Retail electric power market shakeout in Texas, II

Michael Giberson

Following up on a Monday post, in the news another report of a Texas electric power retailer seeking to acquire generation as a natural hedge.  From Platts:

Direct Energy said Wednesday that it plans to acquire and/or develop new generating capacity in the US to support its electricity retailing business.

Direct, a subsidiary of UK-based energy giant Centrica, owns gas-fired plants totaling about 1,300 MW in Texas, where it serves about 800,000 retail electric customers, Phil Tonge, president of Direct’s North American mass market business, said in an interview…

“One thing we’ve found–and it’s not specific to Texas–is that there are obvious advantages to owning generation” to back up retail load that Direct serves, Tonge said, noting that access to generation “takes some of the volatility out.” …

Tonge said that it some instances it can make sense for a retailer like Direct to own generation equal to as much as 40% to 50% of its peak needs. Direct said that in Texas it can currently meet 27% of its peak demand from its three gas plants and five wind PPAs.

Cheryl Morgan summarized my post as asking “whether vertical integration might have been a better option for Texas,” but I wouldn’t say it quite that way.  “Vertical integration” in the electric power industry is typically conceived as bundling retail, local distribution, transmission, and generation.  As I recall Sally Hunt’s point (in her book, Making Competition Work in Electricity, and I too don’t have the book handy so I’m relying on memory), she argued that it make sense to unbundle the wires from the non-wires portions of the business, but it wasn’t inherently desirable from a policy standpoint to unbundle retailing from generation.

Once unbundled from the wires business, the retailers’ decision to own or contract for power supplies seems to be just another “make or buy” decision that any business must consider.  Some gasoline retailers are vertically integrated with refiners and crude oil production companies, others are content to buy on the wholesale market.

Morgan worries about the loss of transparency that comes when retailers acquire generation (rather than buying power through long-term contracts and short-term markets).  So long as consumers can switch retailers and have a reasonable choice of alternatives, we don’t need to worry about the loss of transparency.  Consumer switching can discipline inefficient power supply arrangements, whether through contract or ownership of generation.

Which brings us to Morgan’s second point, that the shakeout will eventually result in relatively few large retailers.  If you think that customer choices will dwindle to a few large companies, then transparency may become an issue.

But I’m not ready to lump the California and Texas retail experiences together.  The approach taken in the two states differed and the differences have seemed to matter.

RELATED: an exchange of views in the February 2009 issue of Energy Policy between Christophe Defeuilley and Stephen Littlechild. (Subscription may be required, check with your local library if you don’t have direct access).

  • Defeuilley says experiences with retail electric power “have proven less than stellar” and wants to blame the disappointing results on an inadequate view of competition arising from the Austrian School of economics, which Defeuilley says served as foundation for the reforms.
  • Littlechild disputes both the claim that retail power competition has been disappointing and the claim that lackluster retail competition is somehow connected to Austrian School views on competition. Littlechild adds that the behavioral economics ideas that Defeuilley cites are more consistent with Austrian ideas than with the concept of compeition offered by traditional neo-classical economics.
  • Finally, Defeuilley elaborates on why he characterizes retail competition as falling below expectations and on the limits he sees in the Austrian School conception of competition and why it matters to the case of retail electric power.

One thought on “Retail electric power market shakeout in Texas, II

  1. Michael:

    Point taken on “vertical integration”, though as most markets have not unbundled distribution and retail the effects are pretty much the same.

    As to consumer switching, all of the evidence I have seen suggests that it doesn’t happen without a lot of effort. The vast majority of consumers are unwilling to switch for any reason other than price, and even then they want substantial savings, not just a few dollars a month. Consumers have shown a consistent willingness to stay with higher-priced suppliers because they can’t be bothered to make the effort to switch. Ofgem claims that the UK retail market is a great success, but they put a lot of effort into consumer education that shouldn’t be necessary if the market was actually functioning properly.

    If consumers could switch easily on a day-to-day basis the way they can with gasoline things might be different, but that would require some of Lynn’s smart gadgets.

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