Peeling Back the Onion on the Connection between Wholesale and Retail Electric Prices in New England

by Tom Michelman – Senior Director, Distributed Energy Resources (DER) Practice Lead

Released September 14, 2021

Estimated Reading Time: 6 minutes

At the September 2, 2021 New England Power Pool (NEPOOL) Participants Committee Meeting, NEPOOL presented an analysis including a big picture look at retail rates as a function of wholesale rates. Specifically, the title of the graph on slide 33 (Page 58 of the presentation (PDF)) is “Retail Electricity Prices Follow Wholesale Prices, But Are Also Influenced by Individual State Policies” (see below). 

Note, as seen in the figure above, the NEPOOL analysis was based on ISO-NE’s 2020 Report of the Consumer Liaison Group (Section 6 – Analysis of Wholesale Costs and Retail Rates – Page 38).

While we agree with NEPOOL’s claim of the slide’s title, eyeballing the accompanying chart does not lead the viewer to the asserted connection between New England wholesale and retail electricity prices.

SEA dives deeper…

Why does Sustainable Energy Advantage (SEA) care about retail electricity rates? At SEA we care about everything that impacts the renewable energy marketplace. For true behind-the-meter (BTM) projects, a substantial portion of the value of the renewable generation comes from the avoided cost of retail kWh charges. Similarly, remote net metering credits, which are the lifeblood of the burgeoning Community Solar sector in the northeast, are a direct derivative of the local utility’s retail rates (New York notwithstanding). 

Our clients frequently ask us to forecast retail rates and its variants (e.g., remote net metering rates) so that they can solidify their revenue projections. NEPOOL’s analysis doesn’t provide the detail needed to obtain that objective. So, we’ve taken the next step.  

Wholesale rates account for some of the variability in retail rates, but this is only a piece to the puzzle…

Table 1 (below) provides correlation coefficients from the data referenced in the NEPOOL figure above.  If there was perfect positive correlation between wholesale and retail prices then the correlation coefficient would be 100%, and if there was no correlation it would be 0%. 

1. As seen in row 1 of Table 1 (below), there is only a small positive correlation between ISO-NE wholesale prices and state residential retail prices from 2009-2020 (12% to 23%).     

Table 1: Correlation between Annual ISO-NE Wholesale Prices and State Average Residential Retail Prices

1. One cause of this low positive correlation is the lag of residential retail prices as a function of wholesale prices. SEA has found that the generation portion of retail rates is strongly correlated with forward wholesale electricity and capacity prices at the time of procurement of the retail default generation service. And those wholesale electricity prices are themselves positively correlated with what happened in wholesale markets historically. Additionally, the passing through of transmission rates also lags retail rates by about one year.
2. If we do a rough justice correlation between the retail energy prices and the average ISO-NE wholesale prices from the previous year (demonstrated in row 2 of Table 1, above), the correlation increases dramatically for all but Vermont.
3. In rows 3 through 8 you can see that with one exception the six New England states’ retail prices move together closely (i.e., correlate highly). Vermont is New England’s anomaly, because unlike the five other states in New England, it never restructured, and the entire state is served by vertically integrated electric utilities. Thus, its retail energy prices are buffered from the vagaries of the wholesale market’s spot prices. For example, Green Mountain Power, the dominant utility in the state, uses its own generation or has entered long-term contracts for the vast majority of its generation needs.
4. While correlating one-year lagged ISO-NE wholesale prices with residential retail prices accounts for approximately half the variance of average residential retail prices, the other half of the variance is a function of many factors including the portion of the state served by vertically integrated utilities (e.g., municipal light plants), default service procurement method, renewable portfolio standard costs, and various wire charge rate components including: distribution, system benefit charges (e.g., energy efficiency assessments), stranded costs, etc.
5. To peel back the onion a couple of more layers, the various wire charge rate components are themselves a function of various factors which in the big picture can be thought of as utility revenue requirements as the numerator and MWh energy sales as the denominator.
   1. Utility revenue requirements are a function of utility costs, investments, rate of return allowed on ongoing and historic utility costs and investments by state regulators (and to what degree the historic investments have been amortized), and revenue true-ups (because when state regulators approves a utility’s rates, they are doing so on the basis of forecasted factors and as forecasts are wont to be, they are almost never correct). The rate of return itself will change over time and generally will be played out in contested rate cases.
   2. The MWh sales volume comes into play because of utility rate decoupling, the practice used throughout the northeast which eliminates the relationship between utility revenues and sales volume. That is, if a utility sells less MWh (due to, for instance, energy efficiency or BTM generation) the utility doesn’t earn less, and when sales go up, they don’t earn more (perverse incentives). Decoupling represents a significant reason why rates might go up if sales are declining or vice versa. 

Thus, we fully embrace this statement from ISO-NE’s 2020 Report of the Consumer Liaison Group (Section 6 – Analysis of Wholesale Costs and Retail Rates – Page 38).

The analysis concluded that wholesale costs and the rates for residential retail power supply can vary dramatically between states and from year-to-year, mainly because wholesale electricity markets and retail electricity markets are used to obtain different products. Wholesale markets reflect the short-term spot market for electric energy, whereas retail rates reflect longer-term, fixed-price contracts. The relationship between wholesale costs and retail rates also varies with each utility’s and each state’s procurement practices for retail power. Understanding these differences is essential when comparing the two markets.

We hope our brief analysis has provided some insight into both the connection between and the essential differences between the retail and wholesale markets.