Consumers and Price Volatility: Texas Electricity Prices

Some Texas consumers who didn't lose power are now finding themselves socked with massive electric bills, as high as $17,000. The reason? They were paying variable kW/h pricing for their electricity at wholesale rates, without any sort of price collar. The Washington Post explains: 

The state’s unregulated market allows customers to pick their utility providers, with some offering plans that let users pay wholesale prices for power. Variable plans can be attractive to customers in better weather, when the bill may be lower than fixed-rate ones. Customers can shift their usage to the cheapest periods, such as nights. But when the wholesale price increases, the variable plan becomes the worst option.

This story jumped out at me for two reasons.

First, it seemed like a replay (on steroids) of the risks of adjustable-rate mortgages with prepayment penalties, and second, it seems like another chapter out of Jacob Hacker's fantastic (and still totally relevant) 2006 book The Great Risk Shift. 

Allowing individuals to purchase electricity at variable wholesale pricing was an obvious recipe for disaster from the get-go. Sure, it's cheaper for individuals when there's mild weather. But it shifts all of the risk of weather volatility to individuals. Individuals are incredibly poorly equipped to manage market price volatility. Indeed, few individuals are likely to understand electricity market pricing dynamics, particularly how Texas's Lone Star stand-alone grid works (or doesn't). Individuals aren't well equipped to manage electricity price volatility because most individuals are either on a fixed salary or have variable earnings that change with a fairly limited band. Moreover, those who have more variable income (other than, say an annual bonus or a farmer or artist with seasonal income) often cannot predict when those variations will occur. It doesn't take a Nobel Prize in economics to realize that variable pricing is just not good for consumers because they cannot readily diversify their income or exposures, or insure against most risks (excluding high net worth individuals who can self-insure). 

I'm not sure whether to feel sorry for the consumers who got stuck with huge bills or not. On the one hand, they clearly weren't expecting this risk when they got into their deal, and the State of Texas let them be served a potentially toxic electricity pricing deal. A reasonable consumer might think that if it's on the menu, it can't be that dangerous. On the other hand, the consumers with these huge bills did get the upside of lower bills in mild weather, and their variable rate plans effectively shifted cost to safer, stodgier consumers with fixed rate plans. Now it looks as if the state might bail out some of the consumers who got clobbered with huge bills, which means that there's a redistribution from the consumers who played it safe to those who took the risky deal.

If I recall, it was precisely that dynamic—bailouts of folks who took on too much market risk—that trigger the Rick Santelli rant that kicked off the Tea Party in 2010. Hopefully, this time the anger will be directed not at the unfortunate consumers, but at the anti-regulatory ideologues who in the name of free markets and consumer choice allowed consumers to be given an option that is affirmatively inappropriate for anyone except high net worth individuals who can self-insure against price fluctuations. 

So bringing this back squarely to consumer finance and credit, let me throw out an idea: maybe suitability standards have a role in consumer credit. We have suitability standards for investment products and separate rules for high net-worth individuals ("accredited investors"). Why not for credit products? Ability to repay requirements, which are increasingly common, shade that way. Perhaps it's worth thinking about whether suitability makes sense in the consumer finance context (or alternatively, why we aren't using it as the standard).