Consumer Benefits of Demand Tariffs

A FABLE

Once upon a time all freight was carried by traditional companies. Online sales led to good times. Each year the freight companies used total online sales to forecast growth and bought new trucks to satisfy increasing demand for their services.

But customers wanted more. They wanted faster deliveries so retailers started to use new technologies able to offer next day delivery and agreed delivery times.

While total online sales continued to grow the traditional freight companies were slow to understand the impact of the new technologies. Each year they continued to buy more new trucks which then sat unused in the yard because demand for traditional freight services was actually falling.

Eventually there were so many unused trucks they contracted an economist to find a solution. The economist quickly determined it was the cost of all the new trucks that was causing the problem. The economist declared “the solution was to reduce demand which would avoid the need to buy more trucks”. The economist advised increasing freight prices to reduce demand.

So it came to pass the freight companies increased prices and demand for traditional freight decreased.

The higher prices also resulted in more consumers choosing new methods of freight delivery. This resulted in even more unused trucks and the higher prices did not recover the cost of the unused trucks.

MORAL

To avoid getting hit by a truck make sure your forecasts are right

And

Simplistic economic theory rarely predicts the final outcome, especially in complex markets.

THE ANALOGY

The above fable is analogous to the current situation in the Australian Electricity Market.

The freight companies are the local distribution network businesses. Their “trucks” are the poles and wires used to carry electricity to customers.

For the past decade distributors have been encouraged to add more poles and wires (“buy more trucks”) in response to incorrect demand forecasts.

The new technology affecting demand forecasts includes solar battery storage and demand response systems. Increasingly these systems are being offered by both new market participants and traditional electricity retailers.

The economist is the Australia Energy Market Commission (AEMC). They have amended the market rules to require distributors to introduce network demand tariffs. Network demand tariffs effectively increase electricity prices at certain times of the day. The AEMC anticipates these price increases will reduce demand thereby avoiding the need to install more poles and wires (“buy more trucks”).

Increasing electricity prices will reduce demand for the traditional supply of electricity. But the price rises will also drive the uptake of the new technologies.

Electricity is an essential service and many consumers who cannot afford to install new technologies will simply end up paying more.

ANALYSIS

The AEMC suggests “80% of consumers can reduce their electricity costs on a demand tariff” but analysis shows a very different result when the demand tariff is applied to typical consumers.

Analysis of Consumer Benefits of Demand Tariffs


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Citation

Copyright of this article remains with Dr Martin Gill. All references to this article should include the author’s name and website www.drmartingill.com.au.

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