This blog was originally published 29 March 2019. Since it was published, the AEMC has released updated and final details on its proposed rule changes. We issued revision to the blog on the 13 November 2019 to reflect these changes. Key items updated between the draft and final rule changes include clarity on legacy networks, reintroduction of individual exemptions and new rules for large generators (e.g. solar) within embedded networks. We have marked the changes with *new* and *updated* flags.
Major changes are on the horizon for embedded network operators. On the 20 June, the Australian Energy Market Commission (AEMC) recently released final rule changes to the network and retail exemption frameworks that currently regulate embedded networks in the National Electricity Market. The rule changes go deep, proposing that exempt network service providers and exempt sellers will face obligations that closely mirror those required of distributors and retailers.
The proposed changes will likely see customers within embedded networks receive much needed protections, but also result in dramatic changes to the embedded network industry.
We have reviewed these changes, summarized them in this article and assessed the effects on the embedded network operators and others that benefit from the current exemption frameworks.
Today, someone that owns, controls or operates an embedded network that supplies electricity to a third party must operate under a network exemption (or be an authorised distributor). And in addition, someone who sells energy (this includes, but is not limited to, gas and electricity) to a third party within an embedded network must do so under a retail exemption (or be an authorised retailer).
Holders of network and retail exemptions currently operate in a regulatory light environment, only needing to comply with a relatively small set of conditions that exist within the relevant exemption guidelines. Penalties for breaches of conditions for a retail exemption exist, but penalties do not exist for network exemptions other than the threat of an exemption being revoked. Furthermore, Australian Energy Regulator (AER) lacks the resourcing or investigative powers to effectively regulate.
With the explosion of embedded networks in the last 5 years, largely due to the boom in residential apartments in our cities, the AEMC now estimate over 250,000 customers live within embedded networks (we believe there are up to 5 times that number). Many customers have unfortunately been subject to poor service, price gouging and difficulty in leaving embedded networks for better “on-market” retail offers. To make matters worse, Power of Choice reforms introduced in December 2017 appear to have failed to deliver better outcomes for these customers.
Calls have been made by the public and COAG to review and improve upon the exemption frameworks.
The AEMC is proposing changes to the National Electricity Law (NEL) and the National Energy Retail Law (NERL), National Electricity Rules (NER) and National Energy Retail Rules (NERR) that will see wide-ranging changes to the embedded networks industry. The key changes are as follows:
*Updated* New registration and exemption processes: Exemption frameworks will be dramatically changed. Many exemptions classes will disappear, and two new market participant roles will be created. Exempt network service providers will now need to register as Embedded Network Service Provider (ENSP) and retail exemption holders will need to be Authorised Off-market Retailers. Due to deemed exemptions creating poor compliance transparency in the market, they are proposed to no longer exist. A small number of deemed exceptions will become registrable exemptions and the remaining deemed and registrable exemptions will be subsumed by ENSP and AER registrations. After initially proposing the removal of individual exemptions (a regulatory pathway typically used by proponents for highly innovative embedded networks), it was ultimately decided to preserve this exemption category to continue to foster innovation and deal with regulatory outliers.
Market and system integration: The AEMC are seeking to fully integrate customers within embedded networks into the national electricity market. Off-market Retailers will need to appoint Metering Coordinators and ENSPs will be responsibility for registering all child connection points with AEMO (in MSATS) and maintaining the information. This will mean greater consistency in the NEM and allow off-market connections points to be “discoverable”, removing a key barrier to retail competition.
Network billing: The AEMC is proposing to standardise the billing arrangements for the recovery of network charges from embedded network customers who choose to go “on-market” with new standardised processes and data formats to bill retailers. All new and existing embedded networks will be required to cap network charges at a level no greater than the amount that a customer would have paid had it been directly connected to the local distribution network.
Network regulation and new connections: ENSPs will be required to provide customer connection services under the NERL and Chapter 5A of the NER. A single connection policy will be established by the AER. Connection charges will need to mirror those of local distributors.
Consumer protections in the NERL and NERR: In essence, on-sellers will now need to meet similar compliance requirements to on-market retailers. The AEMC concluded that almost all existing consumer protections under the NERL and NERR apply. The commission also proposes the establishment of a Retailer of Last Resort (RoLR) for embedded networks, where the retailer to the parent connection point would become the RoLR in the event of the failure of an off-market retailer.
Monitoring and compliance: ENSPs will be subject to a suite of new monitoring and compliance provisions. This includes the AER’s monitoring, investigation, and conduct powers, general information gathering powers and AER reporting requirements. Similar changes will be true for Off-market Retailers. The AEMC is also proposing many of these monitoring and compliance requirements for legacy networks.
*New* Large connections: The AEMC recognised the connection large (registered) generators and customers within embedded networks create a performance risk to the network. Registered participants will no longer be able to connect to exempt networks without a connection agreement that involves AEMO and involves enforceable performance standards.
3. Who will be affected?
*Updated* The new rules will apply to the establishment of new embedded networks. All embedded network operators who own residential or commercial embedded networks established after 1 December 2017 will need to register as ENSPs and, as appropriate, become Authorized Off-market Retailers. Embedded networks created after 1 Jan 2020 will have 9 months to transition after the new law and rules come into effect. Network established between 1 December 2017 and 31 December 2019 will have two years to transition.
Legacy networks established prior to 1 December 2017 exempt sellers will need to transition to become Authorized Off-market Retailers but the network exemptions will be grandfathered (i.e. no transition required). For legacy networks falling into this bundle, there will be two years to transition after the new law and rules come into effect.
*New* Legacy networks may seek an individual exemption from having to register as an ENSP and seek authorisation as an Authorized Off-market Retailer. This will no doubt be an important opportunity to developer ENO businesses with a handful of embedded networks and no path to growth. We would suggest not relying too heavily on this compliance pathway. Individual exemptions have historically been onerous to apply for and with a huge regulatory transition in effect, no doubt this process will be tediously slow to the point of being unworkable.
Embedded Network Managers (ENMs) will have a diminishing role going forward. ENMs will still support legacy embedded networks operating under existing exemptions but they will have no role in new embedded networks under the new framework.
Network service provider and retail exemption frameworks will still be available for a smaller number of activities including short-term holiday accommodation, EV chargers, construction, rail and government agencies supplying energy to non-residential customers.
Interestingly, the AEMC intends to grandfather certain exemption classes, allowing them to be applied for by new embedded networks where the networks exist in jurisdictions that still provide an exemption (e.g. if a network exemption is available under the General Exemption Order to the Victorian Electricity Industry Act, the corresponding network exemption will be available under the new Rules).
Solar PPA providers will still be able to apply for network and retail exemptions.
4. Likely effect in the market
The effect to the energy market will likely be significant, effecting ENOs, Billing Providers to ENOs, Owners Corporations, Property Developers and new Market Entrants.
4.1 Embedded Network Operators
In the AEMCs view, for existing ENOs with large numbers of customers, there may be little difference in the obligations that would apply and transitioning these network service providers to the new framework would likely streamline regulatory arrangements. This is true in some ways:
ENOs that have already registered to operate as Embedded Network Managers (ENM) and that have invested in the appropriate systems to facilitate this task will be able to apply the same systems for the tasks of the ENSP.
Many ENOs already outsource their metering to third party Meter Providers. Requiring the appointment of a Metering Coordinator will be a straightforward change. We’d expect that drives ENOs to also register as Meter Coordinators themselves as has been the case with retailers who have the same task.
Those ENOs who have already made the leap to becoming Authorised Retailers (for e.g. WINConnect) will likely take the new compliance obligations incumbent on Authorised Off-market Retailers in their stride.
Proposed rule changes that streamline and regulate interactions between retailers and embedded network operators for on-market child customers will probably provide todays ENOs with welcome new protections.
But the above largely applies to sophisticated ENOs, smaller ENOs will likely have a daunting task of becoming compliant.
There are also big changes that will almost certainly be felt by all parties:
Requiring all meters to be registered on MSATS will create now upfront costs of establishment.
Requiring the new ENSP to comply with all the provisions under Chapter 5A will likely be a serious compliance challenge for many embedded network operators.
Ongoing reporting to the AER will create new compliance overheads
It will be much easier for customers to churn putting downward pressure on prices and subsequently reducing ENSP margins (we’ll write a separate post on the effects of this).
4.2 Billing Providers
The new rule changes are likely to hit billing providers much harder than fully-integrated ENOs. In our experience, many billing providers currently still operate highly manual systems. To remain relevant, these providers will have a herculean task of becoming compliant with the new rules even if they won’t be directly accountable for compliance. We have already seen consolidation in the industry of many providers as a result of the Power Of Choice changes, such as WINConnect acquiring SA Energy Services. We are aware of a lot more consolidation occuring in the market here.
4.3 Owners Corporations
*Updated* For new developments that fall under the new frameworks, the option to self-manage their embedded networks may no longer be feasible.
Initially it was looking like legacy embedded networks may need to update all their metering if not compliant. With full transition only required for networks established after 1 December 2017, this should be less of an issue that previously expected.
The pathway for OCs will be to find ENOs that operate businesses that pass most (if not all) the value of the embedded network back to OC and end customers. Under this model, operating costs will likely increase relative to previous a billing provider. This increase will reflect the costs of the new regulatory compliance requirements and price in regulatory risk. We are aware of several vendors who already offer this service. Please get in touch if you'd like us to facilitate an introduction.
4.4 Property Developers
*New* Developers have increasingly been looking at becoming embedded network operators as a means of extracting more value out of embedded networks. The proposed changes will likely make it more challenging for this to occur but certainly not impossible. Outsourcing options will likely evolve to create options for property developers. In our view property developers will need to become Authorized Off-market Retailers and find a partner who can perform billing and customer service and the functions of an ENSP. Compared to the little touch embedded network businesses currently in fashion, this arrangement will carry more regulatory risk property developers and have slightly lower but still highly attractive returns.
4.5 Other New Market Entrants
*Updated* There is no doubt that these changes will greatly affect new market entrants. The changes create significant new barriers to entry.
For those wanting to play in greenfield, without really solid differentiation and a healthy pipeline (e.g. via a strong relationship with a large property developer), you will likely have an uphill battle.
We think a better strategy is to offer services to existing embedded networks, especially OCs. Many of them have accepted terrible deals from developers and they are ripe for flipping into better arrangements. Lots of low hanging fruit here.
4.6 Solar PPA providers
Exemption classes will still be available to generators but deemed network exemptions for generators supplying third parties will no longer exist and providers will now need to register for exemptions. This will create a small additional regulatory burden for solar PPA providers by requiring registration for site-by-site network exemptions. Nothing to lose sleep over though.
5. How will the change impact new energy?
*NEW* We are already seeing large ENOs push harder into the new energy space. Fundamentally new energy gives ENOs the opportunity to increase the gross margin of their networks. Increased gross margin means more value that can be passed to consumers in the form of lower prices. Lower prices means a greater competitive edge versus on-market retailers. Greater competitive edge means ENOs to protect themselves from against churn. It's therefore no mystery to its attraction.
Here are some examples we have looked at:
by installing solar, embedded networks can reduce their grid energy requirements thereby lowering operating expenses and increase margins. Local solar can also improve the brand of the embedded network and encourage customers to stay.
by installing batteries or demand management technology, embedded networks can reduce their peak demand thereby further reducing their operating costs and increasing margins
by installing heat-pumps and selling hot water, embedded networks can create supplementary revenue streams to electricity revenue
We see embedded networks and new energy ripe for more innovation. (We'll write more on this in future blogs.)
6. When will the change come into effect?
*Updated* The final changes have been released on 20 July 2019. The AEMC will then need to submit the changes to COAG for endorsement. The next COAG meeting is this month. In our view, it is very likely that COAG will endorse the charges.
The AEMC have forecast the charges will come into effect within 12-18 months from COAG endorsing the changes. We think this is a tad optimistic. But betting against the proposed changes not coming into effect would be unwise.
For the changes to come into effect, changes to the National Electricity Law and the National Energy Retail Law will need to be made before the AEMC can make the necessary changes to the Rules. This will first require South Australia to pass the law. This is largely procedural, so we don’t expect any issues here.
But then, other jurisdictions (NSW, VIC etc.) will need to pass their own versions of the National Electricity Law and National Energy Retail Law. During this process, each jurisdiction may introduce their own tweaks to the laws as is common. The proposed changes to the rules can then occur.
Then just to make everything a little more complicated, Victoria will likely need to work out how it will harmonize its own exemption framework, that requires exemptions under the General Exemption Order to the Electricity Industry Act 2000, with the new national framework (To which we say, for goodness sake - please do it). The embedded network industry does not need the same multi-jurisdictional compliance epic that is currently burdensome upon on-market retailers.
Finally, AEMO and the AER will require a transitional period to consult on an update to the relevant procedures and guidelines.
So while we see these changes as fairly inevitable, don’t hold your breath just yet.
6. What’s still unclear?
*Updated* We now have a clear view from the AEMC on the rule and law changes. What is still unclear is how, when and if the states will respond.
Implementation of the proposed changes could take a long while to filter through and any number of minor/major changes could occur. It’s also still unclear how the ball will bounce in Victoria after they threatened to ban embedded networks.
*Updated* The changes are significant, well-targeted and (as we have argued before) necessary. These changes will harmonise customer protections for customers within embedded networks to those enjoyed by normal on-market customers.
However, the changes will certainly benefit the industry incumbents – mature ENOs, retailers and distributors alike. We are already aware of consolidation in progress.
Mature ENOs will likely take the changes in their stride, and perhaps even benefit from them due to reduced competition and clarity around B2B interactions for on-market child meters. Many will likely opt to acquire smaller ENOs.
Retailers will no longer be losing market share to ENOs for a few reasons. 1) consolidation of the embedded network market is likely to benefit retailers with a war chest of funds for acquisition, 2) retailers already operating as ENOs will face reduced competition and 3) retailers looking to churn off-market customers will face drastically reduced barriers in new embedded networks.
Proponents of smaller embedded networks will likely opt to connect to local network service providers reducing the loss of market share by distributors.
Property developers who want to start their own embedded network operation businesses will still be able to do so but the regulatory risks will be greater.
OCs potentially have a costly transition and will be looking for options to transfer these costs to vendors. This might trigger a significant churn of brownfield embedded networks between current providers.
Recent and new entrants who do not have proven ability to acquire customers, or the skills, appropriate systems or necessary funds to comply with the proposed rules and law are looking for the exits. If you're cashed up and want a fast market entry, now is the time to enter.
Watch this space closely!