Electricity prices – to mandate or not to mandate
The Electricity Authority in its recent consultation paper: Supporting reform to efficient distribution pricing: a refreshed Distribution Pricing Practice Note discusses reform of distribution prices as a priority for the Authority. A key issue that arises is: should retailers be obliged to directly pass on the structure of distribution prices to consumers?
TDB Advisory Ltd (TDB) was asked by the Electricity Retailers’ Association of New Zealand (ERANZ) to investigate the case for retailers being obliged to directly reflect the structure of distribution prices in their retail prices. Our report investigates:
- the characteristics of the New Zealand electricity market;
- commercial perspectives on retail pricing including market segmentation, price discrimination and the role of technology; and
- public policy perspectives on government intervention in electricity retail pricing.
Our analysis finds that efficient pricing in a competitive market like electricity retailing does not require government-mandated pass-through to end consumers of distribution prices. Indeed the imposition of variable pricing on all electricity customers would potentially come at a net welfare cost for society. Some customers, for example, are likely to be willing to pay a price premium in order to have continuous access to electricity at a fixed price. Other customers will potentially be responsive to the cost savings that variable pricing systems can offer. Our report noted that prices are a two-way signal, and that the transmission of information from consumers to suppliers about their preferences is equally as important as the transmission of information from suppliers to consumers about suppliers’ costs. Security of supply is a genuine demand of electricity customers, and this demand provides a legitimate price signal back to the electricity market to encourage innovation and/or an expansion of capacity.
Sufficient market response can come from the proportion of the retail market that is most willing to respond to cost-based price signals without requiring the price signals to be conveyed directly to all consumers. Allowing competitive pressures in the retail sector to reveal who this group is, is likely to be more effective than mandated approaches, and is likely to result in higher net benefits accruing to consumers over time.