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.

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.

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