Energy Pricing: What Protections Do We Have?

Forecasts predict that energy prices may rise by a whopping 56% over the next two years. This will add enormous pressure to households already struggling with the rising cost of living pressures.

Rising energy prices have been exacerbated by a globally disrupted energy market following the Ukrainian war and the imposition of Russian sanctions. The sanctions mean many European countries must find replacement gas supplies which has caused the global price of gas to skyrocket. Extreme weather events, unexpected outages, fuel supply issues and the closure of coal plants have further exacerbated the situation, as generators are increasingly reliant upon gas to generate electricity during peak periods.

Meanwhile, the rising price of gas on the international market has generated significant profits for gas producers. To date, the east coast energy market (which comprises Queensland, Victoria, New South Wales, and South Australia) has imposed few restrictions on the gas export market. However, in an escalating energy crisis, this is a problem. Gas is a public resource, and the government must act proactively to protect vulnerable consumers against exorbitant prices.

What Has the Government Done so far and is it working?

(i) Heads of Agreement

The federal government has extended the pre-existing heads of agreement with gas producers. At the end of September, the Federal Minister for Resources, signed a new heads of agreement, extending the previous agreement entered into by the Morrison government to 2030. This non-legal and non-binding agreement outlines key gas supply provisions. The aim is to ensure there is no gas shortfall in 2023, as predicted earlier in the year by the Australian Competition and Consumer Commission (‘ACCC’) gas report.

The new heads of agreement sets out that uncontracted gas must be offered by gas producers to the domestic market before it is offered to the international market, on competitive market terms, with reasonable notice. There is no requirement that the price of gas offered must be aligned with the netback price, that is, the price that a gas supplier can expect to receive for exporting its gas. The only requirement is that pricing is ‘competitive’. This is difficult to define within a rapidly escalating international market and provides no price security for domestic purchasers.

The agreement further requires gas suppliers to offer gas on terms consistent with a code of conduct. However, the proposed code of conduct is voluntary and therefore only applies to suppliers who have indicated they intend to comply with it. Further, even if a supplier has committed to comply with the code, they may withdraw at any time. The code imposes generic good faith obligations upon producers who do agree to comply. This means they must act honestly regarding the quantity and pricing structure for the supply of gas. However, the code does not impose any mandatory pricing mechanism or cap. It simply states that suppliers should be ‘influenced’ by netback prices and any other ‘relevant factor.’

The Heads of Agreement and Code of Conduct are designed as supply rather than pricing mechanisms. They do not impose any price cap or create a robust pricing mechanism. This means they do not protect domestic consumers on the east coast against the rising price of wholesale gas. Gas producers can choose whether to make commitments to supply uncontracted gas to domestic producers and have the discretion to determine a ‘competitive price.’ Finally, if gas producers breach this agreement there is no legal consequence because the heads of agreement are a non-binding arrangement. 

(ii) Australian Domestic Gas Security Mechanism (‘ADGSM’)

Under the ADGSM, where a gas supply shortfall is forecasted, the Federal Minister may, in consultation with other stakeholders, declare the following year a shortfall year and impose export restrictions on gas producers. This mechanism was first introduced in 2017. Reforms have been proposed by the current federal government which would allow the Minister to trigger the ADGSM following quarterly assessments. However, the ADGSM has always been regarded as a mechanism of last resort and successive governments have failed to impose export restrictions upon gas producers. As such, the ADGSM has never been triggered. It was not even triggered by the Minister this year, despite dire predictions of a shortfall by the ACCC. If it were triggered, and export restrictions were imposed, this would not necessarily translate to price relief for domestic consumers because like the Heads of Agreement, the ADGSM is a supply rather than a price mechanism.

(iii) The Retail Code: Default Market Offer

The retail market is an important contributor to consumer energy bills. Customers have always been able to access two different types of offers in the retail energy market: a standing offer and a market offer. The standing offer includes mandated consumer protections and is therefore usually more expensive than a more competitive market offer. Before 2019, most consumers were unaware of the difference. In 2018, the ACCC found that the National Electricity Market was not operating in the best interests of consumers and reform was needed. The Competition and Consumer (Industry Code – Electricity Retail) Regulations were introduced in 2019 and they do impose a price cap (called the default market offer) on standing offers and fair advertising of prices to consumers. This sets up a framework for the ACCC to monitor retail competition and ensure market participants are treated fairly.

The Retail Code binds energy retailers to the default market offer (‘DMO’) which is set by the Australian Energy Regulator. The price cap is assessed by evaluating the wholesale cost of energy to the retailer with the cost-of-living pressures for the consumer. For 2022-23, the price cap increases are: Victoria – 1% to 9%; NSW – 8.5% to 14.1%; SE QLD – 11.3% and SA – 7.2%. The code has been an important safeguard for energy pricing because it addresses anti-competitive pricing in the retail sector. Since its implementation, standing offers to consumers have been lower and there has been improved transparency and clarity in retail energy pricing.

What Should the Government Do Moving Forward?

(i) Domestic Reservation Policy: East Coast Market

To address rising wholesale energy prices the government needs to implement much stronger and more effective export controls and a legally binding price cap. Export controls should be in the form of a mandatory domestic reservation policy similar to that introduced in Western Australia. Unlike the Heads of Agreement and the ADGSM, a reservation policy requires all gas producers to keep 15 per cent of produced gas in the domestic market. This will gradually increase supply which will then have an impact on pricing. The domestic reservation policy has been in place in the Western Australian energy market since 2006 and has had great success. For example, in Western Australia, energy price rises are averaging $64 a megawatt-hour, whereas, on the east coast, the national electricity market has averaged four times higher at an extraordinary $284/MWh.

(ii) Address Rising Network Costs

Network costs refer to the distribution cost of getting energy to a consumer (e.g., via utility poles and power lines). These costs make up a significant portion of domestic energy bills. Extreme weather events which destroy infrastructures, such as fires and floods, also increase network costs. There are several steps that governments can take to address this. Expanding underground distribution networks would strengthen distribution utility and provide greater resilience. It is also important to ensure that investment is strategic and focused. There should not be over-investment in network assets that do not contribute to energy pricing. The ACCC has found that reforming how network assets are prioritised and funded is critical given our changing patterns of energy consumption, and the need to develop a fairer means of allocating network costs between consumers.

Conclusions

The government needs to address the escalating energy crisis by implementing mandatory export controls on gas producers and imposing mandatory price caps. The existing framework of untriggered mechanisms and non-binding commitments is unsatisfactory. Until renewables and storage are expanded, the price of wholesale gas will continue to play an important role in energy pricing. Renewables are expanding rapidly, and Australia is set to generate half of its electricity needs from renewable sources in three years. However, this expansion is not happening quickly enough to address the imminent pricing crisis. Gas is a public resource that attracts strong public interest responsibilities. Without strong government intervention, east coast consumers are likely to experience severe price increases in the coming 24 months that will exacerbate food and energy poverty and impact economic activity and inflation.