How deregulation made electricity more expensive, not cheaper

American families are feeling the pinch of rising electricity prices. In the past five years alone, the supply portion of the standard service residential electric bill in Philadelphia has increased by 71%. In the Lehigh Valley it has increased by 77%. And in Columbus, Ohio, by 110%. These are three data points in a national trend.

Energy affordability is quickly shaping up to be a key election issue at all levels of American politics. And more than half of U.S. adults surveyed in January reported being very concerned about the price of electricity.

New research from the Energy Markets and Policy Group that includes The Ohio State University and Lehigh University where we serve as principal investigators, provides new insights about another factor you were probably not thinking about — middlemen introduced by deregulation.

Between the late 1990s and early 2000s, several state legislatures deregulated their electricity systems. Deregulation was originally sold as a way to replace inefficient regulation and reduce bureaucracy. People were told that competition would deliver lower prices.

Under the old system, a state regulatory commission set prices for all electricity services — generation, transmission, and distribution — which were supplied by the same monopoly utility company. Each state commission was required by federal law to ensure that rates were “just and reasonable.” Under deregulation, that same commission rate-setting process still holds for transmission and distribution, but the generation part was split off.

Deregulation created competitive wholesale markets for generation, but price competition did not spread widely at the retail level. In states with active retail deregulation, there are two ways the retail generation price can be set. Consumers get to pick which one — buy from a marketer on the open market, or do nothing. Most people choose to do nothing.

Rather than introducing efficiency, this system of retail deregulation created a new complexity: middlemen marketers. In most cases, no matter which choice people make, it’s hard for them to understand how their electricity rates are set.

Electricity customers in deregulated retail markets can choose a company that buys the electricity on their behalf. Energy salespeople have sophisticated marketing programs to sell their companies’ plans.

For example, people who live in the Cincinnati area can contract with one of more than 50 suppliers to buy electricity on their behalf from the wholesale market. In the Lehigh Valley and Philadelphia there are more than 30 suppliers. Their monthly bill would still come from the regulated distribution company (Duke Energy, PPL, PECO, respectively), and would still include regulated charges for distribution and transmission set by state and federal officials. But it would also include charges from an unregulated retail supplier, for the generation part of their bill — their electric supply.

Our research has found that these markets are not working as intended.

For people who choose not to shop on the open market, by doing nothing they remain on what is called the “standard offer” or “default service.” Sometimes it is also called “provider of last resort” service because it is not meant to be the best option.

For these people, state law generally requires each distribution utility to hold auctions or use a procurement process like a request for proposals to determine which middlemen companies get to be their supplier, and of course, at what price.

People in this category still buy from middleman marketers. But rather than choosing their own middleman, they get the middleman the utility company selects for them.

People who live in states with deregulated electricity markets know that these open markets have many problems. There have been investigations into unfair trade practices, lawsuits, and regulatory penalties for misleading sales practices.

Other problems include deceptive marketing, a process called “slamming” in which companies change customers’ suppliers without their knowledge, contract loopholes that increase prices, and outright fraud.

Help for consumers usually comes after problems have arisen, rather than preventing them in the first place.

Our research team sought to determine whether, and how much, electricity consumers would save money if they used the supposedly competitive open market, rather than going with the default rate. To answer this question, we developed a detailed database of every daily retail choice offer filed by every supplier in all service territories in Ohio for a decade — which meant compiling millions of records.

We found that 72.1% of the open-market offers exceeded the utility’s default rate. In some years, there was not even one single cost-saving offer for the entire year, or longer. The vast majority of these supposedly competitive electricity prices were higher than customers would get by doing nothing. Taking the time to research the market and compare prices was often not worth consumers’ time.

Importantly, the study found that suppliers in the open market were not setting their prices based on market fundamentals — like the underlying wholesale price of electricity. Instead, they were setting prices based on the results of the utility’s default supply selection. In a competitive market, that is not supposed to happen.

In a separate study, our team evaluated every default service auction in every utility service territory in Ohio since 2011, nearly 15 years. We found that the number of companies competing with one another in these auctions is a key determinant of the retail markup consumers have to pay.

In some of the default-option rate auctions, as few as five suppliers placed bids. In others, there were as many as 15 companies vying to provide default-option electricity. Our analysis found that in situations when the underlying costs of generating electricity were the same, default supply auctions with fewer bidders delivered significantly higher prices for consumers than auctions with more bidders.

It’s important to note that Ohio’s process for setting default service rates is more robust than many other states. In Pennsylvania, the process is similar to Ohio’s. In some states, it is not uncommon for even fewer companies to bid. So Ohio and Pennsylvania’s situation is not actually a worst-case scenario for consumers. Rather, it’s probably better than many other states with deregulated electricity markets.

The first study showed that the open market is not setting efficient retail rates and is not working as intended. Most of the offers made available to consumers are not worth their time, and the suppliers in those markets are not setting their prices based upon market fundamentals. Instead, these companies are taking their cues from the local distribution utility’s default supply auctions. That is not how deregulation was envisioned.

The second study showed that the process which sets the default supply rate is also not very competitive. Less competition means the middleman companies bidding in those auctions can bid, and win, higher prices — raising electric bills and increasing their profit margin.

Energy deregulation promised lower prices through competition. But instead, consumers got an army of middleman marketers. And, those middlemen have been taking their cues from a bidding process that often has too few participants to keep prices low.

Noah Dormady is associate professor of public policy at The Ohio State University; Alberto J. Lamadrid is James T. Kane professor of economics and industrial and systems engineering at Lehigh University. This article is republished from The Conversation. A version of this article appeared on The Conversation, a nonprofit news website sharing the knowledge of researchers. Read the original article at theconversation.com/us.