However, this approach has generated many billions of dollars of wasted investments in electricity, gas and water networks, because it insulates regulated businesses against the normal commercial risks that all other Australian businesses face,” Professor Kerin says.

“Such insulation from risk distorts investment decisions and promotes overinvestment. This has probably been the single biggest driver of overinvestment in regulated industries in recent decades, yet it has received little or no attention for the harm it has caused. The entire cost of many billions of dollars of overinvestment is ultimately borne by consumers,” he says.

“In competitive markets, prices are determined by demand and supply; past investments made by suppliers are irrelevant to price determination. Yet the Regulated Asset Base approach makes past investments the central driver of prices. In competitive markets, if suppliers invest on the expectation of high demand that does not eventuate, they bear the cost – not consumers. In regulated industries, consumers bear the entire cost of demand shortfalls.”

In his article, Professor Kerin recommends four major reforms, including the elimination of Regulated Asset Bases and the introduction of market-based mechanisms to set network capacity and usage prices.

“Market-based mechanisms will ultimately lead to more efficient outcomes for the community. By using a market-based approach to regulation, we will see resources properly allocated, costs minimised, and productivity growth maximised.

“The kinds of market-based mechanisms being proposed here would include using energy capacity auctions and secondary markets to enable capacity rights to be traded. These mechanisms are used widely overseas. In energy markets, the prices at which these rights are traded would provide hard evidence on the need for further capacity, and result in much more efficient investment,” Professor Kerin says.

His article will be available online in the June 2015 issue of Network, which can be found at: www.accc.gov.au/publications/network

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