Take government out of the electricity market

Prime Minister Malcolm Turnbull is right to envision Australia as an agile, innovative and creative nation.

It's possibly also all right for the government to provide some feel-good industry support as part of Mr Turnbull's "ideas boom". But not if it means sacrificing good, old-fashioned micro-economic reform, the thankless task of ridding the economy of inefficiencies.

A case in point is the National Electricity Market. After two decades of steady reform, the traditional NEM supply chain – large-scale generation, networks and retailers – is facing a phase of rapid change, bringing unbridled risk and complexity.

Advances in solar and battery-storage technology afford consumers exceptional control over the production and delivery of their energy needs. An evolving market of innovative products and services has sprung up around high-tech metering. This supra-NEM is both a user and opportunistic competitor, with the viability of household generation and clever business models underwritten by the bricks-and-mortar industry.

In short, the NEM is no place for ministers and risk-averse public servants. Yet governments still play a big role, not so much via asset ownership but through the Council of Australian Governments Energy Council and the three institutions it oversees.

The Australian Energy Market Commission makes the NEM rules and advises the Energy Council. The Australian Energy Market Operator is the independent system and market operator. Then there is the Australian Energy Regulator, which enforces the rules and regulates access to networks, taking a view on what is justified commercially in areas such as reliability of supply, service enhancements and investment in new capacity. 

The AEMC and AER are government agencies, while AEMO is a not-for-profit with 60 per cent public ownership.

So, why does electricity warrant such special treatment? The standard response – it is an essential service with monopolistic elements – does not stand up to scrutiny.

Why attempt to protect users when they are now running the show? As Andrew Reeves, former AER chairman, observed recently: "Consumers' decisions on self-generation, storage, sharing and use will force suppliers, including monopoly services, to be responsive to demand."

Anachronistic government involvement in the NEM is the result of a lack of vision, combined with a big dose of self-interest. While the industry was rightly broken up and regulated in the 1990s, those doing the reforming never contemplated the possibility the NEM would one day face a viable competitor. The AEMC and state departments worked diligently to develop the market, but forgot to prepare government itself for the radical implications of serious consumer empowerment.

The upshot: NEM agility and inventiveness is severely hamstrung by officialdom, so much so the industry risks being cannibalised by its customers. The core problem is network regulation, a contrived process divorced from market reality.

While generators and retailers scramble to respond to step-changes in technology and daily shifts in consumer sentiment, distribution and transmission companies get the luxury of locking in five forward years of regulated revenue. Rather than relate and share risk with those who actually produce and sell NEM electricity, networks deliver transport capacity consistent with forecast models and incentive mechanisms calibrated against the "public interest", as determined by the AER.

If Australia is to have a viable and efficient NEM, one that coexists in competitive equilibrium with the supra-NEM, the supply chain must work together to offer the best overall service and price. There is now an incentive for this to happen. But it won't while large commercial risks are controlled by government third parties with no skin in the game.

Take history out of the equation, and there is no way NEM participants or a rational federal government would choose the current set-up – it's inefficient, plain and simple. This truth continues to be ignored because the existing bodies, along with the multitude of legal, economic and technical consultancies that feed at the bureaucratic trough, have a vested interest in the status quo. And consumers pay for it.

Without fearless advice, the Energy Council remains conservative, resorting to meaningless rhetoric, such as a commitment to "modernise regulatory frameworks and consumer protections so consumers can engage with increasingly dynamic and decentralised energy markets driven by the need to accommodate emerging technologies".

There is only one feasible response to the financial and technical risks engulfing the NEM: committed co-operation that is flexible enough to capture the qualitative aspects of supply chain efficiency. This means removing the government from its over-bearing role to establish lean and mean commercial arrangements based on a shared industry imperative to survive.

Such micro-economic reform might not be sexy or easy, but it is necessary if Australia is to have an agile and innovative electricity sector.