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Bite size reckons from the RBP team.

2018-10-31

Retail spot pricing: what goes up must come down (and go up, and back down, and back up again etc.)

It is a well-known fact amongst New Zealand energy professionals that low hydro lake levels are bad news for consumers in New Zealand’s wholesale electricity market. The effective capacity of our hydro generators goes down, and prices become higher and more volatile, as more expensive fossil-fuel plants come online to make up the shortfall. Typically, lower lake levels can be partially offset by the use of gas peakers (which can be brought on and offline quickly to match peak demand); however, this spring pipeline issues have reduced production of the Pohokura gas field, further exacerbating things.

To what degree these facts about the wholesale market have been internalised by the average NZ retail consumer is debateable, given that the overwhelming majority of these consumers are on fixed-price contracts which protect them from volatility in the wholesale market. However, recent entrants to the retail market such as Flick and Paua to the People have offered customers the ability to buy power at wholesale market prices – plus a retailer’s fee. This has worked well for many customers, giving them the ability to respond to peak changes in price, as well as enjoying generally lower off-peak prices. However, with the recent increase in wholesale prices, many customers have been shocked to face extremely high bills for a sustained period of time, with the furore in one Facebook group spreading to the media.

Long-Term Price Risk: Unclear?

Energy professionals have been slightly flummoxed by this reaction. To someone familiar with the whims of the wholesale market, consumers’ anger in relation to market conditions (which spot price retailers have nothing to do with!) seems misplaced. However, I would argue that the risks associated with spot price plans have been understated by retailers and websites like Powerswitch. These warnings have been confined to advice about short-term increases, and have not addressed consumer understanding of long-term risks such as dry years and contingency events.

For example, the Powerswitch website was designed to make switching to the cheapest plan as simple as possible, in order to reduce decision fatigue. When choosing Flick or another spot price option, there is a switch warning which states: “A wholesale spot-price plan can bring significant savings but may also expose you to short-term higher prices which will flow through to your bill”. However, short-term price risk is only one of many risks in the wholesale market: hydro dry years, contingency events, HVDC outages are some examples. Such risks can significantly push up price over a long time period. Large retailers are able to hedge these risks by using a team of financial experts and engineers; individual consumers, however, cannot, and may not have even been aware that these risks exist.

Lessons For The Future

Websites like Powerswitch provide a useful service to consumers, allowing them to consider all the options for their power needs and increasing competition in the retail market. However, the underlying risk profile of a fixed-price contract compared to a spot market plan has not been expressed in clear enough terms. Whilst some attempt has been made to explain the short-term volatility difference, more needs to be done to explain to consumers all of the risks involved in the spot market and that fixed-price providers don’t just provide electricity; they provide insurance against these risks. 

New Zealand spot price customers have learnt this lesson the hard way. It is likely that post-November as the spot prices comes down we will see risk-tolerant consumers move back to the spot price plans, whilst their risk-averse counterparts remain in the relative warmth and shelter of a fixed-price plan. However, there are still some things that should be done on the business end in order to make sure consumers are fully aware of these risks. Firstly, whenever spot price plans are being presented for comparison with fixed-price plans, they should be clearly presented as being of a different kind, or in a different category. The two are too much of an apples-to-oranges comparison to be presented together without being misleading. Secondly, any retailer offering a spot price plan should have a prominent disclaimer of these long-term risks on their pages (similar to a financial product disclosure). These two measures, combined with the painful memory of the current spot price, should go a long way towards making sure that New Zealanders choose an electricity plan with a risk profile that suits their real risk appetite.

logan - 10:51 @ retail, pricing | Add a comment

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