Exposing Electricity Customers to Spot Prices — A Lesson From Griddy
AI-enabled homes promise enabling price responsive consumers. But, are consumers really ready/willing to face the stochastic spot prices?
Utility companies are natural monopolies. This is simply due to the high capital and fixed costs to build and maintain a distribution network. Let alone the physical and economical impracticality of wiring redundancy to consumers. To prevent utilities from practicing their market power on end-users, states, through public utility commissions (PUCs), tightly regulate utility tariffs, and usually control the utility rate design. Utilities though are allowed to achieve revenues given that they are justified and approved by PUCs. To be revenue adequate, utilities must design a rate that ensures revenue stability, efficiency, fairness, and simplicity (see Bonbright Principles).
Difference Between Wholesale and Retail Prices
The stable retail rate offered by utility companies hedges consumers against the highly volatile wholesale price, which is a function of multiple variables including power plants fuel type, aggregate load, weather, and transmission constraints. The weighted average wholesale price in the US in 2020 was around 34 $/MWh or 3.4 cents/kWh (EIA), which is 7 cents/kWh less than the average retail price (Statista). This price markup ushered the business of wholesale price offering utility companies such as Griddy.
The increasing price markup between the wholesale and retail electricity rates encouraged utility business models that enable customers to face the wholesale price while paying a small fixed charge to the utility.
The Case of Griddy
Griddy and other utility companies with a similar business model in ERCOT enable end-users to participate in the wholesale market, and recover their fixed costs through a uniform connection charge (around $10). Therefore, customers under Griddy face a two-part tariff where the volumetric charge is levied based on the wholesale price, i.e. no price markup. The payment model is tempting given that in ERCOT, the average wholesale price is around 3 cents/kWh, with a market cap of $9/kWh which occurs only 0.005% of the time.
Based on their rationality, ability to automate, and load deferability, customers can achieve sound bill savings under Griddy’s payment model.
What Went Wrong?
When the Texas energy crisis took place due to extreme weather conditions and improper system weatherization, most of ERCOT’s energy sources went out of service’ leading to widespread blackouts to curtail load and maintain the whole grid. As a result of the extreme generation insufficiency, the spot price wholesale electricity increased by 10,000% and hit the market cap of 900 cents/kWh.
As the crisis extended for almost a week, Griddy’s customers were facing a price that is 10,000% higher than the average price they usually pay, resulting in an astronomical bills hitting $7000/month. It seems that the 0.005 probability of hitting the market cap was sufficient to bust spot prices based volumetric charges.
In March, and in light of the unfortunate Texas power crisis event, Griddy filed for bankruptcy ending a bold 5 years business that promised to initiate an enivronment of price-aware customers.
In Griddy’s Defense..
Despite the outrage from Griddy’s customers, the economical efficiency of Griddy’s tariff model is unquestionable. Basic welfare economics indicates that pricing at the short-run marginal cost (SRMC)is a deadweight loss minimizer. Pricing at any rate above SRMC discourages consumption that was already valued above the SRMC. On the other hand, pricing below the SRMC discourages energy conservation , and behooves the customers to consume irresponsibly. Therefore, Griddy’s tariff model, by pricing at the SRMC is socially optimal compared to the usual high price markup rate design. Griddy’s tariff model is a form of Ramsey two-part tariff, which does not rely on the volumetric charge to achieve revenue adequacy (see the article below).
In addition to the optimality of Griddy’s tariff, pricing at the SRMC becomes imperative when the adoption of rooftop solar increases, which also leads to the so-called utility death spiral forcing utilities to increase their rates to maintain revenues. The higher the price markup, the more severe the net-metering subsidy issue becomes, a problem that is already taking place in many states, particularly California (see here). Despite the economical benefit, it is crucial to ensure the readiness, automation ability and rationality of utility customers, especially residential to interact with the highly volatile spot prices.