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Electricity retailers: Do we really need them?

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People understand what a retailer is: it’s where you go to buy and collect stuff – shoes, clothes, groceries, petrol and other items. They are the points of sale between the manufacturers and wholesalers, and the consumers.

But what about electricity retailers? Is that where you go to buy and collect electricity? Well, actually, no. Electricity retailers don’t actually deliver you any electricity at all. As the diagram below – taken from a presentation by UNSW electricity expert Hugh Outhred – will tell you, that comes straight from the generators via the transmission network and the distributors. And now, some of you will get electricity from solar PV modules on your roof.

The electricity retailers are simply competing for the right to send you a bill, to package up a range of tariffs and lock you into a contract. They are the archetypal middle-man, and the question that is now being put is: Are they of any use?

The question arises because retailers have long been part of an economic model that relies on consumers buying more electricity. That means that retailers can sell more contracts, generators can build more power stations and distributors can build more poles and wires to transport the electrons. But that business model is now changing – demand is falling, energy efficiency is at a premium, more and more consumers (both residential and business) are producing their own energy – and the retailers, like some of the other parts of the value chain – are getting in the way.

One of the biggest problems for retailers is a basic one – they aren’t very good at what they do. They find it almost impossible to hold on to customers. Last year, the major electricity retailers reported that the “churn” rate for 2010/11 was nearly 25 per cent. That means, they lost nearly one in four of their clients, and then they had to go and pay to get them back again, and then bill you for it.

It may have something to do with the long-run inability of retailers to engage with their clients. International surveys show that electricity retailers have the worst relationship with their customers of just about any customer-facing group – their relationships are fleeting, and usually coloured by complaints about price hikes and connection problems.

Still, they make a profit. According to the most recent annual accounts for 2010/11 for the biggest retailers, their gross margin – the difference between the cost of electricity they pay the distributors and generators, and the cost of packaging up you bill and collecting money from customers – was between $150 to $200 per customer. The overall cost of retailers equates to around 15 per cent of your electricity bill, or around $350 a year, depending were you live. That’s nearly half the cost of generation.

But that’s not the end of it. Retailers are now being accused of pocketing hundreds of millions of dollars in profits from schemes that have supported the introduction of technologies such as rooftop solar. For instance, they are allowed by pricing regulators – with the exception of the ACT – to charge customers $40 for each small scale technology certificates (STCs), when the market price has rarely risen about $26. And there are about 45 million STCs washing around the system this year. That has grossly inflated the cost of the schemes, and the returns to retailers, even with their carrying costs.

And electricity retailers are also accused of picking up more profits from exports of excess electricity back to the grid from rooftop solar systems – for which they pay 6c/kWh (and in some cases nothing at all) and then sell it to the houses in the same street for up to five times as much. The retailers can do this because have managed to convince the pricing regulators that the difference is made up with fixed grid, billing and other costs. But the solar industry reckons they are profiting handsomely – hence the push for a “fair value” of solar.

One thing they do achieve is to manage pricing risk, and the rapid and often steep swings in wholesale electricity prices. They do this through a range of hedging policies and by being “vertically integrated”. That means they also own generators, so when the price moves one way, they make it up by increasing profits elsewhere. Unfortunately for customers, this has meant that few have enjoyed the benefits of the lowest wholesale electricity markets since the start of the NEM. Like banks, electricity retailers are slow to pass on the benefits of falling costs, but quicker to act when prices (or rates) go up.

So what would happen if we got rid of retailers? The biggest challenge would be managing the wholesale price risk – electricity is one of the biggest traded markets, bigger by a long shot than carbon. We would need interval metering throughout and, to provide financial risk management, we would also need a carefully designed derivatives market accessible to small players. Such a market was envisaged in the 1990s, but banks and other financial market players argued that this could have been a constraint on competition.

Outhred says perhaps the best answer is to turn them into service providers. “We need energy service companies instead of retailers,” he says. “Because of the way they operate, energy retailers mess-up efficient management of uncertainty and deter end-users from energy efficiency improvements, as well as pocket a fee for doing so.”

Evolving into a service provider, however, would require a massive cultural change. But it may be one that is forced upon them. If the electricity retailing business is about collecting data (metering) and sending out bills, then there is a host of competing organizations that are specialists in data management and IT that can take that role, and offer snappy new devices that offer in-house monitoring and controls. If it is about customer management, there are a host of customer service specialists that can do that better too; and now there are a host of technology providers that can offer alternatives to sourcing electricity from the grid. And now these specialists are recognising their are opportunities to work together. The best chance the retailers have of surviving – apart from regulatory protection – is to strike up some alliances or their own, and to get out of the way of progress. The sooner the better.

 

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  • steve the sparky

    But, who is going to send me my Feed-in-tariff cheque?… Seriously though… you are 100% correct all retailers are is billing providers who don’t even collect the bill data themselves…. there is plenty of fat in the retail energy business when you get your margins and client mix right. I noted with interest that the creator and former major shareholder of now AGL subsidiary Powerdirect, Michael Norster is establishing a new electricity SME retailer in Victoria, Blue NRG or similar…. if this bloke put his hard earned back in energy retailing, i’d say confidently industry margins are healthy!

    Energy service providers…. that’s a laugh… the only reason they have a half hearted attempt at energy efficiency now is legislation… the poor old globe monkeys cop that much shit, its not funny!

    Anyway, I better go and check the inverter….

  • http://www.paulgilding.com Paul Gilding

    Another outstanding piece of analysis Giles that shows just how disruptive, ulimately
    in a good way, the decarbonisation of energy will be to the economy and many players in it. I hope the retailers are thinking about this deeply as some will certainly win in the transition.

  • Nick James

    I agree, great story Giles.

  • Warwick

    Interesting question but I think it is important to consider a few details before assuming the business model is broken:
    - The economic model for retailers is not solely based upon selling more electricity. Reducing demand has always had a value since the NEM started and reducing exposure to high spot prices has driven the need for demand side participation and curtailment products.
    - All the regulators such as IPART do is determine the maximum price that retailers charge. They may have assumed STC’s at $40 rather a more recent price of $26 but this only one of many components of the bill. Virtually all the retailers are offering prices below the maximum tariff of around 10%…perhaps competition might be passing this saving on to consumers?
    - If the retailers are really making hundreds of millions of super-profits, it sounds like an opportunity for a new retailer to step in.
    - One should not confuse the delivered price of electricity with the price of wholesale energy. The network business is responsible for roughly half the delivered price. Sure, quoting 30c versus 6c sounds impressive but it is more like 10 to 15c vs 6c.
    - Reading spot prices is like reading tea leaves. Spot prices have been lower for a while but since July 1 have roughly tripled and hit over $12,000/MWh in SA for 5 minutes. It is the contract market that determines pricing, whilst spot volatility adds to that cost. Wholesale prices are higher than were they were 10 years ago.
    - Credit. The retailers perform a credit function for customers. They have responsibility for paying the market operator on time and need to have multi-million dollar bank guarantees to perform this function every day. They pay network bills every month, energy bills weekly and then charge you quarterly in arrears with a few weeks to pay. Never mind the bad and doubtful debts.
    - Don’t people also seem to be frustrated with the effective grocery duopoly or telephony oligopoly in Australia? These businesses still seem to exist even if others may have a better relationship with their customers…

  • Tim

    Pity there is only one retailer in WA for households, because they charge you carbon tax even when you purchase renewable energy:
    http://au.news.yahoo.com/thewest/a/-/breaking/14109537/power-slug-hits-green-users/

  • Peter

    Excellent Analysis Giles.

    The current retail arrangements also frustrate the ability for small consumers to supply dispatchable loads to the system administrator as a Load Following Ancillary Service (the immediate portion of spinning reserve).

    Such loads would need to be paid for, or charged, in a more sophisticated way than the current tariff mechanism. Dispatchable loads could make a big difference to the costs and penetration of wind overnight.

    The increased requirement for LFAS to meet wind variability in lightly loaded networks is wasteful and the costs are being charged against wind.

    While the NEM is shielded from this effect somewhat by its hydro capacity, system control in the SWIS has predicted an almost doubling of the LFAS requirement to accommodate new wind farms – particularly Colgar.

  • Peter Fries

    Giles provides and excellent snapshot of the current industry. The time is arriving quickly, however, when retailers will start to look like Telstra fixed line providers. Decreasing energy storage and reneweable energy costs is opening up a new market where, like the mobile phones we all love, the wires are gone.

    The new industry is not here to praise Ceasar…

  • http://galahs.blogspot.com/ Dave McRae

    Very interesting stuff.

    I struggle why I, in the ACT, with a single retailer, pay ~18c/kWh, yet for pretty much the electrons (ACT having very small self generation) the cheapest plan from a confusing array of bundles/schemes a Queanbeyan (NSW side of the magic border line) resident can get away with is ~24c/kWh.

  • Diego Matter

    Giles,
    how do the retailers determine how many kWh they must buy on the spot market for the 5 minute period for their customers since not all customers have smart meters installed. Do the retailers have to buy the exact amount equivalent to their collective customer base demand? How would that be even possible?

    Could you please clarify this aspect for me.