Reconsidering the DMO

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The Australian Energy Regulator (AER) has published the Default Market Offer 2023-24 Issues Paper. In the context of unprecedented wholesale energy prices, the Issues Paper makes interesting reading and is going to be closely examined by energy retailers and other participants.

What is the DMO

The Default Market Offer (DMO) is the maximum price that an energy retailer can charge a customer who is on a standing offer and is the maximum price that an exempt seller can charge a customer within an embedded network. The DMO represents a ‘safety net’ for consumers who are disengaged with the energy market. The DMO applies to small business and residential customers in South Australia, New South Wales and south-east Queensland where there is no other retail price regulation. The AER determines the DMO price each year.

Recent Wholesale electricity prices

Commenting on recent unprecedented wholesale prices, the AER notes that ‘We do not consider the recent wholesale price increases and its impact on the retail market require a complete review of the DMO methodology. The cost-stack methodology for wholesale and network costs will ensure developments in the market across most of the 22-23 period will be reflected in the DMO 5 price.’ The AER also notes that while there have been a number of retailers ‘going RoLR’, the total number of customers impacted was a small proportion of the total market (0.3%). 

The AER is not, however, downplaying the impact that wholesale prices will have on the market and, most importantly, on vulnerable consumers. The AER notes that prices are significantly higher and that there is less liquidity in the electricity futures markets.  

There are only so many ‘levers’ the AER can pull to ensure that consumers are protected within the current market.

Points to consider

How the government and AER respond to the energy market crisis will be closely examined. Below we point to some areas that may come under consideration.

More frequent resets

While not within the scope of this review, a question that we believe needs to be asked is whether the DMO should be reset more frequently. DMO 4 was not cost-reflective for retailers, and conversely, a reduction in wholesale prices during the following 12 months would result in DMO 5 being ‘out of the money.’ While retailers are hedged for 2-3 years in advance, the prior 12 months have clearly shown that the energy market moves faster than the regulatory pricing framework, and perhaps that needs to change.

Data rich – insight poor

The AER acknowledges the information-gathering powers it has, including the capacity it has to gather detailed information on the hedging strategies and positions of energy retailers.

The AER point to the potential to ask for relevant information from market participants in South Australia: ‘A potential option to add additional trades would be to obtain confidential contract information from market participants in South Australia and add these into the book build process, as is currently done for ASX contracts. For this to occur we would need to obtain contract terms and conditions, including but not limited to; prices, volumes and dates when contracts were entered in to. This information could potentially be sourced from broker data on OTC trades or contract information sourced directly from retailers. How vertically integrated participants value internal hedging products may also need to be considered. We could also consider this approach for other regions.’

The AER seeks to make decisions on transparent information via public and open processes. Amending the DMO based on specific and commercial in confidence hedging data would not be consistent with an open process however, doing so may enable the AER to more closely align the DMO to actual costs to serve, to reduce the risk of retailer failure and to appropriately set a DMO in line with the regulatory framework.

Something is missing

There is a substantial disparity between the margins of the vertically integrated retailers and their smaller cousins. A single set of assumptions, whilst built on analysis of the different profit margins achieved or achievable by retailers, results in a sub-optimal outcome when it comes to pricing for vulnerable customers.

Additional consumer protections are going to be needed in the next 12-24 months. There are already clear signs that many consumers are at the event horizon of a financial black hole. A question that may arise is whether there should be a special mandated minimum price offer- to be made available by the more profitable retailers or indeed supported or part-financed by the government.

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