Hi, I’m Thomas. I started working with Global-Roam on a contracting basis a few weeks ago. My main focus has been the completion of a detailed review of a large number of factors that drove the volatility in the Queensland region over summer (more on Watt Clarity about this soon).
While working at Global-Roam, I have read the posts here on Watt Clarity and decided to try one out for myself.
In a previous life, I worked for one of the largest retailers in Queensland, Ergon Energy. Here I got involved with review the tariff prices which are set by the Queensland Competition Authority (QCA).
As the QCA happens to be releasing the notified tariff prices later this month, I thought it opportune to write about how prices are set with a particular focus on the price of wholesale energy.
Tariffs are important as they directly set the price for 1.15 million small customers and 7,129 large customers (31 December 2011 numbers). The rest of the small customers are on market contracts and most of these will reference the tariff prices (usually as a discount to tariff) which means that they are still affected by how the tariff is set. At a minimum, small customers can require their current retailer to charge only tariff prices which means that it acts as a safety net for them.
Prior to 2007/08
The QCA wasn’t always involved in determining the price of retail electricity. It used to be the Minister for Mines and Energy until full retail contestability was started on 1 July 2007 when most of the retail load in Queensland was sold.
The last few years leading up to full retail contestability, the price of energy had increased in line with CPI but commencing in the financial year 2007/08 the increase would be based on actual energy costs. The QCA is asked by the Minister to recommend prices for the Minister to approve or reject. In the end, the Minister sets the price.
When they did their first determination, the QCA hired a consultant (CRA International) to create a way of calculating energy purchase cost. The electricity law at the time meant that they had to take into account the cost of building and operating power stations through the long run marginal cost (LRMC) of generation. The final price was determined as a premium to the LRMC based on market conditions and was very similar to what was done in New South Wales by the Independent Pricing and Regulatory Tribunal. They would calculate what the price would be in 2006/07 and estimate the 2007/08 costs. They would then take the percentage difference between these prices and add that to the current costs of tariffs. As the price was based on escalating the existing prices, this methodology was called the Benchmark Retail Cost Index (BRCI).
The 2007/08 process was largely repeated for 2008/09; however a legal challenge meant that the QCA had to re-do the calculation. The outcome was an increase in the energy purchase component of $5/MWh (about 10% higher).
For the 2009/10 determination, CRA used half hourly data to create a hedging strategy. This assumed that a retailer would hedge to the 80th percentile of its off-peak load with flat swaps, to the 90th percentile of its peak load with peak swaps and to 105% of its maximum load with caps each quarter. This hedge strategy is then calculated against a forecast of pool prices and tariff consumption. They find the hedge price by taking the last years’ prices from a forward curve.
2010/11 and 2011/12
This calculation was kept for both 2010/11 and 2011/12 but was now calculated by ACIL Tasman instead of CRA.
2012/13 (current determination)
The 2012/13 methodology was quite different again. The law changed so that each tariff should be calculated separately. The tariffs had to be calculated by adding up all the Network (N) components and the Retail (R) components. Because of this, the new methodology was called N+R. This would mean that the QCA would calculate what each tariff should cost, not just what the increase in the tariff should be.
For the first year, the QCA was asked by the Minister of Energy and Water Utilities not to set a price for the main residential tariff (Tariff 11) as the Government wanted to freeze the tariff (except for the impact of carbon).
There were a number of other changes as well. The price would be calculated as the price a representative retailer would need to charge. This representative retailer was defined as not owning generation which meant that the price was set without reference to LRMC. In the past, it had been assumed that the retailer would contract at the closing day prices however the forward component would now be calculated as the volume weighted average cost of all trades recorded on d-cypha. The Retail Margin (an allowable amount in the tariffs for risk and profit) was increased from 5% to 5.7% and a new margin was added at 5% of the total cost (including the retail margin) which could be competed away.
The change to N+R came at a time when no large businesses (consuming over 100 MWh/year) were eligible for tariff prices in the Energex area. All large tariff customers were therefore in the Ergon distribution area. The QCA decided that they should pay Ergon distribution charges which meant more than doubling the prices for some businesses. The QCA decided this was too much so they created transitional tariffs which increased the current business tariffs by 10 or 20% (depending on tariffs) to allow the businesses time to transition to the new prices.
2013/14 (upcoming determination)
The 2013/14 determination will be out on 31 May 2013 and it will be interesting to see what it holds. For the eager reader who can’t wait for more information, there is a draft determination and a large amount of submissions available on the QCA website.
About the Author.
Thomas Dargue has worked with both private and publicly owned generators as well as for Ergon Energy over the last seven years.