Deregulated vs Regulated Retail Energy Markets The welfare implications of

1. Deregulated vs Regulated Retail Energy Markets The welfare implications of price discrimination vs uniform pricing Prof. Paul Simshauser AM

2. Simshauser, P. 2018, “Price discrimination and the modes of failure in deregulated retail electricity markets”, Energy Economics, Vol.75, pp54-70. Simshauser, P. & Whish-Wilson, P. 2017, “Price discrimination in Australia’s retail electricity markets: an analysis of Victoria and Southeast Queensland”, Energy Economics, Vol.66, pp92-103.

3. Defining the problem • Residential electricity tariffs have increased very materially • The dispersion of residential electricity tariffs in the NEM’s deregulated retail markets have also increased materially (i.e. 3rd degree price discrimination) • Residential Tariff Structures have embedded 2nd degree price discrimination (i.e. fixed rate & variable charge discriminates against large volumes) • Which of these is actually a problem?

4. This. (Qld Avg Residential Tariff 1955 – 2019).

5. Not this. (Default & Discounted Retail Offers – SEQld)

6. Definitely not this. (SEQld Tariff Structures – two part tariff)

7. Why price discrimination is frequently welfare enhancing • In heavy industries (e.g. elec, gas, telecoms, airlines), sunk costs need to be recovered • Avg cost pricing is known to be inefficient, and if pursued produces deadweight losses • With discriminatory prices, sunk costs are differentially recovered from strong (less-price sensitive) segments, allowing for marginal cost pricing in weak (more-price sensitive) segments • Efficient pricing requires the marginal unit sold to be priced at marginal cost • There is nothing in economics which suggests all units be priced at marginal cost • Discriminatory prices are known to distribute the firm’s sunk cost-recovery task more fairly, and in this sense displays positive distributional efficiency effects • Standing Offer Tariffs exist in the same way full class economy tickets exist (i.e. a default with minimum levels of service) • Artificial Tariff Caps are distortionary and can be expected to alter discounting patterns in the market (see Simshauser & Whish-Wilson, 2017).

8. What happens when you Cap the market or limit tariffs? • Big discounts are very popular with consumers • High standing offer tariffs are not, and are derided by consumer groups • Rising tariffs is a problem, dispersion is not (with some exceptions) • Moving from monopoly supply to contestable markets is grounded in dispersed prices and discounts of a default rate • Once defaults exceed 10%, customers get interested (gains are worth the effort (see IPART, 2013; Simshauser, 2014; Littlechild, 2014; He & Rainer, 2017; Flores & Waddams Price, 2018 amongst others) • Tariffs are a weapon used by firms to attack rivals. Consumer welfare is enhanced when this happens. Blunt the weapons, blunts attacks, consumer welfare is damaged, and retailer profits rise. It’s that simple. See Hviid & Waddams Price (2012) or Littlechild (several citations 2014-2018)

9. Some quick stats following SEQld Regulation… Comparison of Industry Switching Sequence Good industry switching rates

10. Some quick stats… Comparison of NEM Region Switching Sequence Good industry switching rates Big incr. following 2016 dereg.

11. Some quick stats… Evolution of Retailers in SEQld Sequence Good industry switching rates Big incr. following 2016 dereg. Number of retailers increases

12. Some quick stats… Sequence Good industry switching rates Big incr. following 2016 dereg. Number of retailers increases Rusted-on customers low & falling Rusted-on Customers in SEQld

13. Some quick stats… Standing & Routine Discount Offers in SEQld Sequence Good industry switching rates Big incr. following 2016 dereg. Number of retailers increases Rusted-on customers low & falling Lots of good Offers

14. Some quick stats… What SEQld Customers Pay vs Ergon Regulated Tariff Sequence Good industry switching rates Big incr. following 2016 dereg. Number of retailers increases Rusted-on customers low & falling Lots of good Offers A majority of customers better off

15. Some quick stats… A globally significant market laboratory- testing Deregulation (1.3m) vs Uniform Regulated Tariff (640k control group) Sequence Good industry switching rates Big incr. following 2016 dereg. Number of retailers increases Rusted-on customers low & falling Lots of good Offers A majority of customers better off $184 million gain to consumers vs Regulated Uniform Tariff

16. Conclusion • Are deregulated retail markets perfect? Of course not. But in aggregate the retail markets have worked well. • To be clear, rising electricity prices are a problem, but price dispersion is not. • Certain marketing practices are problematic and require policy attention: • The “Discounts off what?” problem is a legitimate issue, ie an anchor has become necessary • There is evidence of 1 or 2 excessive (bordering on misleading) default offers. 3rd Tier, but can and should be managed by jawboning rather than re-regulation of the whole market • The inter-consumer misallocation problem (which Retailers should fix by self-regulation) • Price discrimination is pervasive throughout the economy and is how firms recover fixed and sunk costs without relying on distortionary average cost pricing • Eliminating the practice will damage competition and the functioning of the market - you can’t selectively Cap default offers to some lower level and expect discounts to be unaffected