Economic surplus

Economic surplus

Smart meters, dumb policy: the Victorian experience

Smart electricity meters are a great idea. They offer opportunities for consumers and electricity retailers to develop innovative programs to save both power and money. Tied into smart appliances and the internet, smart meters are the way of the future.

Except in Victoria.

Unfortunately, in 2006 the Victorian government decided that it would mandate the roll out of smart meters. It would force every Victorian household to have, and pay for, a smart meter, whether it wanted it or not. It decided that we would all have the same type of meter, whether it suited our needs or not. It was a piece of central planning that would have made the old Soviet Union (or modern North Korea) proud.

The Victorian Auditor-General has just released a report that shows the flaws of this centralised roll out. Add a bit of economics, and it is easy to see why this policy is a disaster for Victorian consumers.

Background

Smart meters (called AMI) have replaced the old-style ‘accumulation meters’ that simply registered your total electricity use. The distributor – the company that owns the wires bringing power to your house - owned the old meters. The distributor is (generally) different from the retailer, which is the company you purchase your power from.

The distributor needs accurate measurement of your electricity use so it can correctly charge the retailer who, in turn, needs to correctly bill you.

In contrast smart meters can register and transmit data about your electricity use in real time. This information can then be used by you and your retailer to manage your electricity usage. You can do this yourself or delegate the task to another party, such as your retailer.

This benefits you, your retailer and the economy. You gain by lower average bills. The retailer gains by not having to buy as much power at the expensive peaks. We all gain by having less idle electricity plant and network sitting around to operate at the peaks. The regulated networks - such as distributors - lose. They don’t get paid for the (now) redundant excess capacity on their networks.

Who has got the benefits?

Smart meters do everything that the old meters did plus they have two big advantages.

First, they allow for remote reading, so your electricity distributor does not need to have someone physically read your meter. Second, they can allow customers and retailers to use the real-time information to design innovative tariffs to save power use and reduce household bills.

Under the Victorian program, all households received and had to pay for the same type of meter. The meter continued to be owned by the distributor, even though the consumer has to pay for it. The auditor-general (AG) notes that:

By the end of 2015, Victoria’s electricity consumers will have paid an estimated $2.239 billion for metering services, including the rollout and connection of smart meters.

Retailers can (and do) offer innovative tariffs to consumers that make use of the smart meter data. But the take-up of these products is low. This means that most of the gains have been to the distributor in terms of reduced meter reading costs. Again, as the AG notes:

The single largest benefits category of the AMI program relates to the avoided cost of replacing and manually reading the old accumulation meters. However, accumulation meter costs have been replaced with smart meter costs that are much higher.

Further:

… benefits associated with the uptake of innovative tariffs and demand management―which has achieved only 2.5 per cent of expected benefits to be realised by 2014

So to date the main beneficiaries of the smart meters have been the distribution companies. The main payers are the consumers.

The economics of smart meters

The benefits of smart meters are uncertain. See page 9 of the AG’s report.

There are two possibilities. The first is that the savings to the distributor, by themselves, justify the smart meters. This may be the case in rural areas with low populations, such as rural Western Australia where Horizon power is rolling out smart meters. But it is unlikely to be the case for Melbourne.

Further, if it was the case, then the distributor should roll out the meters without the customers bearing any cost. If the savings to a distributor outweigh the costs then the rollout should be its decision and it gets the benefits and pays the cost. But that is clearly not what happened in Victoria.

The alternative is that smart meters are only economic if they lead to customers changing their behaviour.

But in that case, the decision about whether or not to have a smart meter, and the type of smart meter, should be made by the customer. Retailers should compete to offer the best meter/management packages to consumers. The meters would need to be certified to ensure that they are compatible with the electricity network. And the regulator should require that the distributor passes the windfall savings that it makes from reduced meter reading costs back to customers. But the retailers or consumers would formally own the meters.

Leaving the decision about smart meters to consumers and the market (like, for example, mobile telephones) would empower consumers, make sure the party who benefits also faces the relevant costs, lead to innovation and encourage competition.

Indeed, it is such a good idea that:

the Australian Energy Market Commission (AEMC) is currently considering a rule change proposal to introduce competition in smart meter services to small customers” (p.9).

Hopefully, for the rest of Australia, this will occur and they will be spared the Victorian-Soviet solution.

What do we learn from the Victorian smart-meter fiasco?

The Victorian roll-out of smart meters is a textbook case of bad public policy.

It came about because the local regulator, the Essential Services Commission, decided that the market would not work and central planning would lead to a better outcome. See the AG’s report at p.4.

This is almost always wrong.

Good economic policy relies on providing the right people with the right incentives. The auditor-general’s report highlights the failure that arises when bureaucrats think that they know best and impose their wisdom on us all.