Discussion: Is Electricity Pricing Different from “Real Markets”? Should It Be? | Energy Institute at Haas

“No company in a real market would ever price that way.” If you’ve discussed electricity pricing much, you’ve surely heard this said by a person opposed to one retail tariff or another. In almost every instance, however, the claim is both incorrect and irrelevant.

Incorrect, because firms in unregulated markets are constantly experimenting with the pricing. Whether it’s fixed charges, increasing-block pricing, decreasing-block pricing, demand charges, or even exit fees, there is something analogous in the unregulated economy.

Irrelevant, because the structure of providing grid services – a monopolist grid operator that has to assure second-by-second network-wide balancing across all transactions — has no analog in the unregulated sectors. We’ll get back to relevance.

But first how about a fun game of Name That Market Pricing Practice?

I give you the electricity price structure and you come up with the unregulated market that has a similar pricing model. But don’t peek at the line below each structure where my suggested answers are.

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But what makes a natural monopoly natural is that the cost of adding one more customer is lower than the overall average cost per customer. That means that the attractive notion of cost causality – that Joe Bob Customer is responsible only for the costs that are caused by adding him to the grid – won’t generate enough total revenue to pay for the whole system. Somebody has to pay more to cover the costs. The array of prices that policy makers, utilities, and other interested parties have cooked up are an attempt to cover costs, follow cost causality, be fair to customers, help lower-income households, and be environmentally friendly, among other goals.

In real markets, companies cook up pricing to maximize profits and…that’s it. There are many things done by the government, or under government regulation, that wouldn’t be financed the same way, or possibly done at all, in the private sector: national defense, local policing, disease control, environmental protection, free K-12 education, and consumer protection to name just a few. Some private sector ideas can be very valuably applied in these area, but almost no one would say that the fundamental organization of these activities should be driven by a private-sector model.

So, let’s continue debating the pros and cons of the pricing alternatives in the rapidly-changing electricity world, but let’s do it without pretending that “real companies don’t price that way” is a useful contribution to the discussion. Whatever the model, there is likely some real company that does price that way, but who cares.

Top Comments

Stephen Littlechild

Stimulating and provocative, splendid examples, good value as always. I am with you all the way – until you reach the conclusions.
“In real markets, companies cook up pricing to maximize profits and…that’s it.” No, that’s just the beginning. What if that’s the only way to produce the product and survive? What if their competitors are doing the same thing?

Why can’t you find examples of net metering? Because it’s loss making. No private sector company could do it and survive.

Here’s another pricing policy you didn’t try to find examples of: single uniform prices. The kind that are found in economics textbooks. Are there any such examples that are not subject to quantity discounts, negotiation, “I’ll throw in this since you’re a good customer”, etc? Probably only in the public or regulated sector.

So “real companies don’t price that way” is indeed a useful contribution to the discussion, if the aim of policy is in some sense to replicate what real companies (ie privately owned companies operating in competitive markets) would do. All the examples you give (except net metering) are tried and trusted methods of surviving in a competitive market place.

But if there is some other aim of public policy, then what real companies do may indeed be irrelevant, and single uniform prices and net metering may (or may not!) have a role to play.

Azmat

Electricity is seemingly different from most other products/ services; but similarities exist with technicians [they get paid by employer any way], airplanes [they fly empty seats or cargo capacity, saved variable cost of ‘meals’ no longer applicable on domestic flights], car rentals [depreciation], clothes [new ‘collections’ degrade value of old ones], web services [capacity not used is like airplane seats, but there are some saved variable costs], etc. Water [utility] is different – it can be stored usually without loss of value.

But electricity largely MUST be used when produced. So if utilities were to offer ‘negative’ rates at trough-hours many retail and even industrial customers would use that capacity, and storage [with its costs that eventually get passed on to users] would be less needed. If stores offered discounts at late-night [because electricity is cheaper or even negative] I would expect many shoppers around.

Dynamic pricing [surge included] would be fine provided there was some advance notice –

Few of us thought negative interest rates were likely until they started happening. The only problem is a side effect might be ‘people’ putting ‘cash in the mattress’ in in a safe deposit box; and the attendant crimes as cash-carrying citizens are mugged.
Negative interest rates not good.
Negative electricity prices good.

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Is Electricity Pricing Different from “Real Markets”? Should It Be?.