Power prices, climate change and ‘going green’:      changes in the Australian energy market                           Whi...
Power prices, climate change and ‘going green’: changes                           in the Australian energy marketAbstract ...
Power prices, climate change and ‘going green’: changes                                     in the Australian energy marke...
Power prices, climate change and ‘going green’: changes                                    in the Australian energy market...
Power prices, climate change and ‘going green’: changes                                      in the Australian energy mark...
Power prices, climate change and ‘going green’: changes                                                          in the Au...
Power prices, climate change and ‘going green’: changes                                                    in the Australi...
Power prices, climate change and ‘going green’: changes                                 in the Australian energy marketThe...
Power prices, climate change and ‘going green’: changes                                  in the Australian energy marketWh...
Power prices, climate change and ‘going green’: changes                                in the Australian energy marketTher...
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Veda Solutions Group_Utility whitepaper AUG2011

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Veda Solutions Group_Utility whitepaper AUG2011

  1. 1. Power prices, climate change and ‘going green’: changes in the Australian energy market White Paper – August 2011
  2. 2. Power prices, climate change and ‘going green’: changes in the Australian energy marketAbstract The retail energy sector has undergone recent extensive change in pricing, regulation and consumption patterns. Electricity price rises are slated and approved for the 2012 financial year. Patterns of consumption have been influenced by „green guilt‟, an increased spectrum of alternative energy sources, and more extensive hardship amongst households battling interest rate rises and price inflation across many basic household goods and services. This paper looks at how these various changes are modulating demand, provider switching and bill default behaviours in the utility sector, with an emphasis on patterns of default in the energy (electricity and gas) markets. In particular, the demography of bill defaults is explored, with changing patterns traced across a five-year window from 2006 to 2011. Several atypical demographic groups are identified as representing a high default risk, and mechanisms available to utility companies for default mitigation at each stage in the customer lifecycle are outlined. ______ Page 2
  3. 3. Power prices, climate change and ‘going green’: changes in the Australian energy marketThe Retail Electricity MarketRegulation and privatisationSubstantive changes have occurred in the structure and regulation of the retail electricity market over the last 2decades. Privatization of electricity assets has progressively occurred in the states of Victoria, South Australia,parts of Queensland and most recently NSW, bringing an increased element of competition - but also greater profitmotive - into the sector.Establishment of the National Electricity Market (NEM) for wholesale electricity supply in 2000 has increased pricetransparency, whilst a national monitoring and regulatory entity, the Australian Energy Regulator, was incepted in2005 to drive efficiency through interstate market and pricing integration.Figure 1: Key milestones in the Australian energy market, 1998 – 2012Electricity market pricing 1Inflation adjusted retail electricity prices have increased by 30% since 2006 , reflecting both a rise in real wholesaleelectricity costs and the expectation of future costs resulting from Australia‟s 20% Renewable Energy Target (RET) 2and hypothecated carbon tax. Although still below the OECD average price , the increase in electricity costs tohouseholds has been significant, outpacing CPI and wage growth. As a result, Australian households who are not1 Deloitte Access Economics 2011, Assessing the impact of key climate change policies on energy users, report for the Energy Users Association ofAustralia, June 2011, pp. ii2 Deloitte Access Economics 2011, Assessing the impact of key climate change policies on energy users, report for the Energy Users Association ofAustralia, June 2011, pp. 12 ______ Page 3
  4. 4. Power prices, climate change and ‘going green’: changes in the Australian energy markettaking direct action to reduce their power consumption have seen power bills consume an increasing slice of theincome pie. Over the last 5 years, the annual increase in electricity prices has been on average, 15 times greaterthan for the previous two decades; put another way, electricity prices rose by twice as much between 2007-2010 asthey did for the whole period from 1990 – 2006.Figure 2: Inflation-adjusted energy prices, 1990 to 2011Impact of the Sustainability agendaAnother significant source of change in the energy markets emerged from the 2007 federal election. The Ruddgovernment rode to power on the back of a strong green message, spurring the implementation of furtherregulatory commitments towards reduced energy consumption and carbon throughput. A range of emission reduction initiatives have since been implemented at state and commonwealth level. A national Renewable Energy Target (RET) has been set at 20% energy from renewable sources by 2020, placing formal pressure on power generation 3 companies to drive emission reducing change . Other sustainability initiatives include mandatory BASIX compliance for residential development and subsidies for insulation, solar hot water and photovoltaic panels.Consumers are also increasingly conscious of the environmental impact of their actions, and this too is alteringenergy consumption patterns. "Consumers are making purchase decisions on the back of their concern about3 Syed, A, Melanie, J, Thorpe, S and Penney, K 2010, Australian energy projections to 2029-30, ABARE research report 10.02, prepared for theDepartment of Resources, Energy and Tourism, Canberra, March. ______ Page 4
  5. 5. Power prices, climate change and ‘going green’: changes in the Australian energy marketclimate change and marketers need to take notice,” says Synovate‟s head of media research, Steve Garton.“People see their purchase decisions as a way to combat the effects of climate change and would undoubtedly be 4open to green products in most categories”.And these preferences translate to behaviour – 67% of Australians have purchased an energy efficient device inthe last 12 months, 83% have consciously saved power and 59% have purchased green products instead of 5standard.A number of utility companies have tapped into the sustainability agenda, offering Green Power products and smartmeters to help consumers regulate and restrain their consumption. Several have made significant investment inrenewables to future-proof demand as fossil fuel sources become less palatable to consumers and more expensiveto operate under a carbon taxed pricing regime.Informed consumers demand moreAs more households become online-savvy, price comparison and consumerwatchdog sites are playing a greater role in consumption choices. A quick Googleof “electricity price comparison” produced thirteen unrelated comparison sites andfour government advisory sites, plus forum, blog and wiki posts discussing utilityproviders, prices and options.More informed consumers with heightened price awareness make competing in the utility sector a tougher asktoday than in the past. Australia has the dubious honour of one of the highest residential utility switching rates, 6ranging from 11% to 25% per annum by state in 2010 . Switching rates have followed an upward trajectory as newplayers enter the market, and this trend is driving increased servicing costs and risk exposure for energy retailers.In a commoditised and increasingly crowded market, opportunities to reduce the cost associated with non-paymentand customer mobility are becoming increasingly valuable.Consumer Utility Bill DefaultsThe volume of consumer utility bill defaults has followed an upward trajectory for the last 5 years. Whilst anincrease in default was expected during the high interest rate period of „06/07 and the global financial crisis (07/08),as market fundamentals returned to normal in 09/10 the rational expectation is a reduction in default volumereflecting economic recovery.In Australia this has not been the case. Whilst average default amount has remained static relative to inflation, thevolume of defaults has continued to rise. This is an indication that cost of living pressures are becoming a moresalient concern for many sectors of the Australian population. It may also be a reflection of the aggressivediscounting and sales strategies used in Door to Door, telemarketing and „above the line‟ advertising in theAustralian utility sector – this may result in customers switching to a new supplier and leaving unpaid bills for prior4 http://www.synovate.com/changeagent/index.php/site/full_story/climate_change_and_consumer_behaviour/5 http://www.synovate.com/changeagent/index.php/site/full_story/climate_change_and_consumer_behaviour/6 VaasaETT 2010, Utility Customer Switching Research Project: SwitchStats Australia Scheme Report, dated 1 April 2010 ______ Page 5
  6. 6. Power prices, climate change and ‘going green’: changes in the Australian energy marketsupply, payment for which is often hard to recoup when the retailer no longer has the threat of disconnection forleverage.Figure 3: Electricity bill defaults – volume and average value, from 2006 to 2011. 35000 $1,000 # defaults $900 30000 Avg value $800 25000 $700 20000 $600 $500 15000 $400 10000 $300 $200 5000 $100 0 $- Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Oct-06 Apr-07 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11Note: Intermittent spikes in default volume reflect intermittent processing or loading of default data by large utility providers.The average Australian household spends $2,046 per year to cover electricity costs. Whilst low incomehouseholds receive some subsidies, recent price hikes mean that those with moderate household - but limited 7disposable- income are struggling more now than in the past to meet their financial obligations . Although the pace of debt accumulation has slowed, aggregate household 8 indebtedness and gearing are at historically high levels. Housing cost and consumer goods inflation, and upward pressure on interest rates prior to August 2011, have whittled down discretionary spend margins, increasing the likelihood that utility price rises will cause payment stress and ultimately default. Petrol prices, although a source of much vocal dissatisfaction amongst consumers, do not have a positive correlation to increased default rates (see Figure 2).7 Australian Institute of Health and Welfare, 2011, Housing Assistance in Australia 2011. Cat. no. HOU 236. Canberra: AIHW.8 Reserve Bank of Australia 2010, Household and Business Balance Sheets, sourced 7/08/2011 athttp://www.rba.gov.au/publications/fsr/2011/mar/html/house-bus-bal-sheet.html ______ Page 6
  7. 7. Power prices, climate change and ‘going green’: changes in the Australian energy market Figure 4: Relationship between inflation, petrol price, borrowing costs and utility default 35000 14.0 # defaults Annual CPI inflation 30000 Petrol price ($/L) Indicator lending rates 12.0 25000 10.0 20000 8.0 15000 6.0 10000 4.0 5000 2.0 0 0.0 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Oct-06 Apr-07 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11Segments under pressureThe effects of utility price rises are not equitable. As a share of household income,utility expenditure is 59% higher amongst old age pensioners than the average.The unemployed (33%) and single parents (26%) also find utilities costs adisproportionately large burden, paying 33% and 26% respectively above theaverage wage to utility cost ratio. These groups traditionally experience bill 9payment stress, and market data indicates that they continue to do so.The rising cost of living is also taking its toll on highly leveraged households inmore affluent segments of the population, driving increases in non-payment acrossformerly „safe‟ demographics. Analysis conducted by Veda examined patterns ofutility bill default by income, household composition, property value and homeownership.Results were further filtered by applying Veda‟s Landscape geodemographic segmentation to elicit thegeodemographic characteristics of bill defaulters. Seven clusters of defaulter were identified as sharing commongeodemographic characteristics, including income level, property value and similar lifestage attributes (measuredusing Landscape geodemographic profiles).9 Dufty, G., 2008, EWOV – Hardship, where are we on the journey? Cost Trends for Essential items – implications for Victorian Households, presentationto CUAC Consumer Roundtable, October 2008. ______ Page 7
  8. 8. Power prices, climate change and ‘going green’: changes in the Australian energy marketThese defaulter clusters can in turn be grouped into three typologies: low-income „strugglers‟, cash-constrainedretirees and highly leveraged urban families. The latter two groups are not typically seen as „risky‟ but haveexperienced significant increases in payment difficulty over the last five years resulting in increased propensity todefault. Figure 5: Default clusters within the Australian energy market, FY11 $500 Struggling $480 Suburbia (CL2, CL5) CL5 $460 CL2 Cash-strapped $440 Retirees (CL3, CL4) Leveraged young families (CL1, CL6, CL7) $420 CL3 CL7 $400 CL4 CL1 $380 CL6 $360 $340 $320 $300 Low: <$18,199 High: >$104,000 Household income bandThe increased presence of these atypical defaulter cohorts highlights the need for energy retailers to applyquantitative and behaviour based filtering at point of acquisition and the value of implementing proactive defaultmanagement across their existing customer base.Mitigating Default RiskA conscious approach to payment risk management across the customer lifecycle can bear significant dividends inthe form of improved retention, reduced servicing costs, and reduction in days outstanding, collections activity andincidence of bad debt write offs.Pre-screen and filter acquisition targetsVarious targeting and credit risk pre-screening measures can be used to eliminate prospective customers with ahigh likelihood of default. Off the shelf credit risk models such as Veda GeoRisk provide a privacy compliant way ofidentifying less risky prospect households, or offering risk-appropriate contracts, payment plans and bond levels. ______ Page 8
  9. 9. Power prices, climate change and ‘going green’: changes in the Australian energy marketWhere more precision is required, bureau based pre-screening may be applied to cold prospects, or bespokemodels developed to reflect specific risk policies.Privacy compliant risk models – both generic and bespoke – can also be used to manage and score inboundapplications, ensuring appropriate bond and contract terms are offered to minimise likelihood of default.Proactive default management and prevention of bill shockEnergy companies are obliged to offer payment plans to consumers who have been identified as experiencingfinancial hardship. Such hardship measures minimise the likelihood of delinquencies resulting in debt write-offs.However, by taking a proactive approach to hardship measures, utility providers can gain further cost efficiencies.Risk models and behavioural triggers can be implemented to identify customers „at risk‟ of hardship well in advanceof default behaviour. Pre-emptive measures utility providers can deploy include the proactive offer of paymentplans to potentially risky customers, promoting Smart Meter systems and online usage tracking, and educatingconsumers in risky groups about peak/ off peak pricing structures and ways to manage their power costs.Emphasis on early collections 10A UK study by Bain & Co. suggests that the continued high rate of utility defaults is more symptomatic of lax riskmanagement procedures on the part of suppliers than on continued affordability stress amongst consumers. Inparticular, the report highlights the absence of aggressive early collections activity, which results in a higherproportion of 60 and 90 day overdue accounts and default write offs. Effective early collections practices reduce theincidence of debt write offs and also reduce the cost associated with recouping funds through external collectionagencies.Future outlookEconomists forecast that both wholesale and retail electricity prices will continue to rise across 2011/12 and2012/13, reflecting the expected imposition of carbon tax, greater investment in renewable source infrastructure 11and increased cost of network services to support growing consumption demand.Although consumers are expressing clear intention to reduce their individual consumption levels, the net level ofconsumer demand will continue to rise, driven by population growth, increased household formation rates andsmaller average household size.Unless significant shifts occur in building construction or dwelling size, consumption reductions will only occur onreadily controllable items such as lighting, hot water and air-conditioning use. Coupled with the anticipated retailprice rises, it is improbable that default volume will decline organically – reduction will require proactive debtmanagement strategies on the part of utility suppliers.10 Bain & Company, 2011, Winning good customers, losing bad debt, Bain Brief, published April 7, 2011 sourced athttp://bain.com/publications/articles/winning-good-customers-losing-bad-debt.aspx11 Australian Energy Market Commission 2010, Future Possible Retail Electricity Price Movements: 1 July 2010 to 30 June 2011, FinalReport, 30 November 2010, Sydney. ______ Page 9
  10. 10. Power prices, climate change and ‘going green’: changes in the Australian energy marketThere are substantial opportunities for energy retailers to boost profitability through effective default riskmanagement, using the strategies outlined in the previous section. There is also opportunity for retailers to assistcustomers in self-selecting appropriate contract and usage patterns to fit their budget. Smart meters, interactive billmanagement and alternate payment models such as prepayment, direct debit, flat rate plans or shorter bill cycles,may provide considerable bottom line benefits when used in conjunction with appropriate risk management tools.ConclusionDefault risk remains a substantial problem in the Australian energy market, however overseas experiencesillustrate ways in which proactive, data driven customer management can serve as an effective counterpoint. In thecurrent economic climate, bill defaults are no longer restricted to the stereotypical „risky‟ customer, and theapplication of behaviour based risk management tools across the customer lifecycle are essential to ensuringprofitability.From fully bespoke solutions to off-the-shelf models, there are a host of tools that utility managers can apply toimprove profitability irrespective of budget. If you aren‟t doing it, what‟s your excuse?Author: Anna Russell, Veda Data Solutions Group Veda is Australasia’s leading data intelligence and insights company and holds the largest, most comprehensive pool of consumer and business data across both Australia and New Zealand. Within Veda, the Data Solutions Group specialises in translating this vast pool of data into pragmatic and robust marketing tools for campaign management, optimisation,targeting and analytics. These tools include the Landscape consumer segmentation model, GeoRisk credit risk profiling,Residential Movers database, and a pool of over 200 geodemographic and behavioural profiling variables.For further information, visit veda.com.au or email the author on anna.russell@veda.com.au ______ Page 10

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