Electricity Markets and Price Signals: Customer Technology in Britain, and a Misleading Wsj Article About Texas

Lynne Kiesling

Two recent news articles highlight the relevance of electricity price signals and intelligent end-use technology during a period of increasing fuel prices, and the juxtaposition of the two articles highlights consumers changing their behavior in the face of high energy prices. In short, the institutional change required to achieve thriving, healthy retail electricity markets takes time, but the combination of intelligent technology and transparent price signals provides economic and environmental benefits for consumers, especially in a time of rising fuel prices.

The first of these articles, by Rebecca Smith in the Wall Street Journal last Thursday, painted a misleading picture of the role that electricity restructuring in Texas has played in contributing to overall increases in retail electricity prices there. In her article she conflates three very important things that are occurring simultaneously, and that conflation makes her article confused and misleading. Because her article hypothesizes that deregulation is the cause of high prices, she misses the many ways that dynamic market processes are doing the opposite.

First, Ms. Smith’s article fails to appreciate the importance of information transmission to and from consumers via prices, especially during a time of rising fuel prices and rising sensitivity to environmental issues. Ms. Smith accurately points out that natural gas prices have more than quadrupled in the past six years, and that a disproportionate share of generation in Texas is fueled by natural gas. But she fails to make the correct comparison, which is between current retail prices and what retail prices would be right now under regulation. In 2006 the Public Utility Commission of Texas (PUCT) performed exactly that counterfactual analysis for the Centerpoint/Reliant and TXU service areas for the years 2002-2005. They found that in the Centerpoint/Reliant area, the estimated regulated price would have been 18 to 26 percent higher than the average of the five lowest actual retail prices. In the TXU area the estimated regulated price would have been 11 to 18 percent higher. Although it’s not been updated, this analysis suggests that the results from retail restructuring compare favorably to regulation.

In other words, electricity prices would have gone up under regulation too, because what is driving the price increases is increases in the input price that composes a large share of the retail price — fuel, and natural gas in particular. In competitive markets, these input cost increases are communicated more transparently to consumers, which leads to changes in their behavior and leads to more (economically and environmentally) efficient resource use. In this case, that efficiency is taking the form of conservation and investing in energy efficient appliances, lighting, heating and cooling.

Second, Ms. Smith claims that “deregulation is to blame” for consumers being switched to the legal provider of last resort (POLR) contract when their retailer chooses to exit the industry:

Five retail companies that sell electricity to homeowners and small-businesspeople have failed. That has left customers facing unexpectedly high bills when they are quietly and seamlessly switched to other, more-expensive retailers.

Firms exiting new markets are common, and in this case the firms that exited the Texas market were too reliant on wholesale spot market purchases to be able to survive in a period of volatile and rising wholesale prices. Moreover, more than 50 retailers serve Texas customers, so five firms exiting means that 90 percent of retailers are still in the market and available to serve customers. Having “quiet and seamless switching” to a POLR is one of the consumer protections embedded in the restructuring legislation, and the high retail POLR price reflects the high degree of revenue uncertainty and wholesale market purchasing risk that the POLR provider faces. A POLR contract is intended to be a cushion while the customer signs up with another competitive retailer, not to be a market option in and of itself. From an institutional design perspective, this experience suggests that the PUCT could require more, and more timely, notification of customers prior to firm exit; it does not, though, suggest that the well-documented benefits that competition has brought to Texas consumers should be forsaken. Ms. Smith’s critique of this POLR backstop does little more than indicate how poorly she understands the dynamics of market processes.

Finally, Ms. Smith discusses the increased congestion, and congestion costs, in Texas this summer. Although she categorizes them as “not well understood”, it is clear that the increased transmission of wind power from West Texas is changing the physical flows on the network, and the outdated zonal wholesale market design (which assigns congestion costs by zone) is not flexible enough to adapt to those dynamic changes in the market and in the grid. ERCOT and the PUCT are in the middle of a multi-year process to change the market design to a nodal market, in which congestion costs are calculated more transparently and more fluidly than in the current zonal market, and these changes are likely to ameliorate much of the congestion-driven price fluctuation seen in May; however, Ms. Smith makes only perfunctory mention of ongoing institutional evaluation and change, and does not refer to the zonal-nodal market design changes at all.

As an antidote to Ms. Smith’s overly gloomy and dramatic representation of the competitive Texas retail markets, I recommend an article in Sunday’s New York Times about the steps individual homeowners are taking in Britain to “green” their Victorian homes, including new windows, solar water heating, and efficient lighting:

But they have done it through inexpensive and nearly invisible interventions, like under-roof insulation, solar water heaters and hallway meters, that leave their homes still looking like old Victorian houses. …

“What’s more important, what we’re encouraging, is to take old properties that were not built for energy efficiency and turn them around to save carbon, save energy and save money,” Ms. Hewitt said. …

But they have made dozens of behavioral changes as well. Mrs. Marchant, for example, has a lovely chandelier in the dining room with regular light bulbs. She turns it on only for dinner parties now — “We girls hate the light from those low-energy bulbs,” she said — and uses a fixture with energy conserving bulbs for day-to-day needs.

What is giving these British consumers the information and the incentive to reduce electricity use and buy energy-efficient appliances? Two things working in concert: retail competition with dynamic pricing and transparent price signals, and smart technologies in their homes that inform them about the electricity use of every household item:

A small box hanging on the wall across from the vase of flowers in the front hall of their tidy Victorian home displays a continuous digital readout of their electricity use and tells them immediately how much it will cost, helping them save energy. …

She now washes most laundry at 86 degrees, instead of 140. She resumed using her pressure cooker for vegetables, after the smart meter revealed its energy efficiency.

The combination of retail competition and intelligent end-use technology sends crucial price signals to consumers, and empowers them to change their behavior in ways that save them money relative to what they would have paid otherwise. In Texas, such pricing and technology will be increasingly available to residential customers, as retailers and the wires companies in Texas are currently working through the technical details of large-scale advanced metering infrastructure (AMI) installations. Thus we can see that the individual, decentralized choices that pricing and technology make available to the British consumers highlighted in the New York Times article will empower Texas consumers even further.