The Political Economy of Electricity Rates
Since Boiteux (1949), economists have argued for electricity prices that vary over
time as demand for power waxes and wanes together with the marginal cost of electricity.
With the declining cost of sophisticated meters and the increased penetration of renewable
generation in the electricity system, the case for dynamic pricing has strengthened,
and its benefits have been established in field experiments as well as theory. While
retail prices that vary in real time with marginal costs are still largely an objective
rather than reality, by 2016 nearly 20% of major private electricity companies had
implemented some form of dynamic retail contracts.
This talk covers the introduction of dynamic pricing, and seeks to understand the variation in pricing in different regions of the country. Cohen’s key finding is that dynamic pricing is more likely to be an option in the absence of competition at either the wholesale or retail level; indeed, the likelihood of customers having dynamic pricing options declines with greater competition at either level. This result appears to put in conflict efficient pricing with another policy intended to enhance efficiency, that is, the discipline of competitive markets. Cohen explains a political economy model that suggests how the conflict may arise.
The model incorporates a public service commission with pricing authority (for regulated retail states) and a looser arrangement in the more fully restructured states. Pricing structure is based on negotiation among wholesale companies, retail companies and consumers. Where a public service commission sets pricing policies, these parties lobby the commission. Cohen incorporates standard collective choice assumptions about the relative lobbying strength of the different actors. The model takes into account the profit opportunities for the different parties. In particular, she considers whether the spotty existence of dynamic retail pricing is due to profit opportunities available to wholesalers from its absence. As Oi (1961) and Newbery and Stiglitz (1979) argue in the context of commodity markets, exogenous variability in demand presents surge pricing opportunities for competitive suppliers. Profits for wholesale companies can be greater when demand is not stabilized, as would happen with the existence of dynamic retail prices. A prediction of the model is that dynamic pricing may be eschewed in markets with competitive wholesale sectors and less organized retailers.