Answers to the Tough Questions

Minister James Hacker: Will you give me a straight answer to a straight question?
Sir Humphrey Appleby: Oh well, Minister, as long as you are not asking me to resort to crude generalisations and vulgar simplifications such as a simple yes or no, I shall do my utmost to oblige.
- Yes Minister (1980)

Community values candour and perceives that an important reason for the low uptake by customers of electricity supply by private retailers is the inability to 'get a straight answer to a straight question'; if the wholesale market is working, why do some politicians say that it isn't, and why don't the regulatory authorities publicise it and how to use it?

In the following Q&A, we attempt to answer the tough questions that all customers should be asking. Please understand that the market authorities themselves would need to form a committee to answer some of the questions, but we try to answer them from our honed-intuition born of years of experience and attendance at many of the committees that both formed the market and now oversee its operation and development. On that basis, our responses are given in good faith to achieve our goal of helping the community participate in the electricity market created to serve them, whether it be via our services or via the several long established private retailers competing for their business. Please remember to read the 'fine print' of any supply contract you enter into. We trust that this will be informative, and possibly even, for our fellow nerds, entertaining; enjoy......

Contents

 

Is supply by a private retailer really safe? Is there any chance that I will be discriminated against by the network operator? Will my electricity supply be of the proper quality and reliability? Would a new supplier have to dig up the street and install new cables?

Supply by a private retailer is safe, there is no chance you will be discriminated against, your supply will be exactly the same as previously - neither better nor worse - and exactly the same 'poles and wires' will be used to deliver it. Please see our sworn Affidavit Attesting the Fitness-for-Purpose of Electricity Supplied - which applies to supply by all retailers - and the description of how the wholesale market works.

Why are you providing all this free information?

One of Community's goals is to provide a service to the community to help contestable consumers lower their electricity costs through participation in the electricity market created to serve them; it's that simple. If you are interested, please see our values and beliefs for more information - this isn't the usual bunch of corporate 'PR'; we are a family enterprise and this is how we live and bring up our children.

You provide a lot of information for free; are you receiving any financial benefits to do this, either from government or from Market Participants?

No, we're entirely self-funded. The information is provided as a community service, to objectively help contestable customers reduce their cost of electricity by making use of the institutions created for them - including arms-length 3rd party retailers with whom we have no commercial relationship or from whom we receive no financial benefit. That said, we do have consulting relationships with several retailers, but these expressly exclude customer acquisition - and we don't receive any kind of payment for advertising, referrals or website links. Our responses here, and our website as a whole, is a reflection of our values, beliefs and goals.

If you have consulting relationships with other retailers, isn't there a conflict of interest?

We understand that at first sight there might seem to be, but when you take into account that electricity retail is an information-age virtual activity then it all boils down to risk models and margin selection; one of the themes of our commercial model is that electricity retail is, like electricity itself, a commodity. Community has a collaborative ethos and provides advice to other retailers on how to model risk and return, but it is up to them to decide what returns to seek and to which customers they will offer supply. If two retailers using the same model are competing for the same customer, the outcome will largely be determined by the 'margin figure' they enter into the model. For clarity, Community does not offer this style of retail product. While it is true that Community in effect 'competes' with other retailers by offering an alternative to the traditional model, the market for our model is specialist and limited - and for the right buyer with the optimal mindset, very difficult to beat.

Why do you charge a fee for an electricity supply proposal when other (traditional) retailers provide them for free?

We can understand that this is, at first sight, how it appears, but actually, you do pay for the supply proposal that you accept, plus you pay 'your share' of the cost of all the proposals that the retailer made to other customers that declined them. Put another way, there is a genuine cost associated with developing a sales proposal and retailers have to recover it. Many retailers do so by allocating it to an overhead which they spread across their customer portfolio. So, if you accept the offer, you pay a price that contributes to the overheads. And if you don't accept it, you accept an alternative, only to have the process repeat with that retailer. Community seeks to keep charges transparent and cost-reflective, so we charge a fee for development of a Cost-of-Supply Assessment and also for the Supply Proposal itself. And it gets better.... if you accept the proposal, we refund 100% of the fees as an offset against the management service fee applied in respect of the electricity supply. So, actually, in contrast to the traditional model, customers that switch to us get free proposals, and those who don't, in reality have to pay for them. We even take this to its logical conclusion, which is to offer proposal development to other retailers on an outsourcing basis.

There is also another dimension to this; the information provided by Community is an objective assessment of the customers' situation, whereas a free proposal from a retailer is a statement of the supplier's terms of supply. It's like the joke about two men being stalked by a tiger and one starts putting on his running shoes. The other man says, 'Don't be silly, you can't outrun a tiger!' To which, the first man replies, "I don't have to; I just have to outrun you." So it is with retailers; they just have to underprice each other, rather than achieve minimum price. On this basis, you need to remain alert to all the contractual details and not just the 'headline' figures. In particular, you need to take care in whether and how your retailer passes through to you the costs of any repeat of the 'Varanus Island experience' - if this applies, it is usually in the contractual 'boilerplate', which you should make sure you understand. Oftentimes, it might entitle the retailer to require you to 'curtail' consumption (cease consuming). While this isn't of itself unreasonable, perhaps it denies the customer the opportunity to understand its exposure to power system contingencies, and how it might mitigate them operationally as they will inevitably occur from time to time.

Okay, so maybe it's fair to charge a fee, but why are your charges so high?

We base our charges on the fee levels charged by accountants and similar professionals; in our experience, we offer, for example, a detailed cost of supply forecast, inclusive of the proprietary knowledge contained in our analytical model, for the same price you would pay an accountant to lodge a straightforward quarterly BAS statement. More relevantly, we also take this concept to its logical conclusion, which is to offer as an outsource service to other retailers supply assessment and proposal development. From that point of view, if a new entrant retailer wanted to establish a sales proposal function, it would have to employ and accommodate a full time professional at a cost of at least $15,000 per year. Net of holiday entitlements, training and the necessary corporate 'time-wasting', our charge equates to around 1 proposal per working day inclusive of developing the system.

On top of that, there's also the 'value' approach - a $100,000 per year customer that is currently on a regulated retail tariff might reasonably expect to save around $20,000 per year by switching to private supply. It is very common for customers to pay consultants around 20% of the annual savings to organise a tender on their behalf - worth around $4,000 in this case. In comparison, we charge $1,000 for a DIY tender manual that will give you insights that a consultant doesn't possess, usually not having worked on the 'other side of the fence' as a retailer. The economics become even more attractive for larger loads.

And all that said, how much money have you failed to save over the past several years by not knowing this information?

Are you saying that the Cost of Supply Indicator tells me how much my electricity would cost if I switched to supply by Community Electricity?

No, absolutely not. First, WEMCOSI is an indicator of the cost of electricity for 'standard consumption profiles' typical of each of the nominated combinations of regulated network and retail tariffs, and your load is very likely to be different from these. Second, the charge you would incur is very sensitive to the capacity charge, which is complex and varies greatly between similar loads according to how much they consume during the power system peaks. This is why WEMCOSI has such a large range of prices.

Community Electricity offers a Cost of Supply Product that uses your historical data to determine the historical cost of supply and forecast it over the coming three years. This is the base cost of your supply, to which you must then add the retailer's additional charges. Purchase of this product is a prerequisite for purchasing from Community a supply proposal which will also provide you with an assessment of your exposure to the 'Varanus Island experience' and how you can mitigate it. Often a traditional retailer offering will include such mitigation.

The Cost of Supply Indicator suggests that significant price reductions can be achieved by taking supply directly from the wholesale market; are you saying that other retailers are overcharging?

No, absolutely not. First, we believe there is genuine competition for contestable customers among several well established and capable retailers, who offer keen prices that are, depending on the capacity charge, lower than the regulated retail tariffs. Second, it is important to understand that the Headroom calculations are expressed relative to the regulated retail tariffs, which are published - private retailer tariffs are not. Third, the state government deliberately builds into regulated tariffs applying to contestable customers a headroom so as to encourage them to leave the regulated tariff and accept a contract tariff, which would often be with Synergy itself.

The primary message of the WEMCOSI is that if you have chosen to remain on a regulated tariff (or more likely, if you never made any decision at all because you didn't know you had a choice) then, depending on your capacity charge, you may well be paying more than a private retailer (or Synergy itself via a contract price) would charge for the same supply.

Another important difference is that the WEMCOSI price involves exposure to energy price volatility, which in the past has been considerable at times of system stress and fuel shortages. Depending on the 'fine print' of the supply contract, the retailer might protect you from that. Traditional retailing is largely an issue of assessing energy price risk and choosing a purchasing strategy and a retail margin that protects the seller from it. If a retailer wishes to win more tenders, it can generally do so by lowering its margins or by buying more electricity from the wholesale market (and thereby taking on more risk).

What happens to your electricity customers if you go broke?

Any such business failure would most likely occur progressively, for example, if income is less than outgoings and exhausts the start-up capital. In Community's case, we pass-through to customers all the market costs, so we bear no risk in that respect. We do, however, incur costs that are not passed through to customers, such as regulatory expenses. We modelled several scenarios in our business plan which we submitted to the ERA as part of our application for our electricity retail licence. The most adverse scenario is that of low customer take-up, which triggers regulatory expenses without generating the income to fund them. Our analysis demonstrates that the enterprise would survive for several years in this scenario even if there was no income from consulting activities. We could, of course, extend that by investing more capital. If such a scenario was to unfold, we would have control of it and it would develop in an orderly fashion, with the decision being taken at some point to cease offering electricity supply. If that was to happen, customers would receive our apologies and be given several months notice and our assistance to find another retailer.

What happens if the "Varanus Island experience" repeats?

The Varanus Island experience resulted in very high wholesale electricity market energy prices for a few months. While the actual cause of the high prices might change from time to time along with their duration, the fact of occasional very high prices is a certainty, as they occur almost monthly for short durations. They also routinely occur during extreme weather, which may either increase electrical demand, damage power lines upon which generators depend, or restrict fuel supplies when gas production platforms have to be shut down. Indeed, to some extent, it is important that extreme prices should occur as they are one important 'price signal' to developers that another power station needs to be built.

All that said, it should be noted that even a multi-month crisis occurs only one day at a time, and once the initial shock is understood, its evolution and the necessary remedy is predictable. It should also be noted that if Community's customers don't like the prognosis at that time, they are not locked-in contractually and are free to transfer to another retailer (albeit, a retailer that might well take advantage of the situation by charging higher prices.) Community's product provides for customers to pre-pay for electricity and at any one time we would have on hand reserves in respect of each customer. The sudden contingency would simply mean that those reserves would be depleted more quickly than during normal circumstances - and customers would be notified of any need to pre-pay earlier than expected or more than expected. While that would, depending on the extent of the contingency, be a reason for switching to a traditional retailer, from the long term financial perspective, the proposition is that the 'losses' would offset the 'gains' and potentially still leave a significant net benefit. Customers should also consider the 'fine print' of the new retailer's supply agreement to ensure that they would be obtaining the protection they seek.

What happens to your electricity customers if for some reason a sudden and unexpected business failure occurs?

The sudden business failure scenario and its regulatory consequences are harder to envisage because it has never happened previously and the robustness of the regulations hasn't been demonstrated in that regard - partly because of the complexity and diversity of the potential scenarios combined with their low probability of occurrence. We perceive that the regulations provide the broad powers required by the authorities to manage such an event while leaving them with sufficient discretion to react in real-time to the prevailing circumstances. In general terms, should a retailer suffer a business failure, it is our intuitive understanding that the defaulting retailer would be suspended from the wholesale market, its electricity retail licence would be revoked, the Supplier of Last Resort Regulations would be triggered, and all of that retailer's customers would be transferred to supply by, we assume, Synergy. In the event of the wholesale market (IMO) suffering a financial loss as a result of such a default, the losses would be allocated across the entire market as a levy on energy.

While this would protect the physical supply of the customers, and they wouldn't suffer an interruption, it would be much harder to untangle the associated contractual obligations and establish the rights and obligations of both the defaulting retailer and the Supplier of Last Resort, and who owes how much to whom. That said, there would be plenty of time for the authorities to resolve the matter because the wholesale market is settled at least 6 weeks in arrears and many decisions could be implemented retrospectively before initial invoices are issued. The starting point for negotiations around this would be, we intuit, that customer contracts would be deemed to be cancelled at the time that the customers were transferred to the Supplier of Last Resort and from that point the applicable regulated retail tariff would apply with customers having the right of anytime termination. We would expect that the customers would then be given a reasonable time in which to establish a supply contract with a retailer of their choice, or default to Synergy's offered contract terms.

Again, we would emphasise that this response is our good-faith intuitive perception of what would happen. We are sure that only Western Power can disconnect customers, and for that to happen someone - a bureaucrat with the opportunity to suddenly become very visible - has to issue the order in the face of the potential political consequences of disconnecting customers in good standing - it would be much easier for "Sir Humphrey" to instead dump the costs onto either the wholesale market or the Supplier of Last Resort as the case may be.

In closing this response, we would reiterate that even severe crises unfold only one day at a time and their consequences can be anticipated and forecast. The IMO calculates the retailers' net prudential position every day, and both the retailer and the IMO itself should 'see it coming'. In the ideal case, the 'sudden business failure' would be resolved before it occurred and at the very least discussions ought to be in progress before it occurs and customers given fair notice and opportunity to respond.

What is the absolute worst case that customers should be aware of?

The "worst case scenario" is probably actually quite subtle; a customer leaves a regulated retail tariff to accept a 'teaser price' from a retailer, only to subsequently have it's price increased beyond the regulated tariff and have Synergy deny return to it on the grounds of a high cost of supply. In this scenario, the customer will suffer cost increases until it manages its cost of supply, which could takes years and the financial loss could exceed the cost of a temporary "Varanus Island" style blow out.

In terms of a 'high profile' worst case, customers need to be aware primarily of the possibility of prolonged high energy prices on the wholesale market and the extent to which they will be passed through to them by their retailer. Such pass-through can occur either expressly according to the terms of the supply agreement (as is the case with Community's product) or via the retailer invoking the 'fine print' of the supply contract during system contingencies.

The wholesale market flags problems via the energy price, which can increase substantially - typically from around 5 to 10c/kWh to around the non-liquid 'price caps' of 30c/kWh, though potentially to the liquid price caps which have been as high as 70c/kWh (40c/kWh at end 2015). The wholesale market is central to the supply of electricity and it is set up to manage the complexity and diversity of a myriad of interacting businesses each with their own technologies, objectives and concerns. For it to perform well, the market requires sufficient generating plant of the right type, sufficient fuel to run the generators as needed, an electricity network to transport the electricity from where it is produced to where it is consumed, and reasonably accurate forecasts of how much electricity is needed and when. Problems occur whenever these needs aren't met. For example, weather storms can damage the electricity network and cause customers to lose supply and generators to shut down. Fuel shortages, and in particular gas shortages, can cause gas-fired plant to shut down or instead to switch to more expensive and dirty diesel fuel. Power stations can suffer prolonged maintenance problems, or be commissioned late due to construction or financing problems. Inaccurate load forecasts can require high-cost 'fast start' generators to be switched on for short periods, or low-cost 'slow start' (usually coal-fired) generators to switch off. Where wind farms are producing especially erratically, coal plants can be turned down, only to have a fast-start turbine switch on an hour later.

The market frequently experiences price excursions for short periods, mainly due to power stations tripping and load (wind) forecasting errors. Maintenance of the low-cost power stations, and primarily the large coal units, can also elevate prices for weeks at a time, though usually only at worst doubling the time for which the price is around 10c/kWh. Extremes of temperature can also cause high-price stations to be switched on, and this typically happens for several hours on very hot days in summer and very cold days in winter.

The most credible worst-case is a repeat of the Varanus Island experience, though it should be noted that this was actually a double-contingency event that occurred during very cold weather; in addition to suffering a shortage of gas fuel, the largest coal plant on the system (330MW) suffered a several week maintenance problem.

In closing this response, it should be noted that customer rights and obligations under formally declared 'System Emergencies' remain the same now as they were prior to deregulation of the industry - for example, should major storms damage the network, customers lose supply and those with supply can be ordered by System Management - under penalty of fines - to minimise consumption. This remains true regardless of your supplier and there isn't anything anyone can do about without investing more in the power system.

Community's electricity product entails disconnecting the customer quickly in the event of non-payment, when you admit that other retailers would probably allow some time to pay; isn't that unreasonably harsh?

We agree that at first sight that's how it seems, but you need to take into account that if we default on payment of our (meaning your) obligations to the IMO because you defaulted on your obligations to us, the IMO will act very swiftly to suspend us from the market - and by extension all the customers supplied by us. We regard responsibility for a customer's electricity supply as a special trust and having been invested with that duty we won't allow default by another customer to interfere with any other customer's supply. In addition, our fees are so low there's no fat in them to absorb any customer mischief and Western Power, properly, requires due diligence before disconnecting; that's why we act quickly to get the process started. In all candour, we prefer not to supply customers for whom this might be an issue because any unhappy customer is bad for business, even if the reason they are unhappy is of their own making - by defaulting on a reasonable contractual obligation - and we responded exactly as we said we would in the Electricity Supply Agreement. Equally, we would ask you, how would you feel if something happened to your supply despite being in good standing because we failed to disconnect another customer that had defaulted?

Given that the Wholesale Electricity Market is so important, has it been 'stress-tested'?

Yes it has - and in particular by the Varanus Island experience during which no customer lost electricity supply and though market participants suffered financial distress, they all remained in good standing with the IMO. It is a little-known fact that during this incident, which lasted 3 months, a diesel-fuel tanker was diverted from Singapore to replenish diesel fuel stocks and arrived when stocks had fallen to only a few hours normal operation.

More recently, the market routinely rode through the 'baby Varanus' experience of summer 2011 when Cyclone Carlos caused the orderly shutdown of the gas processing plant at Varanus Island for a week and simultaneously brought extreme weather to Perth. Prices approximately 'doubled' during this time, but the public scarcely noticed. Prices also doubled for a few weeks during the winter of 2011, when 800MW of coal-fired stations simultaneously performed maintenance. This was investigated by the IMO and the ERA, but found to be an outworking of normal market operation. Nonetheless, the issue has featured in ongoing deliberations on how to improve the market.

The market has also been unaffected by Griffin Energy, which supplied 15% of the market's energy, being placed into receivership three years ago as a result of defaulting on a bond payment to investors. In part, the default was caused by Griffin having incurred market 'penalties' due to being late to commission its Bluewaters 1 power station. This also exposed the market to a potential capacity shortfall in response to which the IMO tendered for extremely expensive 'Supplementary Reserve Capacity' but in the event didn’t use it.

While Griffin and its successors remained in good standing with the IMO, the power station developer WA Biomass defaulted in delivering a 40MW power station, which it subsequently cancelled. This default triggered the IMO market levy provisions, which proved to be more of an inconvenience to market participants rather than materially significant.

More generally, the IMO calculates on a daily basis for each Market Participant the balance of the participant's net liabilities versus its prudential support, and the IMO has the power to make a 24 hour margin call for top-ups as required. In the event of the participant failing to meet the call, the IMO can suspend it from the market within a few days.

What happens if your principal gets 'hit by a bus'?

Steve's role has been primarily to set up the commercial system and quality procedures, and in the future he will be overseeing performance standards and developing new business and products. The 'business as usual' operation mainly involves operating the IMO and Western Power web portals, populating analytical models with data, issuing invoices to customers and paying the invoices of suppliers. Stuart and Gina can run the daily operation without Steve, and the operation would trundle on without intervention as long as the IMO and Western Power are paid on time. That said, we do have a key-man risk management policy that provides for continuity of the enterprise should the bus win the encounter. This policy was provided to the ERA as part of our licence application. The details of this depend on the circumstances, but in the worst case, the enterprise would either be sold to another operator or would be closed in an orderly fashion, giving customers plenty of time to find another retailer.

What stops traditional retailers from competing with Community Electricity and offering the same style of electricity product?

Absolutely nothing. In fact, most retailers do offer a partial pass-through product, in which all costs are itemised and passed-through except for energy, which is expressed as peak and off peak prices. In this case, the retailers' margin and costs are included in the energy prices. These energy prices can be indicatively compared with those published in the WEMCOSI, but please note that it is necessary to use average prices across a complete year to ensure that seasonality is captured, and ideally over a few years to ensure that a system contingency is also captured. It should also be noted that the WEMCOSI prices depend on the load profile of each of the tariff styles, although there isn't significant variation between them. The development of pass-through tariffs has now become widespread and is largely a response to the fact that the wholesale market has caused the cost components to be transparently unbundled and has highlighted the fact that there isn't much retailers can do to influence them (with the possible exception of the Capacity Charge). Community's electricity product extends this unbundling process into the retailers' internal costs as well, including the cost of retail operations, its profit margin, its cost of capital and its 'hedging' costs - the latter being a defacto insurance against energy price volatility. While all retailers can, in principle, compete with us on this basis, this path logically leads to competition on the basis of only the cost of retail services - in which we expect to be the lowest cost operator because we are a self-contained family enterprise with no external bankers or investors to service and a sound track record. In addition, many retailers have existing long term offtake agreements for which they have paid a premium over the volatile spot price and need to place this with customers in order to avoid the 'haemorrhage'.

Community permits a customer to terminate its electricity supply agreement at anytime without notice. How does that work, and why don’t traditional retailers offer that?

In order for a customer to be supplied by a particular retailer, the incoming retailer must instruct Western Power to allocate to its account the customer’s unique meter identifier. On receiving such an instruction in respect of a contestable load, Western Power will accept it at face value and implement it. The important thing for Community is that once the transfer to a new retailer is made, Community stops incurring the costs of supply and so doesn’t incur any ‘losses’. The situation is often different for a traditional retailer for two main reasons. First, the retailer may have offered a tariff price that is fixed as an average across the year, while the supply costs incurred by the retailer are seasonal – so the retailer needs a complete year in order to recover its costs plus a margin. Second, the retailer may have bought bulk power from a generator with the intention of passing that on to the customer. In this case, if the customer ends the supply, the retailer has surplus energy that it must ‘spill’ to the market at, possibly, a lower price than it paid. A third reason is that the traditional retailer may have incurred significant administration costs in negotiating the contract, and may need sufficient time to recover those costs.

What’s your view on whether solar PV owners should “pay more”?

We believe it’s the wrong question. We believe that consumers should pay for the network services that they consume and, therefore, insofar as consumers with PV consume more of the service they should pay their way. So, on the face of it, yes, you might say that we do think they should “pay more”.  However, we also think that:

  • consumers should be provided with cost reflective tariffs with sufficient signals so that they are informed of how much they are costing, the desired behaviour and how they might reduce their costs; and
  • the network charges should be based on what it costs to run the network and service the capital invested in it – it shouldn’t be used as a backdoor tax;
  • the network services should be kept fit for purpose with no unnecessary adjuncts. In this respect, we consider that networks should be anticipating the future and preparing for that, rather than shoe horning the future into their existing operation.

Let us elaborate the ‘backdoor tax’. In respect of electricity costs, government can pay them in one of two ways – either via the tax base (such as transfer duty on house purchases) or via charges levied on electricity consumers. The “cost” of the network is basically the cost of running it plus the cost of servicing the capital (interest and principal). However, government actually charges “what it’s worth to an investor” (via the weighted average cost of capital) and receives the difference as a “dividend” from Western Power, which goes to the Treasury in the same way as a tax.