Why do low-income customers pay higher prices in Retail Choice Markets? – Blog of the Institute for Energy

Five startling facts from a new Energy Institute working paper

Consumer choice is generally a good thing. For most of the consumption that takes place in my home – coffee, lego, bicycle parts – we understand our preferences and our choices are not very complicated. This makes it easy to make good decisions. Other categories of consumption are not so simple. For example, it’s tricky to keep track of how much electricity we’re consuming and what price we’re paying for it.

Many of us have no choice when it comes to electricity suppliers. But several jurisdictions (including 13 US and DC states) support “retail choice.” In these markets, the incumbent provides the transmission and distribution services for all. But households can choose to buy electricity from utility at a predefined (regulated) rate or sign up with one of the many retail suppliers offering to source electricity and provide retail services.

Map source: RESA

Early proponents of retail choice hoped that allowing for-profit retailers to compete with the reigning utility would lead to innovations in customer service and lower costs for consumers. We’ve 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 begun regulating these markets more strictly. Massachusetts has been considering shutting down retail choice altogether.

As regulators work their way through retail market reforms, we could really use an objective and careful analysis of how electricity consumers fare in these markets. Cue this new working paper by Energy Institute graduate student (and outstanding 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 doc. My goal here is to draw your attention to five startling facts from the paper, summarize some high-level insights from its economic models, 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 no matter who sells me the kilowatt-hours. So you might expect electricity prices offered by competing retailers to be very similar…

These graphs show the distribution of retail electricity prices billed in the Baltimore Gas and Electric Company service area (September 2019 data) and the Eversource Connecticut service area (September 2018 data).

In fact, Jenya finds that consumers in the same retail choice market pay vastly different prices. These figures chart the distribution of the retail electricity prices (measured in dollars per kWh of electricity) that retail customers were paying in two of the markets Jenya studied. In case you’re wondering, only a small fraction of this variation can be explained by several attributes (such as differences in renewable energy content).

Fact 2: Low-income households pay higher retail prices on average

This data on retail electricity prices can be broken down by income group. The chart below shows the average prices paid by residential electricity consumers in Baltimore.

You can see that low-income households (light blue) pay higher electricity prices on average. Similar pricing patterns play out in the other retail choice markets Jenya studied.

What’s going on here? Jenya rules out a couple of possibilities. Some retail suppliers sell “green energy” based on renewable supplies. This drives up costs, but he believes wealthier households have a higher demand for green energy, so this should drive the price gap the other way.

Another possibility is that the higher rates reflect the extra costs of serving customers who may not be paying their bills. But in Baltimore, retail vendors get paid even when customers are past due, and the utility smooths out overall missing payments to vendors, so that can’t explain the gap.

Jenya offers three additional facts that provide some clues.

Fact 3: Prices go up (if you’re not paying attention)

When households sign up for a new retail electricity supplier, they typically sign a contract at a fixed retail price for 2-3 months. Subsequently, it is quite normal for these supply contracts to automatically renew from month to month at an updated retail price.

Suppose the majority of consumers aren’t paying attention to their electricity bills. If for-profit retailers figure this out, they can raise their prices over time. Some observant customers will notice. But for most clients who don’t pay much 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, you can see how long a customer has been with a particular vendor and monitor contract renewal pricing trends over time. The figure below shows how retail prices go up for customers who don’t catch on (or don’t care).

Notes: This graph was constructed using regression estimates of the electricity supply price on time fixed effects, the number of unique prices a consumer has faced since the last switch, and income group. On average, consumers pay higher electricity prices the longer they go without switching suppliers.

Fact 4: Search (online) and you will find…. a lower retail electricity price

To help consumers navigate this complex environment, regulators have created comparison websites. If you are an active researcher, you may have used one of these websites to help you find the retailer that best suits your needs.

Notes: This is an example of a Massachusetts website.

Who wants to spend Saturday night scrolling through lists of contract terms? Not me. Among Jenya’s 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.

Therein lies another potential opportunity for retailers to price discriminate between active researchers and the rest of us. Jenya compares how prices on comparison websites compare to prices offered via other membership methods (e.g. direct marketing). The figure below shows that customers who register via the comparison website pay significantly lower prices.

Fact no. Myth #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 certain types of customers. Jenya collects data on these marketing activities by postcode to better understand how efforts are being allocated. In both marketing data and her consumer survey, she finds significantly more direct marketing activity in low-income neighborhoods.

Why do low-income households pay higher electricity prices?

To understand the market forces that give rise to these facts, Jenya constructs an economic model of market supply and demand. On the demand side of the model, consumers don’t pay much attention to bills. Some consumers find it expensive to look for the best price. On the supply side, savvy retailers understand this. Direct marketing allows them to recruit customers with high research costs and to charge these customers higher prices. Marketing is expensive, so retailers focus their direct marketing efforts on areas with relatively low marketing costs.

Jenya brings this economic model to real-world data to investigate Why low-income neighborhoods end up paying more. He believes that lower marketing costs in lower income areas (for example these neighborhoods are more densely populated) have an important role to play. Overall, the price gap can be mainly 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. As for the benefits, there is evidence that some customers choosing retail are willing to pay more for premium product attributes (e.g. ‘green’ power options) that may not have been provided in the absence of choice at the retail level. detail. But cost-wise, it seems many families who sign up with a retailer end up paying more than the regulated rate. While low-income households are particularly sensitive, this raises both efficiency and equity concerns. I’m interested in hearing what our blog readers think about the trade-offs between consumer protection and retail market innovation highlighted by this fantastic paper.

Keep up with Energy Institute blog posts, research and events on Twitter @energyathaas.

Suggested quote: Meredith Fowlie, “Why are low-income customers paying higher prices in retail choice markets?”, Blog of the Institute for Energy, UC Berkeley, November 21, 2022.

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