Q&A on Austin Energy’s Rate Review with Stathis Tompaidis

 

Takeaway

McCombs Professor Stathis Tompaidis finds inefficiencies in Austin Energy's operations as the utility considers a rate increase.

Motivated by a 12% shortfall of revenue (approximately $130 million per year), Austin Energy is undergoing a rate review. To cover the shortfall, the public utility proposes raising rates and better aligning the cost of generating and distributing electricity with the revenues it receives by each of its customer classes--resulting in relatively larger increases for its residential customers, schools and places of worship, and relatively smaller increases for its commercial and industrial clients. 

Professor Stathis Tompaidis of the UT McCombs School of Business has been following the review and has written an Energy Brief on the Austin Energy rate review process, providing his insights on the process, as well as the preferred outcome.  

Stathis has also agreed to answer a few questions for Energy Insights.

Q: Austin Energy is owned by the city of Austin. Is it unusual to have a municipality own a utility, and what are the advantages and disadvantages of a city owned utility relative to the various alternatives?

A:  Though it's currently relatively uncommon among major cities in Texas, with the exception of Austin and San Antonio, there is a long history of municipalities owning utilities in the United States. Traditionally, utilities were granted a monopoly over an exclusive service area; this was the situation in most of the United States until the late 1990s and is still the case in Austin. Given that electricity is an inelastic good – meaning that very large profits can be made under a monopoly – regulation was thought to be necessary. In a regulated environment, utility owners are compensated with a return based on the average cost to the utility of providing the electricity. In such an environment, utilities can only increase their revenue and profit by increasing their costs. Compared to an investor-owned utility, a municipally-owned utility has the advantage of having ultimate control by the citizens. This control results in lower prices, compared to a competitive retail market, when Texas-wide generation is limited and higher prices when Texas-wide generation is ample. Disadvantages are that the utility is subject to the political process, has limited incentive to reduce costs, and has to balance conflicting goals (a situation Austin Energy finds itself in today).

Q: Roughly speaking, do Austin residents pay more or less than their counterparts in other parts of Central Texas that do not have city-owned utilities?

A: It depends. Currently Austin residents, on average, pay less than other people in Central Texas, who do not have a city-owned utility. However, since Austin Energy is currently losing money, it is proposing a rate increase. Based on a study conducted by Austin Energy, the cost to provide electricity to residential customers, before accounting for the transfer of 9% of Austin Energy’s revenue to the general fund of the City of Austin, is roughly the same as what a customer would pay in a deregulated area of Central Texas. Under the proposed new rates, Austin residents would pay, on average, 9% more than other central Texans pay – with the 9% difference being transferred to the city.  Not everyone would be equally affected, though: under the current proposal residents that use relatively less electricity would be paying less than comparable people in Central Texas, while residents that use relatively more electricity would be paying more--potentially much more--than their counterparts.

Q: As a city-owned utility, Austin Energy does not simply want to maximize profits. But what are its objectives and what should those objectives be?  

A: Austin Energy is subject to the decisions of the Austin City Council, which sets the objectives for the utility. There are many contradictory objectives Austin Energy is currently trying to achieve: to minimize costs; to combat greenhouse gases by achieving a certain percentage of electricity generation from renewable resources, including wind, biomass, and solar (sometimes through incentives for rooftop solar installation); to promote economic growth for the city; to promote conservation (through rebates, an inclining rate structure, weatherization for homes of people with limited resources); to generate revenue for the city. It is difficult to balance these objectives, as no guidelines are provided to help prioritize efforts. As long as Austin Energy is owned by the city, it is hard to see how this situation might change.

Q: Should Austin Energy be generating profits that can be used to fund other initiatives within the city?  Should it try to minimize the cost of electricity to Austin residents and businesses? Should it try to reduce costs to our less privileged residents? Should it be taking steps to reduce green house gases?

A: Perhaps Austin Energy is generating profits from its sale of electricity to its commercial and industrial customers. From Austin Energy’s analysis, it appears that it is not generating profits from its residential customers. It is hard to consider the transfer to the city as a profit when competitive retail rates are, on average, roughly comparable to the new proposed rates before the transfer to the general fund of the city. To me, the cleanest solution would be to have the utility minimize its costs; the City of Austin can separately decide how to raise the revenue it currently receives from Austin Energy and which programs it wants to continue pursuing. As an example of the inefficiencies that result from trying to implement city priorities through Austin Energy, the city has a goal of reducing the cost of electricity for our less privileged residents. Some of that reduction is achieved by providing assistance based on income level, and some through the reduced price of electricity for people that consume little. Yet, as Austin Energy’s study details, residents with limited means are more likely to use more, not less, electricity (they stay at home longer, do not have energy efficient appliances, and have more people live in the same space). The unintended consequence of reducing the price of electricity based on low consumption, is that Austin Energy provides a subsidy to people living in small, well-insulated spaces, who are rarely home.

Using Austin Energy to fund other initiatives may be convenient for the City Council, but is neither transparent nor efficient. Allowing the utility to minimize its costs, and raising the money Austin Energy contributes to the city budget through other sources would not change how much the residents pay to the city, but would streamline the operations of the utility and provide it with incentives to become more efficient in producing electricity. The city can still fund the same programs it currently funds without taking in more money – rather than have a transfer through Austin Energy, it would raise the money directly. The advantage would be a more transparent process where costs and benefits are directly compared.

Disclaimer

The views expressed are those of the author and not necessarily The University of Texas at Austin.
 

About The Author

Sheridan Titman

Walter W. McAllister Centennial Chair in Financial Services, McCombs School of Business

Sheridan Titman is a professor of finance at The University of Texas at Austin and a research associate of the National Bureau of Economic...

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