Big news! If you live in California, Massachusetts, New York, Illinois, or a few other states you may soon have the opportunity to ditch your local investor-owned utility and buy your electricity from a competing retailer. And in a few locations in those states, you recently got that option.
Wait. Is that really new? “Retail choice” for electricity has existed in Texas, Pennsylvania, and Connecticut and a number of other states (as well as England, Australia, New Zealand, and other countries) for more than a decade.
What’s new is that increasingly it’s not private for-profit companies providing consumers retail alternatives to the utility, but local governments or coalitions of governments. These entities, known as Community Choice Aggregators (CCAs), are usually set up with environmental and other social goals in mind, such as getting a larger share of power from renewable (and sometimes local) sources, or reducing or eliminating purchases from coal-fired generation or nuclear plants.
And that’s why some people refer to CCAs as “politically correct retail choice.” (One of Jim Bushnell‘s many insightful and humorous comments.)
But snarky labels aside, what do CCAs do? Are they a good idea? And what risks might they bring?
First, retail choice, whether with a for-profit firm or a CCA, does not mean you are ditching your local utility. The utility still owns and manages the distribution lines that carry electricity to your house. And in most cases the utility is still in charge of metering each customer’s usage and sending them a bill. That’s because on each kilowatt-hour you use, you still have to pay the utility’s distribution charge and, in many cases, fees for transmission and for public interest programs like energy efficiency investment and assistance for low-income customers.
Retail choice means that your CCA or for-profit retailer replaces the utility in contracting to purchase electricity on your behalf. The hope is that competition will have the same effect in electricity procurement as in most other markets: better prices and a wider variety of products. Of course, we have learned that electricity is not always like other markets.
For example, the electricity itself is not differentiated once it is on the transmission grid. You are not getting electricity from any particular source. Once it is injected into the grid, it all gets “mixed together” and what you get is your helping from that soup (OK engineers, you can stop wincing now). Still, if your retail provider is out there on your behalf signing contracts to put more renewable electricity generation onto the grid, that is likely to help change the mix and make the soup greener.
For instance, if your utility has a goal of getting 20% of its electricity from renewable sources, and you want your consumption to be associated with 100% renewables purchases, then a retail choice provider that contracts 100% for renewables may be the solution. Interestingly, among the for-profit retail choice providers few tout high rates of renewable generation. But among CCAs, the vast majority do.
Yet, while offering much higher renewable shares than the IOUs, CCAs are also charging prices that are generally very close to those of the incumbent IOU they compete with, sometimes even a bit lower. How can they do that?
I’ve been at a number of public discussions of CCAs and watched as this question led to raised voices and red faces.
Making the case for CCAs
CCA advocates generally rest their case on two arguments: renewables are cheaper than you think and utilities are less public spirited than they claim.
First, supporters argue that renewables are much less expensive than they used to be and can compete head-to-head with conventional generation. There is no doubt that renewables costs have dropped drastically in the last decade. With the very favorable federal tax credits and depreciation rules they receive, wind and grid-scale solar power may cost about the same as gas for a new plant built today.
Second, the CCA advocates argue that utilities have all the wrong incentives and don’t procure power cost-effectively. In particular, utilities like to build their own power plants so they can earn a rate of return on their investment. And when they do buy power from merchant generators they get to pass those costs along, so they are not out there searching for the best possible deal.
There is clearly some truth to this argument. One need not look far to find examples of utilities that have not been as cost-conscious as they should, even with the oversight of regulators. Of course, it is also not hard to find examples of local governments spending money unwisely.
But CCA advocates can point out that at least governments are supposed to be acting in the interest of consumers, while the fiduciary responsibility of an IOU is to its shareholders. Furthermore, advocates argue, CCAs don’t replace the monopoly utility retailer with a monopoly CCA retailer. Rather, the CCA has to compete with the utility.
But are CCAs really looking for a fair fight?
The incumbent utilities and other skeptics respond that the competitiveness of renewables-heavy CCAs is mostly smoke and mirrors. They point first to the historical obligation of the utility to procure electricity every year, not just at a time when renewables costs happen to have dropped. In many cases, regulators required utilities to purchase renewables under long-term contracts that are much more expensive than current renewables prices.
This is clearly true, but it’s not a reason that CCAs shouldn’t be allowed to compete. It’s just a reason that customers leaving the utility for a CCA need to pay their fair share of the costs of past contracts. Most CCA advocates agree that some sort of “exit fee” is justified. The fight comes down to what a “fair share” is and how high that exit fee should be. A lot of accounting hocus-pocus can be introduced on both sides.
While the accounting can be complicated, the fundamental concept isn’t. A CCA should succeed or fail based on its ability going forward to procure power from the sources its customers prefer at a cost that is competitive. Whatever regulatory mandates, managerial mistakes, or incompetence occurred in the past, customers switching to a CCA should not be allowed to shift their share of costs from past decisions onto other ratepayers.
If the exit fee is set too low, it’s easy for a CCA to offer “competitive” rates that are just a cost shift. But it is also easy for the utility to squash efficient competition if it gets to charge the CCA’s customers an excessive exit fee. Getting the exit fee right is central to making sure that retail choice provides fair and efficient competition.
Who Gets To Be the Default Provider?
Utilities also complain about a particular advantage that CCAs usually get, default status. Most CCAs that have been established have been allowed to tell customers in the community that they are joining the CCA unless they explicitly opt out. That turns out to be a big advantage, because most customers pay little or no attention to the issue. Utilities say that is unfair, and they are right. But the opposite is unfair as well.
In fact, from the deregulation of long-distance telephone service in the 1980s, to the introduction of electricity retail choice in the 1990s, to CCAs today, the choice of default provider has tilted the competitive landscape during the transition. No one has come up with a great solution that doesn’t unfairly advantage the incumbent monopolist or arbitrarily assign customers to a seller they have never dealt with before. CCAs argue that they are different, because they are affiliated with the local government that is supposed to be acting in the interests of residents.
Recreating Flawed Deregulation?
Nearly two decades of retail choice experience with for-profit companies has made clear a problem when customers have too much flexibility to jump back and forth between a utility and a competing retail provider. During California’s disastrous deregulation, when wholesale prices skyrocketed in 2000-2001, many retail providers folded and sent their customers back to the utility.
In that case, the utilities were obligated to take the customers back, but it was clear that customer option created an incentive for some retailers to bet on risky procurement strategies. They (and their customers) knew that if the strategy failed the customers could just return to the utility rates. But that meant the utility would then have to buy more power when it was especially costly, driving up the rates for all.
This problem has been solved in other deregulated electricity markets by making rules that customers who switch will not automatically be able to switch back to the utility’s standard rate. In some markets, the “provider of last resort” utility just has to sell them power at a rate that reflects wholesale electricity prices, even if those prices are sky high.
Applying this scenario to utilities and CCAs, one could argue that without clear rules customers from either side might later want to switch opportunistically, creating the same sort of free riding problem we saw during the California crisis. There might, however, be one important difference of perception. Without clarity about switching rules, CCA customers seem more likely to expect they have a free option to switch back to the utility than the other way around.
Do These Contracts Make Me Look Green?
Finally, as I blogged about last month, merely buying unbundled Renewable Energy Certificates doesn’t necessarily mean that the electricity provider’s purchase is increasing the total amount of renewable energy on the grid, or decreasing greenhouse gases.
There are generally strict rules about what utilities, CCAs and any other retailer can count towards a Renewable Portfolio Standard, the minimum renewable share that many states mandate. But beyond a state’s RPS, there are often few restrictions on what a retailer can claim counts as providing renewable power. So, regardless of the retailer, green energy claims deserve close scrutiny.
So Is Community Choice Aggregation a Problem or a Solution?
My own view is that carefully implemented CCAs may benefit a community without dumping costs onto other utility ratepayers. Benefits are more likely if either (a) the community wants a much greener power mix than the utility will provide, and the community is sophisticated about the prices and greenness of the power it buys, or (b) the utility is doing a poor job of procuring electricity cost-effectively and the community can do better. Of course, if either situation exists, why should retail electricity competition be limited to local governments?
Regulated investor-owned utilities are flawed organizations that operate under a distorted set of incentives. But local governments are also flawed organizations subject to their own set of distortions, a fact that is often less appreciated by the local government leaders who are promoting the CCA. If your community is considering a CCA, you need to think about which organizational structure is most likely to have the sophistication and the incentives to serve you best.
I’m still tweeting energy news articles and new research papers @BorensteinS
Severin Borenstein is E.T. Grether Professor of Business Administration and Public Policy at the Haas School of Business. He has published extensively on the oil and gasoline industries, electricity markets and pricing greenhouse gases. His current research projects include the economics of renewable energy, economic policies for reducing greenhouse gases, and alternative models of retail electricity pricing. In 2012-13, he served on the Emissions Market Assessment Committee that advised the California Air Resources Board on the operation of California’s Cap and Trade market for greenhouse gases. Currently, he chairs the California Energy Commission's Petroleum Market Advisory Committee and is a member of the Bay Area Air Quality Management District's Advisory Council.