Why do low-income customers pay higher prices in the retail selection market? – Energy Institute Blog

Five startling facts from a new Energy Institute working paper

Consumer choice is usually a good thing. For most of my family’s consumption—coffee, Legos, bike parts—we know our preferences, and our choices aren’t complicated. This makes it easy to make the right decision. Other consumer categories are not so simple. For example, tracking how much electricity we consume and the price we pay for it is complicated.

Many of us have no choice when it comes to our electricity provider. But several jurisdictions (including 13 U.S. states and the District of Columbia) do support “retail choice.” In these markets, incumbent utilities provide transmission and distribution services for all. But households can choose to buy electricity from the utility company at the default (regulated) utility rate, or contract with one of the many retail providers who offer both purchased electricity and retail services.

Source: RESA

Early proponents of retail options hoped to allow for-profit retailers to compete with dominant utilities, leading to innovations in customer service and lower costs for consumers. We’ve already seen some consumer-friendly innovations. A significant number of residential customers in these markets are now exercising their options.

But there are growing concerns about confusing customers, high retail prices and deceptive marketing practices. Some states have begun to more strictly regulate these markets. Massachusetts has considered closing retail options entirely.

With the way regulators scrutinize them through retail market reforms, we can really do some objective and careful analysis of how electricity consumers are doing in those markets. Cue this new working paper by Energy Institute graduate student (and outstanding job market candidate) Jenya Kahn-Lang. Jenya combines a wealth of consumer-level data, surveys of Retail Choice customers, and some intuitive economic modeling to explain what we’re seeing in the Retail Choice market (and why we should be concerned).

A short blog post can’t do justice to Jenya’s impressive job market report. My goal is to draw your attention to five compelling facts from this paper, distill some high-level insights from her economic models, and get people talking about this important issue.

Fact 1: Holy retail price changes for Batman

Unlike coffee beans and bicycle parts, electricity is very uniform. No matter who sells me a kWh, I charge the same for my laptop. So you might think that electricity prices offered by competing retailers would be very similar…

These charts show the distribution of retail electricity prices for the Baltimore Gas & Electric service area (September 2019 data) and the Eversource Connecticut service area (September 2018 data).

In fact, Jenya found that consumers in the same marketplace of retail options paid wildly different prices. These figures depict the distribution of retail electricity prices (measured in USD/kWh of electricity) paid by retail customers in the two markets studied by Jenya. In case you’re wondering, only a fraction of this variation can be explained by different attributes such as differences in renewable energy content.

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

These retail electricity price data can be broken down by income group. The chart below shows the average price 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 emerged in other retail options markets Jenya studied.

What’s going on here? Jenya rules out several possibilities. Some retail suppliers sell “green electricity” based on renewable energy purchases. This comes at the cost of a cost premium, but she found that wealthier households have higher demand for green electricity, so that should drive the price gap in the opposite direction.

Another possibility is that higher rates reflect the additional cost of servicing customers who may default on their bills. But in Baltimore, retail suppliers get paid even if customers default on payments, and utilities wipe out all supplier arrears, so that doesn’t explain the gap.

Jenya provides three additional facts that do provide some clues.

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

When households sign up with a new retail electricity provider, they typically enter into a 2-3 month contract at a fixed retail price. After that, it’s fairly standard for these supply contracts to automatically renew each month at the updated retail price.

Let’s say most consumers don’t pay attention to their electricity bills. If for-profit retailers understand this, they can raise prices over time. Some attentive customers will notice. But for most clients who aren’t paying close attention, it can take months or years to catch on.

Jenya documented data patterns consistent with this story. Using detailed billing data from the Baltimore market, she can understand how long customers have been with a given provider and track how contract renewal prices change over time. The graph below shows how the retail price gradually increases for customers who are not popular (or don’t care).

Note: This graph is estimated from regressions of electricity supply prices on time fixed effects, the number of unique prices consumers have faced since they last switched suppliers, and income groups. On average, the longer consumers go without switching providers, the more they pay for electricity.

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

To help consumers navigate this complex environment, regulators have created comparison websites. If you’re an active searcher type, you’ve probably used one of these sites to help you find the best retailer for your needs.

Note: This is a sample site for the state of Massachusetts.

Who wants to go through a list of contract clauses on a Saturday night? not me. Among Jenya’s survey respondents, the most commonly reported method of signing up with eCommerce is through face-to-face marketing interactions. In other words, the retailer is actively involved in direct marketing to potential customers.

This is another potential opportunity for retailers to price discriminate between active searchers and the rest of us. Jenya compares the prices on the comparison site with those offered through other registration methods such as direct marketing. The graph below shows that customers who signed up through the comparison site paid significantly lower prices.

Fact 5: Marketers are more active in low-income neighborhoods

Given the facts we have reviewed so far, it is clear that direct marketing plays an important role in recruiting certain types of customers. Jenya collects data on these campaigns by zip code to better understand how the workload is distributed. In marketing data and her consumer surveys, she found significantly more direct marketing activity in low-income neighborhoods.

Why do low-income households pay higher electricity prices?

To understand the market forces that generate these facts, Jenya builds an economic model of market supply and demand. On the demand side of the model, consumers don’t keep tabs on their bills. Some consumers find it costly to find the best price. On the supply side, savvy retailers understand this. Direct marketing allows them to recruit customers at high search costs and charge higher prices to those customers. Marketing costs are high, so retailers focus their direct marketing efforts on areas where marketing costs are relatively low.

Jenya takes this economic model to investigate in real-world data why Low-income communities end up paying more. She found that lower marketing costs in low-income areas, such as those neighborhoods that are more densely populated, could play a big role. Overall, price gaps can be attributed primarily 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 choice?

Overall, this research makes me wonder whether the benefits of opening retail electricity markets to competition might justify the costs. In terms of benefits, there is evidence that some retail option customers are willing to pay more for premium product attributes (e.g., “green” power options) that might not be available without the retail option. But when it comes to costs, it appears that many households who sign up with retailers end up paying more than the stated price. This raises efficiency and equity concerns if low-income households are particularly vulnerable. I’d love to hear our blog readers’ thoughts on the consumer protection/retail market innovation trade-off highlighted in this excellent paper.

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Suggested citation: Meredith Fowlie, “Why Do Low-Income Customers Pay Higher Prices in Retail Choice Marketplaces?”, Energy Institute Blog, UC Berkeley, Nov. 21, 2022.

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