Are energy retailers’ profits really higher in Victoria than in other states?
Much has been written recently about high profits made by energy retailers, particularly in Victoria, by Grattan, ESC and AEMC. But how robust is the analysis underpinning these claims?
Deriving the retailers’ profits
The retailers’ ‘profit’ is commonly derived by deducting the estimated energy costs, network costs, retailer costs and environmental costs from the total retail price.
However, the methodology is inherently imprecise – the ‘profit’ will be high if the total retail price is overstated or if the component costs are understated.
A range of retail prices exists in Victoria. Prices vary depending on the retailer, distribution area, and type of offer.
Customers can choose market offers. If not, they default to a standing offer.
In Victoria, standing offers typically have much higher prices than market offers so a retailer’s calculated ‘profit’ based on standing offers will appear much higher. However, the AEMC has found that only 9 per cent of customers are on standing offers , so this type of analysis is flawed.
Market offers also vary widely. Grattan concluded that ‘margins’ were 11.4 percentage points higher for the incumbent retailer’s market offer than for the best option. This means that there are some customers who pay more than they need for electricity, but not that all retailers earn those 11.4 percentage points.
Retailers have many costs, but the only component that can be estimated with any certainty is network costs, which are regulated. However, metering costs are sometimes inadvertently excluded, so ‘margins’ are again overstated.
Wholesale prices are forecast to set retail prices. However, actual wholesale prices will inevitably vary from forecast based on weather, availability of plant etc. Any sensible analysis of retail margins needs to consider the wholesale prices as forecast when retail prices were set, not with the benefit of hindsight.
Grattan assumed a $15 per MWh premium to the time weighted price in calculating the wholesale cost to retailers, based on our modelling for Queensland. However, our modelling indicates that the ‘uplift’ for small customers in Queensland is $24 per MWh , so Grattan’s ‘margin’ could be overstated.
Grattan assumed a “cost to acquire, serve and maintain customers” that is the “highest cost observed across … Origin and AGL” and relevant pricing determinations in NSW, SA and Qld (notably not Victoria). Grattan assumes that the retailer costs are the same in each jurisdiction.
In 2016, we benchmarked retail electricity costs and margins for the QCA. Our analysis indicated that retailer costs don’t depend on retailer size and are similar across states, except Victoria. The retailer costs in Victoria were around $40 per customer per annum higher than in other states. This is due to:
- Victoria’s higher churn rate, which increases cost to acquire and retain customers
- higher costs of processing smart metering data used in Victoria
- potentially higher costs for the Victorian-only retail regulatory regime.
The problem with some analysis of retailer ‘margins’ is that it doesn’t acknowledge the potential differences in these type of costs. This means that any cost not explicitly considered shows up in the margin and Victorian retailers may appear to be earning more than they actually are.
 AEMC, 2016 Residential Electricity Price Trends, Final Report, 14 December 206, page xix
 Grattan, Price Shock. Is the retail electricity market failing consumers?, March 2017, page 36
 Difference between hedged price and time weighted spot price. Modelling data available at http://www.qca.org.au/Electricity/Regional-consumers/Reg-Electricity-Prices/Final-Report/Regulated-Electricity-Prices-2016-17#finalpos
 Grattan, Price Shock. Is the retail electricity market failing consumers?, March 2017, page 35
 ACIL Allen, Regulated Retail Prices for 2016-17, Estimating the Efficient Retailer Costs, 13 May 2016