Kari-Anne Fange, Department of Business, Foreign Languages and Social Sciences, Ostfold

HOUSEHOLD CUSTOMERS CHOICE OF ELECTRICITY CONTRACT IN A LIBERALIZED ELECTRICITY MARKET

Kari-Anne Fange, Department of Business, Foreign Languages and Social Sciences, Ostfold University College,

Phone +47 69 215 292, E-mail:

Olvar Bergland, School of Economics and Business, Norwegian University of Life Sciences,
Phone +47 64 965 7 00, E-mail

Overview

In Norway, the Energy Act came into force in 1991, and laid the foundation for one of the first market based electricity systems in the world. The intention behind introducing a new Energy Act was to ensure efficient production, transmission and consumption of energy with the means of competition in generation and retailing. Through an online price comparison site offered by The Competition Authority (CA), consumers have access to full information about prices and contracts offered by retailers. From an economics perspective one would expect price to be the main decision variable on which consumers make their contract decision. With readily available price information one would expect prices charged by retailers not to differ much. However, data from the CA indicates substantial price dispersion over time. Consumer’s choices of electricity contracts appear to be based on more factors than price alone. Previous studies investigating consumers choices in a liberalized electricity market include Littlechild (2006), Johnsen (2003), Olsen, Johnsen, and Lewis (2006), Bye and Hope (2005), von der Fehr and Hansen (2009), and Amundsen, Bergman, and von der Fehr (2006).

Diamond (1971) showed that no more than a small amount of search cost will lead to market prices over and above the competitive market outcome. In markets with both active and passive buyers there will be significant and persistent price dispersion. Furthermore, retailers can soften the price competition by product differentiation.

In this paper we investigate both theoretically and empirically if consumers search costs and product differentiation can provide an explanation of the observed price dispersion. Our empirical supports both the existence of substantial search costs for certain groups of consumers and a large fraction of the consumers perceive electricity as a differentiated good.

Methods

Standard theoretical models in industrial organization predict that the presence of search costs and differentiated products lead to higher prices and price dispersion. We use this theoretical framework to specify a set of hypothesis about search costs and product differentiation. The empirical testing of these hypotheses is done using a dataset collected for the Norwegian Water Resources and Energy Directorate (NVE) in 2013 from a questionnaire answered by 1108 respondents each answering questions regarding their household, electricity consumption, and choice of electricity contract. This dataset allows us to specify and estimate a number of detailed choice models for electricity contracts, and relate these choices to a wide range of explanatory variables.

Results

The descriptive part of our analysis shows the extent of price dispersion in offered contracts, and the persistence over time. We find that there is a large group of consumers that neither changes retailers nor do any active searching for potentially cheaper alternatives. The empirical analysis of the consumer survey shows that a small group of consumers have very large search costs. A larger group of consumers hold the belief that there is little to gain from searching for a different contract (retailer). This implies that a large share of the consumers is not actively searching for cheaper retailers. We also find that a large proportion of consumers do not switch retailer because they see their current electricity contract as a differentiated product, i.e. the retailer is not only offering electricity in the contract but other valuable services as well. This bundling of electricity and services increase the switching costs associated with changing retailer serving to increase the switching costs and creating opportunities for charging higher prices.

Conclusions

Our empirical analysis of the consumer survey shows that product differentiation and bundling of electricity with other services are the most important factors in preventing customers from changing contract (retailer). This finding supports that product differentiation can provide an explanation of the observed persistent price dispersion.

Based on the findings in this research we are able to evaluate whether the current status in the market fulfills the intention behind introducing the new Energy Act and we gain a better understanding of how consumers choose contract in a mature, liberalized electricity market.

References

Amundsen, E., Bergman, L., and Von der Fehr, N. H. (2006). The Nordic electricity markets: robust

by design? in Sioshansi, F. and Pfaffenberger, W. (eds) Electricity Market Reform: An International

Perspective, Amsterdam: Elsevier

Amundsen, E., Bergman, L., & von der Fehr, NH. (2006). The Nordic Electricity Markets: Robust By

Design? Electricity Market Reform: An International Perspective, Elsevier, 145-170.

Bye, T., & Hope, E. (2005). Deregulation of electricity markets: the Norwegian experience. Economic

and Political Weekly, 5269-5278.

Diamond, Peter A. (1971). A model of price adjustment. Journal of economic theory, 3(2), 156-168.

von der Fehr, N.H. and Hansen, P.V. (2009). Electricity retailing in Norway. RSCAS Working Papers

2009/04, European University Institute.

Johnsen, T.A. (2003). Residential customers and competitive electricity markets: The case of Norway.

The Electricity Journal, 16(1), 74-79.

Littlechild, Stephen. (2006). Competition and contracts in the Nordic residential electricity markets.

Utilities Policy, 14(3), 135-147.

Olsen, O.J., Johnsen, T.A., & Lewis, P. (2006). A mixed Nordic experience: implementing

competitive retail electricity markets for household customers. The Electricity Journal, 19(9), 37-44.