Why Are Low-Income Customers Paying Higher Prices in Retail Choice Markets?
Five striking facts from a new Energy Institute working paper.
Consumer choice is generally a good thing. For much of the consumption that goes on at my house – coffee, lego, bicycle parts – we understand our preferences, and our choices aren’t very complicated. This makes it easy to make good decisions. Other consumption categories aren’t so straightforward. For example, it’s complicated to keep track of how much electricity we’re consuming and what price we’re paying for it.
Many of us do not have a choice when it comes to electricity suppliers. But several jurisdictions (including 13 US states and D.C.) do support “retail choice”. In these markets, the incumbent utility supplies the transmission and distribution services for everyone. But households can choose to either buy electricity from the utility at a default (regulated) utility rate or sign on with one of the many retail suppliers offering to procure electricity and provide retail services.
Early proponents of retail choice hoped that allowing for-profit retailers to compete with the reigning utility would bring customer service innovations and lower consumer costs. We have seen some consumer-friendly innovations. And a significant number of residential customers in these markets are now exercising their right to choose.
But there are growing concerns about confused customers, high retail prices, and deceptive marketing practices. Some states have started to regulate these markets more strictly. Massachusetts has considered shutting down retail choice altogether.
As regulators deliberate their way through retail market reforms, we could really use some objective and careful analysis of how electricity consumers are faring in these markets. Cue this new working paper by Energy Institute graduate student (and exceptional job market candidate) Jenya Kahn-Lang. Jenya combines truckloads of consumer-level data, a survey of retail choice customers, and some intuitive economic modeling to explain what we’re seeing in retail choice markets (and why we should be concerned).
A short blog post cannot do justice to Jenya’s impressive job market paper. My goal here is to draw your attention to five striking facts from the paper, summarize some high-level insights from her economic modeling, and get people talking about this important issue.
Fact 1: Holy retail price variation Batman
Unlike coffee beans and bicycle parts, electricity is pretty homogeneous. My laptop charges the same regardless of who is selling me the kilowatt-hours. So you might expect that the electricity prices offered by competing retailers would be very similar…
In fact, Jenya finds that consumers in the same retail choice market pay wildly different prices. These figures plot the distribution of retail electricity prices (measured in dollars per kWh of electricity) that retail customers were paying in two of the markets that Jenya studies. In case you are wondering, only a small share of this variation can be explained by different attributes (such as differences in renewable energy content).
Fact 2: Low-income households pay higher retail prices on average
These retail electricity price data can be broken down by income group. The graph below charts the average prices paid by residential electricity consumers in Baltimore.
You can see that lower-income households (light blue) pay higher electricity prices on average. Similar price patterns show up in the other retail choice markets Jenya studies.
What’s going on here? Jenya rules out a couple of possibilities. Some retail providers sell “green power” based on renewable procurement. This comes at a cost premium, but she finds that wealthier households have higher demand for green power, so that should make the price gap go the other way.
Another possibility is that higher rates reflect added costs of serving customers who might default on their bills. But in Baltimore, retail providers get paid even when customers fall into arrears, and the utility smooths out missing payments overall providers, so this can’t explain the gap.
Jenya offers three additional facts that do provide some clues.
Fact 3: Prices ratchet up (if you’re not paying attention)
When households sign on with a new retail electricity provider, they typically sign a contract at a fixed retail price for 2-3 months. After that, it is fairly standard for these supply contracts to auto-renew month-to-month at an updated retail price.
Suppose that a majority of consumers are not paying attention to their electricity bills. If for-profit retailers understand this, they can ratchet up their prices over time. Some attentive customers will notice. But for the majority of customers who aren’t paying close attention, it could take months or years to catch on.
Jenya documents patterns in the data that are consistent with this story. Using detailed billing data from the Baltimore market, she can see how long a customer has been with a given supplier and track the movement of contract renewal prices over time. The figure below shows how retail prices ratchet up for the customers who don’t catch on (or don’t care).
Fact 4: Seek (online) and ye shall find…a lower retail electricity price
To help consumers navigate this complex environment, regulators have set up comparison websites. If you’re an active searcher type, you may have used one of these websites to help you find the retailer that best fits your needs.
Who wants to spend their Saturday night scrolling through lists of contract terms? Not me. Among Jenya’s survey respondents, the most commonly reported method of signing up with an electricity supplier is through an in-person marketing interaction. In other words, retailers are actively engaged in direct marketing to potential customers.
Herein lies another potential opportunity for retailers to price discriminate between active searchers and the rest of us. Jenya compares how prices on comparison websites compare with prices offered via other sign-up methods (e.g. direct marketing). The figure below shows that customers signing up through the comparison website pay substantially lower prices.
Fact # 5: Marketers are more active in low-income neighborhoods
Given the facts we’ve reviewed so far, it’s clear that direct marketing plays an important role in recruiting some types of customers. Jenya collects data on these marketing activities by zip code to better understand how efforts get allocated. In both the marketing data and her consumer survey, she finds significantly more direct marketing activity in lower-income neighborhoods.
Why are low-income households paying higher electricity prices?
To understand the market forces that give rise to these facts, Jenya builds an economic model of market supply and demand. On the demand side of the model, consumers do not pay close attention to their bills. Some fraction of consumers finds it costly to search for the best price. On the supply side, savvy retailers understand this. Direct marketing allows them to recruit customers with high search costs and charge these customers higher prices. Marketing is costly, so retailers focus their direct marketing efforts on areas with relatively low marketing costs.
Jenya brings this economic model to the real-world data to investigate why low-income neighborhoods end up paying more. She finds that lower marketing costs in lower-income areas (e.g. these neighborhoods are more densely populated) have an important role to play. Overall, the price gap can be primarily attributed to supply-side differences in marketing costs, although demand-side differences in choice behavior also play an important role.
Do electricity consumers benefit when they have the power to choose?
Overall, this research leaves me wondering whether the benefits of opening up retail electricity markets to competition can justify the costs. On the benefits side, there is evidence that some retail choice customers are willing to pay more for premium product attributes (e.g. “green” power options) that might not have been provided absent retail choice. But on the cost side, it seems many households who sign on with a retailer end up paying more than the regulated rate. If lower-income households are particularly susceptible, this raises both efficiency and equity concerns. I’m interested to hear what our blog readers think of the consumer protection/retail market innovation trade-offs highlighted by this terrific paper.
Keep up with Energy Institute blog posts, research, and events on Twitter @energyathaas.
Suggested citation: Meredith Fowlie, “Why Are Low-Income Customers Paying Higher Prices in Retail Choice Markets?”, Energy Institute Blog, UC Berkeley, November 21, 2022, https://energyathaas.wordpress.com/2022/11/21/why-are-low-income-customers-paying-higher-prices-in-retail-choice-markets/
Thank you for your post, but there is no mention of the subsidized rates that some low income customers are paying for electricity supply. What price is the subsidized low income customer paying and what is the proportion of the subsidized low income customer group to your low income group?.
I think the benefits of retail “choice” of electric supplier have been oversold. Yes, in theory choice is a benefit, but the benefit is in large part because of real differences between the various choices, such as your examples of coffee (do you want Peets or Ritual or Philz, do you want Ethiopian or French Roast, etc.) or bike parts (cheap or expensive, Shimano or Campagnolo, etc.). For electricity, you just want the lights to come on and your phone to charge – there is no difference in the actual product.
So the main benefit of “choice” for electricity is just price (and for a smaller number, the generation source), which really only excites economists. Most people are too busy to spend their time trying to compare electric rates, especially with all of their variables. I think for most retail electric customers the priorities are low rates, predictable bills, and reliable service. And this paper confirms that choice does not provide that.
Choice was intended to bring discipline to the market and provide price controls. Gas stations all sell largely the same product so we shop on price and that keeps some level of control on prices. Unfortunately regulation has failed in many places so choice was intended to replace it. The problem is that to be effective, competition requires that investors be at risk for losing money. In California, AB 57 (2002) and AB 113 (2003) guaranteed that the utility shareholders wouldn’t lose money no matter the level of competition, even when new generation costs less than half legacy contracts. So there has been no real incentive for utilities to control costs to be competitive.
This leaves us with the only real option for competitive discipline–exit. California rates are now going high enough to make stand alone microgrids cost effective for many customers.
See also Baldwin, Susan M., and Frank A. Felder. “Residential energy supply market: Unmet promises and needed reforms.” The Electricity Journal 32.3 (2019): 31-38.
Several questions (without having the time to read the paper yet):
– Do the price variations reflect differences in risk in the contracts? In Texas, that explained some of the variation (with those taking a lot of risk getting bitten in February 2021).
– What are the amounts of fixed charges in these service areas? (And are the prices reported total utility or just the generation portion?) Lower income consumers generally have lower usage rates to spread those charges.
The chart Residualized Price… is telling because the price gap exists across the range which indicates an endemic disparity. The last point about differential market seems to be at the core of the difference. Lower income households usually don’t have access to the resources needed to discern these differences. They are being lured by low introductory prices.
This situation is why California moved to CCAs for residential customers. That gives customers access to two choices–the incumbent utility or one run by the local government that has a minimal profit motive. Unfortunately the political hold of the incumbents prevent bring to bear the full brunt of competition.
Thanks Meredith (and Jenya Kahn-Lang) for this insightful analysis. Among other things, it truly begs the question of what business models DO work for electricity?
The Natural Monopoly model is hardly thriving and seems a relic given electricity industry market developments in the 21st century. The quotation marks inevitably placed around “deregulated markets” and “retail service providers” seem to imply that these models don’t work particularly well (as Jenya’s paper shows). CA’s experiences circa 2000 and the TX deep freeze show the risk and subsequent harm that “deregulated” wholesale electricity markets can create. Municipal and publicly-owned utilities have the potential to deliver signficant value, but often are highly politicized (among other things).
Jenya’s focus on marketing practices of retail service providers is particularly compelling (and frightening). “Retail Choice” is not a new idea—–once upon a time it existed in CA and I’ve often wondered what significant value-added can truly be created by retail marketers. “Green Rates” are offered by many investor-owned utilities in hybrid states—-like CA, so service differentiation seems questionable. At a time when CA is in a battle royale over Net Energy Metering, it would be very interesting to see similar analysis around marketing of solar rooftop services. I now have a clearer picture of why so much of it has been done door-to-door.
Thanks again for the sharp analysis.
In California, there is substantial differentiation between CCAs and IOUs on providing “green” power and local power. The IOUs have a very limited green power program and local is “greenwashing” in the way they procure it thanks to a 2014 CPUC ruling. The CCAs have driven up the amount of RPS in the state beyond what the IOUs would have provided without the CCAs.
I beg to differ, Richard. I’m a customer of the state’s largest CCA, the Clean Power Alliance (CPA). Their “Green Rates” are no better (or worse) than the local IOU, Southern California Edison. Yes, the CCA’s have driven up the amount of renewable energy, but they’ve had their customer base handed to them.
I’ve also worked on a number of Community Solar-Green Tariff projects that CPA has procured (or tried to procure) and they simply do not pencil—–thus the tiny amount of completed and contracted CPA procured Community Solar projects. In fact, I’ve yet to see the unique “local” or “community” value that CCA’s deliver. Much (most?) of their procured electricity is utility scale, in-front-of-the meter projects that are nowhere near the communities they serve. So much for local job benefits. Of course, the CPUC bears some responsibility for overly complex and cumbersome policies around renewables (especially community solar).
First CPA is one of the newer CCAs that has not had the ability to procure as much power as the older CCAs such as MCE, SCPA and EBCE. But more importantly CPA and other CCAs are able to offer 100% green power rate options that SCE and the other IOUs do not offer. In fact, the IOUs cap their 100% green tariffs at just a couple hundred megawatts or less than 1% of their loads.
As for who is responsible for the lack of local power projects, this is entirely the fault of the CPUC and the IOUs when they blocked the true intent of SB 43 (Wolk) in 2014. (I testified in that proceeding.) The CCAs have difficulty getting around the IOUs’ interconnection obstacles.
While retail prices for electricity have been going up in all markets, The price of rooftop solar panels and the associated inverters have been going down. When pro-rated over 25 years, Today’s rooftop solar system, grid connected, without batteries, comes in at 10 cents per kilo watt hour when on a 1 to 1 NEM contract with the utility. A rooftop Solar System with batteries (and the necessary replacement batteries) works out to 21 cents per kilo watt hour but can be “off-grid” and is not subject to the whims of utilities, or suppliers, for price fluctuation. As utilities keep modifying NEM contracts to benefit them, Like the California proposed NEM 3.0 that requires 4 kilo watt hours, banked with them, to get back just one kilo watt hour for later use, The costs for Rooftop solar, under such NRM programs, climb up to levels that encourage “off-grid” adoption of batteries. Commercial Solar farms are claiming 2 cent per kilo watt hour production but none of that low-cost energy is getting back to consumers in the form of rate reductions but as added profits to the bottom lines of the utilities. Rooftop Solar installer also keep pushing expensive Lithium based batteries when lower cost lead Acid Batteries would also work but are less profitable to the solar installer’s bottom line.
Your article might want to look into the so called “green” power options being offered by retail suppliers. They sometimes or perhaps often offer this based on Renewable Energy Certificates that do not even link to the retail market they are operating in. Do customers even know that a retail supplier in New York is offering “renewable” energy based on a wind farm in Texas or a biomass facility in California? This entire industry is built on a deceptive notion–that the wholesale power they are selling is any different from a bulk purchase contract by the utility for default service.