COVID-19 pandemic: impact on the retail energy market

While the COVID-19 pandemic is not yet over, it is already clear that it has had a significant impact on energy markets, with the worse potentially to come.

Because most small consumers pay bills three months in arrears, they will only now be starting to need to pay their electricity bill under lower income and higher consumption conditions. And because electricity retailing is a relatively high-volume, low-margin industry (about $4 in every $100 bill) and retailers carry the credit and cash-flow risks for the entire sector, a relatively small increase in the number of non-paying customers could quickly place some retailers in a position where they can’t pay their bills.

All the way through from the experience of people who can’t pay their bill, to the possibility of retailer financial collapse, the COVID-19 pandemic has shone a light on cracks in Australia’s power system resilience.

The AEMC has taken a forensic look at the pandemic’s impact from the customer’s point of view to identify what’s needed to keep the lights on when bills can’t be paid.

COVID-19 was declared a pandemic by the World Health Organisation (WHO) on 12 March 2020. The Commonwealth Government started closing borders in early February, and by 20 March all foreign nationals were banned from entering Australia. Jurisdictional governments started closing non-essential services and imposing social distancing measures in late March.

The shut-down has led to significant effects on energy consumers. Residential consumers have faced a combination of higher unemployment and underemployment, lower average incomes and income uncertainty, and have higher consumption due to staying home during this crisis. Small business consumers have often been required to enter hibernation while the shut-down exists. The Australian Bureau of Statistics (ABS) reports that almost three quarters of small businesses' cash flow has reduced.

The NEM has established regulatory frameworks that govern what happens in the retail energy market when consumers experience financial stress. The main mechanisms include payment and hardship plans, government energy assistance payments and restrictions around disconnections for customers facing payment difficulties due to hardship.

These protections are in place because energy is an essential service, and are even more important during the pandemic to support customers in being able to work from home, have access to medical support (through services now provided virtually or via telephone), and have access to online services such as Centrelink.

Governments, the Australian Energy Regulator (AER) and Victoria’s Essential Services Commission (ESC) have enhanced these programs to protect and assist consumers under pandemic conditions. Most notably:

• the Commonwealth government has introduced the Jobkeeper program and doubled payments under the Jobseeker program
• jurisdictional governments have substantially increased payments and accessibility to their respective energy assistance payments
• the AER issued a statement of expectations during the pandemic which outlines that it expects retailers to not disconnect customers for non-payment and be proactive in promoting and allowing access to payment plans and hardship programs.

The combination of the increase in consumer financial distress and the increased regulatory obligations to continue to supply customers with electricity may place significant financial stress on energy retailers.

The level of stress individual retailers face will depend on a combination of factors, including their underlying profitability prior to the crisis, their corporate and financial structure, and their hedging strategy.

The AEMC's high-level scenario modelling indicates that the combination of retailers bearing the cash flow risk for the entire supply chain and retailing being a high volume, low margin business, means retailers are particularly exposed to increases in late and non-payment by customers.

With retailers facing financial stress under pandemic conditions, we have assessed the adequacy of the existing market and regulatory framework to deal with the potential for retailer failures.

In order to preserve continuity of supply to customers following the insolvency of a retailer, the National Energy Retail Law (NERL) sets out arrangements which provide for the immediate transfer of the customers of a failed retailer to one or more other retailers that act as a “Retailer of Last Resort” (ROLR). This mechanism has been invoked in the past for the failure of a few small retailers. It has operated smoothly without consequences for the wider market.

However, there is the risk of financial contagion from the failure of a large retailer or a number of smaller retailers over a relatively short period, potentially resulting in cascading insolvency across the sector.

Using extensive analysis from the AEMC’s earlier NEM financial market resilience review, updated for the unique conditions under the pandemic, we have identified specific concerns, including: 

• the heightened risk of the existing ROLR arrangements triggering financial contagion across the sector through the transfer of non-paying customers to retailers who already have a growing number of non-paying customers;
• both paying and non-paying customers being automatically placed on the receiving retailer’s standing or default offer contracts, when experience shows that it will take many years for customers to shift onto lower-priced market offer contracts; and
• reduced competitive pressure on prices generally through the loss of second and third tier retailers who have over recent years been increasing their market shares at the expense of the “Big 3”.

The pandemic has also highlighted the lack of consumer protections for embedded network customers such as those living in retirement villages as they do not receive the same standard of consumer protection as all other small consumers.

While we consider that cash-flow and non-payment risks should generally rest with retailers as they are best placed to manage them, it is clear that the unprecedented circumstances presented by the COVID-19 pandemic may justify providing assistance to retailers to manage cash flow risks that are exceptions to the usual efficient allocation of cash-flow risk within the sector. In particular, the AER's Statement of Expectations of energy businesses expects retailers to continue to supply non-paying customers to a greater degree than could have been foreseen by retailers before the crisis.

Governments and Energy Networks Australia (ENA) have reduced the size of the retailers' cashflow burden respectively through the increase in financial assistance and the ENA relief package, which provides direct support for affected small business customers and small retailers, and allows larger retailers to defer network charges incurred up until 1 July 2020 for pandemic- effected customers.

There are also two rule change requests that may further reduce the cash flow burden on retailers. The AER submitted a rule change request to the AEMC to allow retailers to defer payments for electricity network charges in respect of electricity hardship customers and customers on other forms of deferred payment arrangements due to COVID-19.

The AEMC is considering this rule change request, as well the rule change request submitted by the Australian Energy Market Operator (AEMO) to delay five-minute settlement (5MS) as a result of the pandemic. We will also review the effectiveness of cash flow burden sharing measures in next year's Retail energy competition review.

To address retail market financial stability risks, the Commission considers that improvements should be made to the ROLR scheme. These include:

• removing the ROLR requirement for small customers to be placed on the default offer.
• changes to the ROLR regime, as previously proposed by the NEM financial market resilience review, to reduce the impact of increased cash flow and/or credit support requirements, including greater clarity of cost recovery arrangements, delayed designation of ROLRs so the AER has greater ability to appoint multiple ROLRs if appropriate, and delayed requirements for the ROLR to provide credit support to AEMO associated with the additional customers.
• removing the ROLR regime from the National Energy Retail Law and including it in the National Energy Retail Rules in order to make the above changes to the ROLR framework.
• requiring retailers to provide advance notice of retailer distress to the AER.
• implementation of the comprehensive package of changes to laws, rules and regulations to protect consumers and improve choice in embedded networks, as recommended in the AEMC’s embedded networks review completed in 2019.

In addition to these recommendations, we will continue to provide strategic information and advice to energy ministers on appropriate short-term measures to maintain market stability.