There are a number of Texas electricity providers that seem to be selling electricity at a loss. That is what I see when I look at the Power To Choose website and look at the lowest priced plans. Does that seem like a ridiculous statement? It certainly does to me. However, breaking down the math I have a difficult time coming to any other conclusion. It seem illogical past the point of believing to think that companies are taking a deliberate loss on customer acquisition for extended periods of time. However, lets break things down. For starters, when someone puts in a zip code or enters their TDSP (I chose Centerpoint since I live in Houston) on PTC, the first category they’re dropped into is fixed rate plans, and the lowest fixed rate plans listed are at the very top of the page, the 3 month fixed-rate plans. Right now Pennywise Power, Summer Energy, and Reach Energy are listed at the top. As of Friday January 25th, their rates for a 3 month plan are 4.9, 5.0, and 5.3 kWh, respectively.
For the simple math on a monthly customer bill that used 1,000 kW of electricity, that would break down approximately to the rate times 10, or $49 (or $50, or $53, etc.). Cheap bill, right? But here is the catch; electricity providers advertise rates to customers to include lots of little charges rolled up into the final kWh rate. That is the cost of energy itself, ancillary charges, shape costs, nodal costs, TDSP charges, and various other potential energy charges that can be confusing. That doesn’t even include a company’s profit. Right now, per my sources, the cost of energy alone for 3 months is trading between $38 and $40 dollars. If an energy charge were the only charge a company had to pay for each customer, that would give the cheapest guy in the market a $10-$12 margin on each customer, which is actually pretty nice. But that’s just the energy charge. Here’s the real kicker. Of all the various charges I listed above, the TDSP charge ALONE in Centerpoint right now is roughly $45. In Oncor (Dallas) it is currently $37. That means ignoring every other charge I listed, it costs a retail electricity provider (REP) more than $85 per month to service a customer in the city of Houston. And yet an REP setting their 3 month price at 4.9 kWh, like Pennywise Power, could be taking a $35/month loss on each new customer for that plan. If this were a Math Equation, it would looking something like this:
TDSP Charge (Houston): $45
Nodal Cost: $1
Ancillary Service Charge: $1
Overhead Charge: $X
Margin Expectation (profit): $Y
Energy Charge: $Z
Residential Price Offer: $49
This is simply Algebra. If the TDSP charge is a constant at $45 dollars, and if we are extremely generous by saying that the Nodal Costs and Ancillary Charges are only $1 apiece, and we are certain the Residential Price Offer is $49, then we just have to figure out X, Y, and Z. And if Overhead Charge is Zero, and expected profit is but one measly dollar, that means the Energy Charge would have to be $1. One Dollar. The problem is that I also know from talking to people that the Z/Energy Charge number is around $40 dollars. And that makes this an unbalanced equation unless Margin is a negative number.
Remember, these are all businesses that have overhead and costs of their own, just to operate, so the overhad charges would never really be just $1 either. Some of the companies might be 3 traders at a card table who know how to buy energy and pass it on, and some companies might be really big with a huge infrastructure and massive operating costs, like NRG, who owns Reliant Energy and Pennywise Power. Taking a loss on a large scale over a long period of time, can be unequivocal business suicide for a company of ANY size, and yet that is what the math above illustrates as happening.
The Question To Ask
The question to ask isn’t “How Much Money Are These Guys Making?” It isn’t even “Are These Guys Making Any Money?” The question is “Why Might These Guys Be Selling At a Large Loss?” I freely admit that I haven’t been trading for decades like many people undoubtedly involved in supply and price setting for these companies. As a layman who might be missing something, I’d like to understand the math being used to get to profit at these rates. I’m not sure someone can provide it. Either way, let’s at least take review who is doing what in the market.
As of January 25th, 2013, Pennywise Power (NRG) has the lowest priced plan, followed by Summer Energy, and then Reach Energy. We’ve guesstimated a number of $85 dollars before we get break even for a customer in Houston, but lets be generous and call it $75. There are 8 plans in Houston with rates between 4.9 kWh and 7.4 kWh, 3 of them offered by Reach Energy. We also have TXU, Veteran Energy, Infinite Energy and 4Change Energy. Oh, and TXU owns 4Change Energy, and Infinite Energy owns Veteran Energy. So in reality you have 8 plans between 5 companies, all offering plans that I’d argue are operating at a loss or at BEST, break even.
One other thing to consider is that many of these plans might come with exceptionally high Minimum Usage charges. Companies tend to charge a small fee each month if an electricity bill is under a certain amount of usage. If a company decided to highly inflate this fee, say from $5 to $20, for anyone who uses less than 1,000 kWh of electricity per month, then that would be another possible way they would make their money back. This fee wouldn’t be reflected in the advertised kWh pricing, so the plan would still look like a great deal. And even in Texas, it would be hard for most households to use more than 1,000 kWh of electricity during the winter months, meaning most peoplew would be getting tacked with an additional $10-20 each month off the bat. Check the electricity facts labels for any of these plans to identify the Minimum Usage charges for each plan.
That still leaves the question of “Why.” Why would these companies willingly operate at a loss. Well, I have a few thoughts on the possible reasoning.
The first answer is market share, and this isn’t anything new, in any field. For electricity in Texas, we’ve seen things like this for years now. A newly formed REP will enter the market, fresh with investment capital, and will take an early loss to acquire a customer book as quickly as possible to try and become a player in the market. But that is a short term play, and that is usually how it plays out for companies on Power To Choose. New companies will take a short turn at the top for a few months, then move back in the pack. The reasoning for this is that much as it didn’t work for the dot.com bubble, negative margins into perpetuity are not attractive to anyone and can’t sustain a business long-term. A good reason for why new, small companies aggressively attempt to gain market share is that reaching certain thresholds, much like many industries, leads to economics of scale in running their business. It makes their power needs more resemble tradeable blocks of power in the market, which reduces their trading premium. Think about it…a company can’t buy power for just 10 customers from the power generators, those energy metrics are traded at much higher volumes. Economies of scale also lead to price breaks based on volume for things like mail, call center expenses, forecasting expenses, and so forth. Beyond that, no acquirer is looking to buy someone who is building their business on Power To Choose by gaining customers at a wide loss. So why is market share a feasible answer here? For Summer and Reach and some others, it MIGHT be a feasible answer. However, it is also dangerous gamble. Attempting rapid market share gains at potentially huge losses is a bet against or on the company’s bank account, depending on perspective. For Pennywise Power, owned by NRG, it most certainly can be simply a desire to gain market share. Of course, that speaks volumes about NRG’s ability to win on practices selling above cost with their other brands, if so. What’s disturbing in the NRG case is that Pennywise has been at or near the top of these low prices for roughly more than a year now. That’s a long time to be taking a loss. But just keep that in mind and we’ll get back to Pennywise/NRG.
In regard to newer companies entering the market, not having a complete grasp on what some of the costs will be for each customer realistically could result in them perhaps underestimating customer costs. Or they couldn’t have a proper grasp of renewal rates that will rise for customers over time…any number of things. Perhaps they really are betting that they will renew customers signed at these rates for double or more the price at summer time. If so, they must have some churn magic that no one else has yet to discover. Like it or not, there’s a learning curve for new companies entering the market without the right experience, and there’s no shame in not understanding the costs and difficulties of growing a company from 1,000 to 5,000 customers, or from 5,000 to 10,000 customers. And as someone with a heavy background in eCommerce and customer acquisition, I can take a look at their websites and tell you that they don’t appear to have the infrastructure in place to be helping themselves gain customers using technology platforms, and building platforms cost money. Again, this is nothing to be ashamed of, it’s simply a fact that building companies up takes time and money, and it’s a reasonable expectation that new companies might not have a complete grasp on what the expenses will be for each customer short and long term. Again, however, that doesn’t apply to companies like NRG, who are the best at what they do from a trading perspective and have literally decades of experience in this realm.
Another aspect, similar to renewal rates and lofty or naive assumptions, is perhaps a strategy that involves hammering customers who don’t pay attention to their term ending. For those who don’t renew and don’t switch, they’ll roll over to a variable rate, which is standard market practice. What that rate is could be any number, and it is often a function of a company’s cost to buy that period’s previously unhedged power for non-fixed customers. However, there are occasional cases where companies then send the variable rate on customers up by 3-4 times in order to recoup costs, especially if they don’t expect to renew the customer after their term has lapsed. As someone who works with customer reviews in this market on a daily basis, this obviously concerns me a great deal , and it also leads pefrectly into my next point.
Timing is Everything?
This is just a theory I have, but I’d like to flesh it out here. One thing that is important to consider is that the costs of many of these companies can’t be sustained long term, and that’s not just because they’re taking a loss to acquire customers. With summer approaching all of the electric rates in Texas are going to rise for a number of reasons. The main reason, however, is the inevitable scarcity that hits Texas during the hot summer months. This drives up wholesale prices for all providers because the cost of energy being sold from the generators also skyrockets. That in turn, is reflected in the cost of plans for all electricity companies. The thing to consider here is the timing of a bunch of 3 month plans that are sold in January and February coming up for renewal in April and May. Coincidentally enough, the plans expire just in time for customers to renew their plans at much more expensive summer rates, or at worst to simply be rolled over onto extremely expensive month-to-month plans at the most expensive time of the year.
However, hopefully this kind of behavior will reveal the charlatans in the market. Any company that continues to behave this way into the summer will either need to have extremely deep pockets after selling for so long at a loss, or they’ll have to be praying for no summer volatility in what is without doubt an extremely volatile market.
What Does This All Mean for You And The Market?
So after reading all of this, perhaps your first reaction is “so what?” After all, it doesn’t really have anything directly to do with you, and at the end of the day you’re benefiting from some extremely low electricity bills, right? If some huge energy company wants to take losses on customers so you can have some low electric rates, by all means, why should you care? Believe it or not, there are reasons why you should. The Texas electricity market, which is THE model for all of the other states which are currently deregulated, is built on the fundamental core concept that competition between the REPs will spur new efficiencies and innovations that will lower prices for customers. But that can only happen if the market itself is healthy and functioning. If the biggest companies with the deepest pockets are willing to take a loss to starve out any new competition, or any competition without the resources to wait things out, they are essentially creating barriers to entry into the marketplace. And I’ve written before about how the market itself seems to be consolidating into the bigger companies with the most financial resources (and generation assets). We’ve all seen that with the flurry of well-known Texas based REPs that have been purchased over the past 3-4 years. So if the biggest companies are buying up the other companies, and there are de facto barriers to entry that ensure that no new companies can successfully enter the market and make a profit, you’re essentially removing the aspect of competition that is vital for the Texas electricity market to remain healthy. What you will have instead is 5-6 big name companies with huge financial resources carving the state of Texas up between themselves. And once that happens, prices will likely rise as they seek to make back losses, and there will be less stress to innovate and work to be attractive to the actual customers. After all, there won’t be much in the way of alternatives, and there won’t be any upstart companies nipping at the heels of the big guys to keep them honest. And historically that has been bad news for customers everywhere.