It’s time to rethink how we think about the consumer energy market

In a recent paper, Dr Ron Ben-David argues a new way of thinking is urgently needed about the relationship between energy consumers, markets and regulation. Why? Because the current way of thinking about such things is resulting in market and regulatory design that is making demands on consumers for which they are ill-equipped. According to Ben-David’s paper, without urgent redress, many consumers will increasingly find themselves bound by incomprehensible contracts that do not align with their interests. The energy market will become a source of significant consumer harm – putting at risk consumers’ confidence in the market (and its regulation), thereby imperilling their ongoing support for the energy transition. He fears this is too big a risk to take.

Encouragingly, Ben-David observes it does not need to be this way. Genuine change, however, will only be possible if we ‘rethink how we think’ about the relationships between energy consumers, markets and regulation. A new knowledge system would enable a new way of thinking about market and regulatory design.

Before turning to this new knowledge system, Ben-David examines how the regulatory treatment of consumers has changed since the original market reforms of the 1990s. He then carefully scrutinises some of the key ideas, beliefs and assumptions that guide market and regulatory design. Doing so reveals many misconceptions.

Ben-David argues these misconceptions necessitate a new ‘knowledge system’ to guide market and regulatory design – one based on reality rather than unsustainable ideas and assumptions about consumers and markets. Without this new way of thinking, he observes regulatory measures to allay emerging consumer concerns will only ever be reactive ‘fixes’ necessarily comporting with these unsustainable ideas and assumptions.

This brings to mind Einstein’s famous warning against trying to solve problems with the same thinking used to create them.

The place of consumers in market and regulatory design

In his paper, Ben-David traces the evolution of the place of consumers in market and regulatory design from the time of the National Electricity Market’s (NEM) original reformers through to today’s regulators.

The original reformers treated electricity demand as the consequence of consumers’ countless unconscious decisions as they went about their daily lives. In this sense, the reformers conceived of consumers as disinterested and passive takers of electricity. The regulators who then assumed oversight of the NEM decided to pursue retail competition as an end in its own right. In doing so, these early regulators reframed what it meant to be a consumer. Regulators switched to viewing consumers as counterparties to the burgeoning number of retailers the regulators were enticing into the market. This saw regulators shift to designing rules and regulations predicated on consumers acting as active and discerning shoppers of electricity.

More recently, the regulatory conception of consumers has shifted again. Ben-David identifies how regulators now view consumers as ‘market participants’ who are interested, willing and capable of trading the shape of their load, the volume and timing of their electricity exports, and access to their storage assets (including EVs). Consumers are now treated as traders of these services. This switch has seen regulators taking a permissive approach toward ever more complex market contracts despite the incomprehensibility of these contracts for most consumers.

Ben-David reminds readers that the consumer electricity market is not a ‘natural’ market. It did not evolve over time through a process involving producers and consumers negotiating the terms of exchange. Instead, it is an administrative invention entirely defined by its rules and regulations. In turn, those rules and regulations are entirely framed by how regulators view consumers. When regulators view consumers as shoppers, they create rules and regulations that presume consumers act as discerning shoppers. When they view consumers as traders, they implement rules and regulations that presume consumers act as proficient traders of electricity and related services.

But what happens if most consumers do not, in fact, act in this way?

Barriers to new ways of thinking

According to Ben-David, the path to genuinely rethinking market and regulatory design is blocked by an entrenched regulatory narrative about the relationship between energy consumers, markets and regulation. He explains how the narrative is not a document, but a conceptual framing that flows through regulatory decisions, instruments, papers and speeches. It consists of the ideas, beliefs and assumptions that determine how rules and regulations are designed. Ben-David’s paper scrutinises many of these ideas, beliefs and assumptions. He finds regulatory confidence in these ideas, beliefs and assumptions to be misplaced. Some of the examples he explores include:

• The regulatory narrative contemplates the consumer energy market in broadly equivalent terms to other consumer markets. This is a false equivalence. The benefits consumers gain through energy market participation are entirely (or almost entirely) financial. Unlike other consumer markets, there is no or negligible additional utility to be gained from shopping around.
• The narrative’s ideal of “putting consumers at the centre” is belied by rules, regulations and rhetoric that treat consumers as “market participants”. The only consumers who can make it to “the centre” are the ones who proficiently participate in the ways presumed in the market’s design. For other consumers, the regulatory ideal rings hollow. After all, competition is a selective process.
• From what are consumer protections protecting consumers? Answer: The harms the market can cause. But those harms are enabled by the market’s rules and regulations. This invites the question: Why not just design the consumer energy market in a way that lessens the need to protect consumers?
• Market and regulatory design continue to embody the ideal of cost reflective tariffs. This overlooks one major problem. There is no objectively correct (or ‘true’) way to design tariffs. Every tariff design is the product of subjective judgements about the preferred distribution, or redistribution, of risks, costs and benefits.
• It is often said markets allocate risks to the parties best placed to manage them. For this to be true, parties must be free to avoid a market if they consider themselves ill-equipped to manage those risks. Electricity consumers face barriers to exit, meaning they can find themselves bearing the risks they are least well-placed to avoid (rather than the risks they’re best placed to manage).
• Economic regulation judges itself according to efficient outcomes at a ‘macro’ (whole of system) level. Consumers form their judgements at a ‘micro’ (individual experience) level. There is no a priori basis for assuming the two align. The political economy of the energy transition cannot be taken for granted.

Ben-David therefore concludes, it’s time to cast aside this tired and flawed regulatory narrative and adopt a new knowledge system to motivate and inform the design of market and regulatory arrangements.

Proposing a new knowledge system that reflects reality

Ben-David’s paper reminds us the consumer-facing electricity market is a ‘designer market’ – an administrative invention where all outcomes are enabled and permitted by the market’s design. In this ‘designer market’ there are no genuine market failures (as defined by economics). He argues there are only market design failures. These design failures reflect rules and regulations predicated on misconceived ideas and assumptions. Ben-David then proposes a knowledge system free of unsustainable ideas and assumptions about consumers and markets.

The core of his proposed new knowledge system consists of a regulatory objective focussed on upholding consumer confidence during the energy transition. This objective is expressed most efficiently with reference to the risks consumers face, namely:

To avoid exposing consumers to risks they are ill-equipped to understand, manage or price.

Ben-David explains this objective does not compete with the National Electricity Objective (NEO)’s focus on efficiency. It recognises however, that fulfilment of the NEO is unachievable if risks are misallocated to consumers because they are unqualified to identify, avoid or efficiently transact away those risks. Importantly, this proposed objective disposes of the regulatory narrative’s oft-repeated claims that the NEO is satisfied by enabling more consumer choice, more consumer information, more shopping around, and more efficient price signals.

Pursuing the proposed objective is made difficult by consumer and market realities. These realities must be respected and not assumed away as a matter of regulatory convenience. The proposed knowledge system recognises these realities in a series of “truth statements” which replace the misconceived ideas, beliefs and assumptions that have guided market and regulatory design for the past 20-30 years. Pursuing the regulatory objective subject to these realities represents the problem to be solved through institutional design. The final element in the proposed knowledge system consists of some guiding principles.

Some examples of potential reforms reflecting the objective and realities are offered in the paper. These include:

• focussing on contract design
• establishing reciprocal regulatory obligations through a duty of care
• applying behavioural insights to identify the limits of market signals
• accommodating electric vehicles in a separate sub-market
• examining opportunities for far-reaching tariff reform.

Despite these potential opportunities for reform, Ben-David raises some profound questions.

Is the investment that goes into developing and implementing ever-expanding rules and regulations even worth the effort? Is exposing consumers to an extraordinarily complex market risking community support for the energy transition?

This leads him to suggest the time has finally come to consider the option of structural reform.

 Structural reform to protect consumers

Ben-David suggests such reform would be designed to shield consumers from risks they are not well-placed to identify, manage or price. This would entail the creation of an entity responsible for identifying and managing the risks that would be unreasonable to expect consumers to manage on their own. These risks would be internalised within the entity, which would be given the necessary powers to manage those risks through the strategic procurement and sale of services, and investment in assets. The idea of an intermediary with the scale and authority to procure, invest and act on behalf of consumers is not a radical one. It is how the energy system was built in the first place. Importantly, he proposes ‘off ramps’ should be available for consumers wishing to actively participate (trade) in the energy market.

This is an overview of a recent paper by Dr Ron Ben-David. The full text can be found here: https://www.monash.edu/energy-institute/research/publications/2024-reports