It’s cheaper because we pass the risk on to you!

by @edent | 4 comments | Read ~5,920 times.

Texas is under a mountain of snow. As the energy grid struggles, the law of supply-and-demand kicks in.

Electricity prices climb ever higher. The wholesale cost rises. And doesn’t stop rising.

Some people signed up to “Griddy” a service which charges users the wholesale rate for electricity. In normal times, that might be a good deal. Cut out the middle-man and get access to market rates. But this week it led to some homes receiving bills for tens of thousands of dollars.

Griddy’s prices are controlled by the market, and are therefore vulnerable to sudden swings in demand. With the extreme weather, energy usage has soared, pushing up wholesale power prices to more than $9,000 per megawatt hour — compared to the seasonal average of $50 per megawatt hour.

The original purpose of corporations was to spread risk. With multiple people incorporating into a single company, risk was lowered. As corporate law developed, the notion became that a “limited” company could face financial ruin without the investors losing more money than they had invested.

(It’s all a bit more complicated than that – but I’m not your history teacher.)

In the modern era, we rely on companies to shield us from the risks of the market. Let’s say wholesale electricity costs £0.10 per kWh. You buy retail from a company at a price of £0.13/kWh fixed for a year.

If energy prices stay steady or drop, the company makes a profit. They may or may not pass that on to the customer.

If energy prices dramatically rise, the company makes a loss. They almost certainly pass it on to the customer next year.

An individual exposed to the wholesale markets probably can’t afford a huge bill resulting from a sudden swing. But hundreds of thousands of customers together over a period of a few years, could afford to absorb the price rise.

The UK is experimenting with variable energy pricing. Octopus Energy (referral link) has an “Agile” price plan which reflects the wholesale costs on a half-hourly basis.

Octopus wants to make this tariff a positive experience for those who are interested in more actively managing their energy more actively. So, to take the sting out of the market volatility we do cap the maximum price you will pay at 35p/kWh for your electricity.
Agile Octopus Pricing

Which is handy, seeing as the wholesale price briefly ran up to £1.50!

Generally speaking, customers having access to market rates – without scavengers taking a cut – is a good thing. It reduces cost and increases choice.

But, as we’ve seen with GameStop shares – direct access to the market comes with significant risks. Would the people have lost money on memestocks if they had to go through a service which had some duty to insulate them from risk?

In the UK, we mandate that certain insurances have to be taken out. You legally need car insurance – because access to the wholesale cost of repairing a damaged car or human is too big a risk for any one person to bear.

This is the essential necessity of collectivism. Individually we are at risk. Only by pooling our resources can we weather the storm.

4 thoughts on “It’s cheaper because we pass the risk on to you!

  1. Alex B says:

    It occurs to me that perhaps the most appropriate concept in relation to this sorry tale is that of the “sophisticated (or accredited) investor”:

    Certain high-risk investments are locked away from investors who do not meet the legal standards to qualify as such.

    Regulation that applied a similar standard to e.g. utility suppliers would seem to be a reasonable compromise measure that protects unsophisticated billpayers, whilst preserving freedom for those billpayers well-placed to be able to shoulder any downside risk.

  2. Ester Newhouse says:

    Why did wholesale prices spike in the first place, hmmm?

    I would guess there is a bidding market at work, and as the capacity of available power declined (scarcity of supply) and demand remained constant, some automated program bid up the price to these exorbitant levels.

    There are always scavengers (middlemen)… Do you think “Griddy” isn’t taking a fixed cut of the proceeds?

    I’m sure “Griddy” ran test cases for when there are power failures, didn’t they?

    Actually, a well designed system would not have these cost spikes, as you would be using futures to buy power capacity ahead of time (but that leaves someone else to pay).

    When you turn everything into a financial market, there will always be those simply in there to speculate and turn a quick profit.

    What a crap name, “Griddy”, for an electrical power company.

  3. Jez Higgins says:

    In the UK, we mandate that certain insurances have to be taken out. You legally need
    car insurance – because access to the wholesale cost of repairing a damaged car or
    human is too big a risk for any one person to bear.

    And more importantly, the likelihood of having to pay those costs is relatively high. If the risk of car crashes was low or the harm they cased was small, insurance wouldn’t be required.

    This seems very relevant in the case of electricity supply. Electricity prices change all the time. Some of those changes are reasonably predictable, but even within that there are highs and lows and the fluctuation is pretty wide. When something outside that happens, which it will, it can really spike.

    Exposing individual buyers to the wholesale market rate without the kind of cap that Octopus provides seems to be pretty much guaranteeing problems for those buyers.

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