Recently I was looking up utility rates in the Houston area and I found that I had a handful of options (60 to be precise) when it came choosing my power provider. This is because the Houston area participates in a deregulated energy market. In comparison Austin, TX (my hometown) only has one power provider option available, which utilizes the public utility Austin Energy that does not participate in retail deregulation. Power providers in the Houston Area offered residential rates ranging from 13.5₵ - 28.8₵ per kWh, while Austin Energy customers are offered a rate of 10₵ per kWh when consuming the same amount of electricity. Which leads me to ask the question why? If deregulation is supposed to make energy markets more competitive and therefore reduce energy cost, why are deregulated rates in Houston so variable and high compared to a more traditional utility like Austin Energy?
Well first let’s talk about what a traditional utility is and then move onto why a deregulated model became popular. For nearly one hundred years, the fundamental building block of the electric power sector was the vertically-integrated utility, regulated by the public utility commission in the state(s) in which the utility operated. Roughly speaking, the electric power supply chain has three links generation, transmission, and distribution. Most utility regulation occurs through a process known as "cost-based ratemaking" or "rate of return regulation." Under rate of return regulation, the utility sets prices (rates that are paid by retail customers) to recover the costs associated with providing service, plus a level of profit determined by the state public utility commission. Technology improvements and economies of scale caused electric rates to fall until 1970, which made industry and residential customers happy. In 2002 dollars, price fell from about $5.15 per kWh in 1892 to about 9.7 cents per kWh in 1970. The highly regulated structure of the electric utility business created a stable environment for expansion of access to electric power. Beginning in 1970, however, prices for electric power began to rise sharply: 320% in current dollars from 1970 to 1985 (28% in inflation adjusted prices). The price increase was due to growing technical complexity of the grid, over investment in infrastructure, and bureaucratic/political problems. Additionally, hard economic times and rising fuel cost contributed to increased rates.
Let’s get back to Texas and try to figure out why retail market rates are greater in Houston compared to Austin. In Houston your electric bill comes from the Retail Electric Provider that you choose out of dozens that are available in your area. These Retail Electric Providers are middle-men in the transaction, because they purchase electricity from the Electric Reliability Council of Texas (ERCOT) and also have to pay for the transmission and distribution of electricity (transmission lines). ERCOT maintains electrical grid reliability and facilitates competitive wholesale and retail markets. However, ERCOT doesn’t actually produce any power, so they pay power plants (gas, coal, hydro, solar, wind, nuclear, etc.) to produce electricity. If fuel is needed to generate electricity (coal, natural gas, uranium, etc.) then power plants must purchase that from a fuel provider as well. However, Retail Electric Providers don’t have to go to ERCOT to get their energy; they can also buy Intercontinental Exchange (ICE) Futures contracts. At ICE Retail Electric Providers can bid on the cost of future energy and then purchasing electricity at the agreed upon price and date. This route requires payment to futures contract traders.
So why might electricity cost more in Houston than in Austin? Well, I am sure there are many more reasons than I have uncovered in this post, but a highly possible reason is in deregulated markets, especially with retail deregulation, money passes through so many more hands before arriving to consumers when compared to vertically integrated regulated markets. Many of the hands I mentioned above are trying to maximize their profits along the way. A report by the Texas Coalition for Affordable Power stated that Texans in deregulated markets have paid higher average prices than those in regulated ones. Their findings showed that Texas customers could have saved $27 billion from 2002 through 2016 had they paid the same price as customers living in regulated parts of the state. Additional rate hikes have occurred due to the February 2021 winter storm too, but that is for another blog. The fact of the matter is that both regulated and deregulated markets have advantages and disadvantages associated with them, but hopefully we can utilize the beneficial aspects of both systems as we continue to modernize our electric grids to support more clean, distributed, and affordable power generation.