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.
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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/