Should your electricity distributor also be your electricity retailer?
Maximilian Auffhammer explored the question, “How Local Should Your Energy Retailer Be?” at the Energy Institute at Haas blog. He said the issue had come up over lunch in the office.
The distribution utility of the future is going to buy electrons in this reordered market (mostly renewables and some fossils) and sell them to its customers. It is also going to engage in massive efforts to improve energy services. It will do this by hopefully:
- Improve the energy efficiency of its customers to deal with “peak-i-ness” of demand.
- Provide innovative (by that I mean stuff suggested by economists in the 1970s) pricing to deal with demand peakiness.
- Advocate for low social cost (counting both the production costs and the pollution they produce) generation
- Provide incentives for load shifting through storage or further behavioral interventions
The question is whether this is better done via a large behemoth distribution utility or a large number of small local providers, something like the community choice aggregators we have seen popping up in recent years. The lunch table did not agree on this one!
We could debate the bulleted list, but here I am more interested in a hidden assumption in the discussion.
Over lunch, one economist pitched for the small utility that could get to know its customers better. Rate designs and efficiency programs could be better tailored to the community. Another economist argued for the large utility: a large company would attract better talent, do tech better, and offer more innovative pricing structures. This second economist asked, “Why is almost every Californian happy to have Amazon deliver them everything from videos to cleaning products, but we all want a local, community-based electricity provider?”
Ah. Yes. Amazon.
As presented, the conversation simply assumed the local energy distribution monopoly would also be the retailer. Why assume distribution and retailing are best done by one firm? Buying and selling electricity is a much different kind of business than building and operating a system of electrical wires and poles.
The Amazon that “almost every Californian” is happy to have deliver almost everything from videos to cleaning products is neither the product monopoly nor the delivery monopoly. Almost never is it both retailer and delivery company. Amazon is not even always the retailer. Sometimes Amazon is just the platform on which buyers and sellers meet.
The local energy distribution company (LDC) could be such a platform. It could host a market, help consumers link up with retail providers, then manage the delivery of power from producer to end consumer. Lynne Kiesling and I discuss this idea in more detail in our Regulation magazine article, “The need for electricity market retail reforms.”
In the debate over electric power restructuring, retailing has mostly been an afterthought. Twenty years ago Paul Joskow asked, “Why do we need electricity retailers? Or, can you get it cheaper wholesale?” His answer was that some simple wholesale power price pass-through mechanism should do the trick. But Joskow’s article made clear that “simple” isn’t easy. Stephen Littlechild, in a reply, raised many other good questions: Is that simple spot price pass-through an hourly variable price or a monthly average price? How much hedging is built into the price? Who decides? (Littlechild, “Wholesale Spot Price Pass-Through,” Journal of Regulatory Economics).
Getting the institutions right
Auffhammer concludes by saying, “Overall, getting the institutions right for this brave new world is key.” Here “institutions” refers to rules that structure social interaction. It is an important point and reflects an advance in economics.
Years ago respectable economists would have said, “Overall, getting the prices right for this brave new world is key.” Marginal cost pricing is still seen as an ideal in electric power utility economics. A focus on getting institutions right is an order of magnitude better than a simple focus on getting the price right.
One of the first steps in thinking about the institutions of electric power in the twenty-first century is recognizing we are not stuck with a twentieth-century bundling of distribution and retail services.
A second step will be to examine what it can mean to “get institutions right.” Perhaps the best way to start this examination is to read a bunch of Elinor Ostrom. Her Nobel Prize lecture offers a thorough overview: “Beyond Markets and States: Polycentric Governance of Complex Economic Systems.”