What's Up (or Down) With Texas Electricity Rates?

Since deregulation began within the state of Texas at the turn of the millennium, Texans have learned as much or more about how electricity works than people in any other place in the world. Some of the lessons learned were great for the foundation of understanding how the market would affect customers in principle. Some of the lessons learned could be considered more symptomatic of the times than as part of the bedrock of how the market will always function.

One of the lessons that we’ve all learned and been taught to expect is that electricity rates will always go up, sometimes way up, during the summer heat season. The notion of the rate increasing and the bills increasing seems almost intuitive. And frankly, why wouldn’t it? Since the days before deregulation, Reliant’s rates jumped each summer from May – November.

Was the seasonal rate increase a product of additional expenses during that period? Greed? State mandate?

The reality of it is that it was almost exclusively a product of the companies incurring additional expenses in the summer time. But shouldn’t the cost of generating electricity more or less remain constant between the winter and the summer? The simple answer is usually “no”.

Why?

Given that it is much hotter in the summer within the state of Texas, more air conditioners are run, for both homes and businesses. It takes more A/C power to heat the same room at the same temperature as the outside heats up, too. The A/Cs have to run longer and later to keep homes and businesses cooled off. As more electricity is needed on a household by household basis, and a business by business basis, more electricity has to be generated and placed onto the state’s electricity grid. As that happens, more electricity generators need to be run to keep up with demand than in other times of the year. The generators that are forced to come on line during this period are usually more expensive to run for the provider – which is why they’re not the first generators online each day. When the generation becomes more expensive, the price increase is spread down the supply chain. The Retail Electricity Provider has to pay more and the customer, ultimately, has to pay more as well.

That makes it seem as though electricity rate increases really should be part and parcel to each year’s heat season. But should this always be the case? Perhaps not.

Often times, experts will speak about this cause and effect relationship and then divert on a tangent in regard to natural gas prices. Natural gas prices affect the price of electricity in a place like Texas because many of the less-used generators run on natural gas as fuel for generating the electricity. Natural gas, as opposed to coal, nuclear, or various other products also used to generate electricity within the grid, is a much more expensive and volatile product on the price side. As a for instance, last summer saw record electricity prices that correlated almost symmetrically with record natural gas prices. Heading into this summer, however, we find that as a market, natural gas prices have basically collapsed to points that we haven’t seen in more than half a decade. With that as a given, can’t we basically assume that prices won’t rise significantly? Yes, as part of the equation, as long as natural gas prices are lower, electricity prices will be lower. This is a foundational principle to how the market functions.

But that’s not the entirety of the story. Another variable within the equation is often ignored and typically, by the average trader and forecaster within the Texas market, dismissed as relevant because it is assumed to be a relative constant, is market demand for electricity. And why wouldn’t it be? It’s always a hot summer in Texas, right? Homes will always need to be cooled, right? Businesses will always be booming and consuming more and more energy to create more products, right?

Well, the truth to one of those questions is, it’s often a hot summer in Texas, so that assumption is ok.

On the question about home being cooled, well, homes always do need to be cooled, too. And so do apartments. But what happens if the mix of homes using electricity versus apartments using electricity ever dramatically shifts? Can less people living in homes drive the overall demand for electricity within the market down? Let’s think about it.

On average, home dwellers use about 1.5 times the amount of energy that is used by apartment dwellers. Overall, the residential demand within the Texas grid, in aggregate, is roughly 40% of the total electricity used. If the mix of home dwellers to apartment dwellers is historically 55% to 45% of the population within Texas, this would indicate that almost 70% of the residential electricity demand traditionally comes from home dwellers. That also means that home dwellers generally impact about 27-30% of the total demand within the Texas electricity market as whole. Let’s assume the 27-30% consumed by home dwellers within the market works for the summer, which is the most likely.

Now consider the possibility that a migration within the marketplace occurs from people living in homes to people living in apartments. In recessionary times, this is usually a reality and this recession is no different. Apartment communities are nearing capacity throughout Houston and Dallas, just as foreclosures rise and people move out of homes after layoffs and payroll decreases as an act of reducing expenses. Publicly available data on this is scarce, but we can use some of the information provided recently by http://HAR.com, which covers Houston real estate sales. This shows that more than 30% less new homes were sold in the Houston area over the first quarter this year and last. They’ve also released data disclosing that roughly 25% less existing homes were sold in the same time period. Meanwhile, foreclosure rates continue to increase, as do apartment occupancy rate. Extrapolate that across to Dallas as well and the numbers and demand within the overall market starts to look considerably different than years past. Specifically, a shift of that nature on the residential side of electricity usage translates into a relevant decrease in overall market demand for usage. The market clearing price for electricity within the market is based on what the last electricity generator selling electricity to the market has to charge to cover its costs. If the more expensive generators are impacted by that “demand destruction”, and given that since those generators are the last to be used, they are impacted, the prices are not going to see the potential exponential increase that those generators would create.

That portrays what role something as simple as a shift in dwelling type for Texas residents could do to the market.

What happens if demand destruction also exists on the business side of the market? Are businesses using less electricity today than they were a year ago in Texas?

The answer is that if demand destruction occurs on the business side, the need for excess, more expensive electricity capacity within the market would see an even sharper decrease than what we looked at on the residential end. Business usage is demonstrably higher than residential usage within the Texas market, as whole.

So are businesses using less electricity today than this time last year? Well, yes. For one, any business that has gone out of business is using less, to be sure. It is a simple fact that the market is contracting right now, which means we’re experiencing negative growth today. A classic and directly related example of this situation is what’s occurring on the Houston Ship Channel. As a group, this set of businesses uses more electricity than any other specific group of businesses within the state. They have to use enormous amounts of electricity to create the products, such as plastics and tires for automobiles, that they ship throughout the rest of the world. When orders for new products weaken or dry up, these businesses are forced to take action, such as extended shut downs or flat out closures of production lines or the businesses themselves. These events have occurred within the last 12 months, and they’ve happened across multiple plants with few plants being unscathed.

With business usage for electricity on the whole representing a net decline within the market, coupled with less residential usage for the same reasons, demand destruction is a very real part of the overall prices reflected within the market at the beginning of this summer. If the demand remains depressed compared to the past 7+ years, this often dismissed potential variable within the equation for electricity prices to the public will continue to play a big role. The end result may be so significant that prices throughout the summer don’t actually rise much at all, and could ultimately wind up lower at the end of the summer than when the heat season began. With that as a possibility, if not a probability, Texans can count on continuing to see some of the lowest electricity prices within the entire country for the duration of 2009. For every Texas resident within these recessionary times, that should be considered good news.

from May 24, 2009