The great energy rip-off

| November 22, 2023

Monopoly electricity networks are exploiting flaws in the regulatory system to generate billions in extra profits well above the normal profits required to compensate shareholders, at the expense of households, businesses and the broader economy, according to a new report from the Institute for Energy Economics and Financial Analysis (IEEFA).

The report – Power prices can be fairer and more affordable – is a detailed analysis of the performance of the regulatory framework governing Australia’s electricity providers, carried out by consultant Simon Orme and the IEEFA team over more than a year.

The report shows networks have extracted more than $11 billion a year in supernormal profits since 2014, peaking in 2022 at $2 billion. In 2022 supernormal profits reached two and a half times the “normal” profit the Australian Energy Regulator (AER) considers necessary to compensate network shareholders for their investment.

Network prices are usually the second largest component of consumer power bills, and the supernormal network business profits are adding to these network prices.

“Families and businesses are already experiencing power bill shock from higher retail prices, and the persistent and large extra network profits are making this worse than necessary,” Mr Orme says. “The extra profits are reducing energy affordability and adding to economy-wide inflation.

The report finds consumer retail bills could be reduced by preventing these unnecessary wealth transfers from consumers to network shareholders. Depending on the network area, up to 70% of the retail price rises from 1 July 2023 could have been avoided.

The report accepts that some extra network profits (up to 1.3 times normal profits) are fair under a high-performance regulatory system. However, of the 162 profit outcomes examined, 64% exceeded 1.3 times the normal profit and therefore can be deemed as excessive supernormal profits.

Over the nine-year period from FY14-FY22, IEEFA estimates supernormal profits totalled $11 billion, on top of normal profits of $16 billion – meaning overall profits were on average 1.7 times the normal profit.

The AER does not appear to be addressing this issue despite significant evidence that network businesses are receiving much higher-than-expected returns on equity. Two major recent reviews concluded no significant changes to current regulatory systems are necessary.

The AER’s approach means large wealth transfers from power consumers to network shareholders are very likely to continue for the foreseeable future.

The IEEFA report shows the AER has so far not provided evidence that persistent extra profits of around 70% above the normal or “allowed” profits are necessary under the relevant laws and the AER’s corporate objective of ensuring that consumers pay no more than necessary for safe and reliable energy.

The IEEFA report shows that, according to the AER’s profitability and productivity data, the extra profits are not caused by unexpected improvements in network performance, inflation, changes in interest rates, “gold plating” by networks, or higher than expected payments to debtholders.

Instead, the report shows the extra profits mainly come from forecast network costs that are higher than actual costs – including financing costs, operational costs to keep the networks running and other costs. When there is a difference between the forecast and actual cost it is eventually pocketed by network shareholders.

“There has been a failure to correct these differences in forecast and actual costs once they become evident, leading to supernormal profits for network shareholders” Mr Orme says.

“Two major reviews published by the AER so far this year do not acknowledge the persistent and large extra profits and their implications.

“The AER has so far not provided evidence to show that the multi-billion-dollar extra network profits accumulated over nine years are a necessary outcome,” Mr Orme says.

“The extra profits substantially increase the costs to consumers of the energy transformation. This is because renewable energy and storage require large-scale investment in new network infrastructure. If the supernormal profits are baked in over the coming years, the new network investment will cost much more than necessary.

“Government action is needed to make power bills fairer and more affordable. This should begin with commissioning an expert advisory group to report on whether it considers the current profit outcomes are consistent with the current laws and policy support for the energy transformation.”

While structural solutions to excessive extra profits will take some time to design and implement, the report identifies some early wins that could be made to reduce the network part of power bills from July 2024.

“Some solutions could be made in time to come into effect from mid-2024,” Mr Orme says. “Without these changes, excessive supernormal profits will continue for the foreseeable future.”

Suggested improvements to the regulatory system include greater transparency on the size, persistence and bill impact of the extra profits. Improvements also need to be made to the governance of the AER, including independent evaluation of AER performance supported by clear definitions of where and by how much extra network profits are determined as reasonable.