Until the late 1990s, utilities throughout the United States held almost complete monopoly power over supply. Consumers, with the exception of major industrial manufacturers, were required to purchase their electricity and natural gas from their local utility. Beginning with the opening up of the Columbia group of utilities in Ohio, Pennsylvania and Maryland, utilities in major population areas opened themselves up to retail competition from independent marketers. These marketers were allowed to sell commodity to consumers by using the utility pipes and wires.
Today, in 20 states and the District of Columbia, consumers from large industrials to homeowners can buy their electricity from third party suppliers other than their local utilities. Two more states have utilities that permit the purchase of natural gas from independent retailers as well.
Deregulation began as a voluntary effort by some utilities. While many utilities followed on their own volition other utilities were encouraged, without much opposition, to open themselves up to competition by state regulators.
Why were utilities so willing to open up to retail marketers? The reason was simple: Utilities have never made any money from their commodity sales operations. Since the days of Thomas Alva Edison and the first utility in New York City, utilities have passed through the cost of energy to their consumers without any profit margin. Utilities have made their money by earning a return on their fixed assets known as the “rate base.” Under a widely accepted pact with state regulators utilities have been permitted to earn a guaranteed rate of return in exchange for their monopoly control of all retail distribution systems within their territories. This guaranteed rate of return has made utilities attractive, low-risk investments for pension funds and retirement funds.
With the advent of deregulation, utilities continued to pass on the cost of electricity and natural gas as they always had. Utility prices change as market prices change in response to supply and demand factors. Meantime, retail marketers in states that deregulated traditional monopoly control were able to offer consumers a number of different supply contracts, including:
Interestingly, most of these products cannot be offered by utilities. Fixed price contracts, for example, are discouraged by regulators. They maintain that if a utility were to hedge forward price risks in order to protect consumers from price spikes their customers would get the benefit of the hedge if market prices went up. But if market prices went down the utility would be forced to pass on the lower prices to their customers and would have to absorb the losses from their higher priced hedge.
These additional types of products give customers options they did not have under deregulation. To that extent, utility deregulation certainly provides benefits to consumers. Frequently, however, one hears independent suppliers – and even some regulators — claiming that another benefit of deregulation is lower prices. These people claim that under deregulation suppliers are able to help their customers save money compared to the local utility. Many retail marketers even make the claim that consumers are guaranteed to save money by buying retail.
It is true that there are certain times when the floating prices offered by suppliers can “beat” utility floating prices. There are also times where fixed prices offered by suppliers are less than utility prices.
But these short term savings are not the result of competition. Most importantly, customers are not guaranteed to save money from retail energy supply. Retail marketers that claim that their products “save money” are misleading their customers. Let us look at these claims in the context of the two principal alternative supply contracts.
Fixed Price Products. Fixed price products protect customers from higher prices. But they do not guarantee savings. Retail marketers cannot predict the future. Utility prices could go up or down. If they go up the customer will save money. But if utility prices go down the customer will spend more money.
As with a fixed rate mortgage, which protects homeowners from higher interest rates, fixed price protection is certainly worthwhile. But it does not guarantee savings, any more than a fixed rate mortgage saves a homeowner money compared to a lower floating rate mortgage.
Floating or Variable Price Products. A retail marketer may offer a floating rate that saves money in the short term compared to utility rates. But can an independent marketer guarantee that floating rates will always save money? No.
By definition, utility floating prices will, in the fullness of time, always be lower than floating prices offered by independent marketers. All state regulators prohibit utilities from marking up their commodity prices. Therefore, consumers pay utilities the cost of electricity and natural gas.
By contrast, independent marketers must make a profit margin from commodity sales. Customers pay “cost plus.” Accordingly, over time a floating rate contract offered by a marketer will on average be more costly than utility pricing.
For short periods of time utility prices may be higher or lower than market prices. Utility prices are generally set in advance for three to six months. If the actual cost of the commodity during the period is greater or less than the utility had estimated the utility will make a “prior period adjustment” in the next period, adding or subtracting from the price for the next three to six month period an amount representing the additional amount paid or the amount saved in the earlier period. Over time, however, the utility costs will average out as the actual costs with no markup.
During the period of the prior period adjustment the independent marketer’s floating rate supply may temporarily be less than that of the utility. Theoretically, consumers could switch between marketer supply and utility supply depending upon when one becomes more expensive than the other. However, switching is not as easy as it sounds. First, customers must watch prices closely. Second, customers frequently don’t know the variable price they are being charged by a marketer until it appears on their bill at the end of a billing period. Third, changing from the marketer to the utility can take as long as three months in some cases. Finally, some marketers charge exit fees to customers who switch.
A perpetually vigilant customer located in a utility territory that permits instantaneous switching might stay on top of daily changes in marketer prices and avoid paying more than utility pricing. More likely than not however they will get caught by higher prices on either the marketer or the utility side, thereby not saving money compared to the utility price as they expected.
Conclusion. Retail marketers provide many benefits to their customers, most notably alternative products besides floating rates. Other benefits may include consolidated billing, on-line payments, loyalty rebates, or other premiums.
But savings is not one of those benefits. Savings from retail energy supply is, quite simply, a myth.