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Why are we buying insurance from power companies?

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Much has been said in the discussion about the introduction of smart meters. According to Michael West in the Sydney Morning Herald, “smart meters and ‘flexible pricing’ merely shift the business risk from the company to the consumer”.

This entirely misses the point that shielding consumers from the price volatility is counter-productive. In our electricity generation system, wholesale energy is traded on an open market where the laws of supply and demand dictate prices from minute to minute. However the consumer is shielded from dynamic price changes, contributing to ridiculous wholesale price spikes for a few hours per year. Sometimes peak price can be more than one hundred times the typical off-peak price.

So ‘protecting’ consumers from dynamic pricing is a reason why the wholesale price is so unstable in the first place. The wholesale price volatility would be reduced if consumers are exposed to the price. This  would also lead to lower peak demand, therefore less peak-time generating capacity has to sit idle most of the time.

So yes, at present the power retailers do assume peak pricing risk, but in return they extract from every consumer a significant premium built in to the everyday price of electricity. Since we pay them a premium in return for avoiding some risk, that puts our power retailers in the insurance business.

As a power consumer, I would love to avoid paying that risk premium for the 99 per cent of hours when wholesale price is low to moderate. So West’s proposition that flexible pricing is a way of the power companies to offload risk misses the point that there is significant potential for lower everyday prices through the paring back of the risk premium that gets passed to consumers in power tariffs.

I propose that retailers offer a pricing plan that, very simply, charges the dynamic wholesale price plus a fixed margin. With smart meters and in-home displays, the dynamic price charged can be displayed to the consumer. Most of the time the consumer would pay much less than they pay today. On average they should be no worse off, but now there is the incentive for more mindful consumption and the prospect of reducing costs in ways that really benefit the grid.

So when the consumer is exposed to the market price fluctuations, therein lies an enormous potential for financially motivated innovation in energy management. The incentive arising from this price signal will drive great innovation. Already today companies like Enernoc are using clever means to make a buck out of ‘demand-side management’. This will start first with large consumers, but there is scope for it to apply at all levels.

Imagine if, on request, 100,000 pool pumps of consenting customers are automatically turned off on a hot day instead of bringing online a 50MW peaking power plant for a couple of hours. Imagine if auto-defrost home fridges are signalled to defer their defrost cycle for a critical few hours. These are some of the less-visible innovations that smart meters could enable. There are bound to be others we haven’t thought of yet. This benefits the grid, and so indirectly benefits all consumers through lower prices from avoided investment in peak generating capacity.

Beyond the benefits to grid is the capacity for smart meters to enable other interesting things directly for the consumer. I have an in-home display that talks directly to my meter and can help me keep an eye on  power guzzling devices, and on the immediate cost of power. I also have access to a web portal from my power distributor that presents my usage data and lets me see the big picture. It also lets me plug in different retailers’ tariffs to let me make the most of competition and calculate what my costs might be should I choose to switch.

No doubt some consumers would choose to continue to pay a premium to the power companies for them taking on the peak price risk. However I would much rather pocket the premiums and put that towards clever ways of lessening my own need for power.

Richard Keech is a research coordinator on the Zero Carbon Australia Buildings Plan at Beyond Zero Emissions and an energy efficiency consultant

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  • Warwick

    Conceptually this is a great idea but the reality is more complex than suggested in this article. Firstly, this kind of arrangement “pool price pass through” does exist already for large enough customers and has enabled businesses to save money.

    One issue is that much of the premium that is mentioned from the “ridiculous wholesale price spikes” is actually paid to generators through wholesale contracts rather than being pocketed by the retailer, so if generators contract less they will be incentivised to push wholesale prices higher as they will be less contracted than before. Secondly, the cost of metering, the data acquisition, verification and settlements does not come for free i.e. this added complexity adds additional cost that may be in excess of any saving gained.

    Finally, there is some risk to customers changing to a ToU tariff as they may think that they can save money but have limited data about their consumption and may find that their usage profile is worse than that of the net-system load profile cohort i.e. the large group of currently non-smart metered customers. Others that do move to smart metering will benefit, but inherit in the existing tariff is a cross subsidy between good and bad energy use, so as the better customers move, the worse the remaining profile becomes and subsequently the higher the cost to those left behind. It is a serious equity issue that needs to be considered…

  • Robbie Van Winkle

    To answer the question posed in the title, consumers buy insurance from electricity retailers because retailers are able to perform at least two functions that are prohibitively expensive for individual consumers:
    a) Retailers combine a large number of loads, resulting in a smoother, more predictable load compared to an individual’s load.
    b) Retailers can enter contracts for difference to cover their exposure to pool price volatility for a large proportion of their expected load.

    Journalists should question the motives and incentives behind vertically-integrated energy companies weighing in on energy policy issues. There have been a few instances recently of AGL, Origin et al pushing for policy changes on the basis that the changes could benefit consumers, including privatisation of government-owned energy assets and installation of smart meters.

    What is missing from articles reporting these comments is an examination of whether the changes will actually generate the claimed benefits, and whether the benefits will be passed to consumers. Is there any evidence to date that these entities have passed such benefits through (to the detriment of their shareholders)?

    In the case of smart meters, will energy retailers reduce the retail price of electricity when wholesale prices are low, or will they only increase retail prices from the base tariff during high-price intervals?

    When the price is $12,900/MWh, will the entire cost be passed through to consumers? If so, I would look to purchase insurance against electricity price spikes. But I would be concerned about how much will it cost to insure against price spikes when the insurance company isn’t benefitting from the upside associated with collecting a retail tariff above the wholesale price of electricity for at least some trading intervals.

  • D. John Hunwick

    This is the sort of discussion that should be in all forms of the media. I am tempted to go with a smart meter if it will reduce the need for so much infrastructure to cover the ‘spike” of peak demand. IN time I would prepared to have my own (ZEN?) battery to store my own solar energy and MAKE my family live within that energy budget. Can I be directed to a website that allows me to compare smart meters?

  • Sean

    Perspective.

    $12,900/MWH is only $12.9/kwh
    this is not a “there goes my house” moment
    nor even a “whoops i wrote off my car”

    I would not want to be paying 12.9/kwh for my power every day, but this only occurs now because there is very little demand management
    spikes often occur only for 5-10 minutes.
    having your air conditioner compressor cut out during that time wont kill you, nor will having your pool pump switch off.

    Most price increases happen with only a small percentage change in supply/demand. with price signalling, ridiculous generation prices would be a thing of the past.

  • Mike

    There is a very simple solution to the peak pricing problem and it already exists. Power companies have the off peak hot water circuit that they can arbitrarily cut in and cut out when the load on the system is too high. There are so many applications that do not requite a continual load on the system – high usage products that come to mind are pool pumps, hot water, refrigeration under certain conditions, any appliance with battery back up – massive solution when EVs are more widely in use and am sure there are plenty of industrial examples. It does not take much of an imagination to see where a bit of organisation can easily smooth out the peak power problem.

  • http://thisnessofathat.blogspot.com.au/ Gillian

    I’ve had a smart meter since 2010 but I don’t have any of the display gadgetry that shows consumption minute by minute inside the house. Instead I know to avoid the 2.00-8.00pm peak period.

    Thanks to a comment on this website the other day, I set out to calculate how much I would pay if I was not billed by time of day. I used my most recent bill, and tariffs on the website of my provider, Energy Australia.

    I was astonished to work out that we’re saving about $800 a year because of time-of-day billing. Our annual bills are about $1,000, but I worked out that we’d be paying about $1,900 if we were on standard billing rates. That means our smart meter paid for itself in the first six months. Good investment!

    Only 15% of our consumption falls in the expensive 2.00-8.00pm period. Our Friday pizza nights were the first casulty when we went to time-of-day billing. Nowadays, pizzas are a lunch time affair.

    Now I feel REALLY good on two counts – I’m saving serious money on my electricity bills AND I’m contributing to reduced peak demand.

    I don’t see any downside to smart meters. The sooner they are rolled out the better.

    • John

      Hi Gillian, thoght your story was most interesting. Could you please contact me on 0402 060 100 as I would like to find out more about your success with a smart meter

  • Chris Fraser

    I disagreed with Michael West’s views on TOU and almost every one of his sentiments. The end of the world – Yeah bring it on Michael !
    Clearly here is an opportunity for retailers to offer their customers a choice of tariff systems which are changeable by opting in or out when the customer wants. With the introduction of a bit of live technology, it should be possible to get a huge following for wholesale price-exposure.