Moral hazard misunderstanding watch: Electricity retailing

As I have noted before (here and here), “moral hazard” appears to be one of those terms thrown about to oppose something but without much care as to whether it really is an issue. An alert reader has sent me an example of what appears to be another misunderstanding.

This time it is in a report on options of Retailer of Last Resort provisions for electricity retailers who go under. That is, what happens should an electricity retailer fail in terms of their customers getting electricity and in terms of who should foot the bill for any outstanding contractual liabilities. NERA Consulting and Allens Arthur Robinson argue that the retailer’s customers should be the ones liable. The argue:

The resulting costs that arise from a RoLR event, ie, administrative costs associated  with transfers and unhedged supply costs, should not be smeared across all customers because such an approach minimises the incentive of customers to consider the risks of signing with a new retailer;

Instead the costs should be borne by the customers of the failed retailer as far as possible.  This provides an incentive for customers to consider the risk of retailer failure in signing up with a new retailer and avoids the issues associated with moral hazard.

Then in a footnote they write:

The concept of moral hazard in this context is that if energy customers know that they will not bare the costs associated with a failed retailer, then they have an incentive to undertake greater risks, such as signing with a high risk retailer who is offering extremely low prices.

Now this actually does not misunderstand the concept of moral hazard per se. The issue here is whether we  really believe that electricity consumers are in the best position to consider the risk of retailer failure. Remember this is as opposed to those signing supply hedge contracts with them. Come on, surely industry insiders are more likely to have that information? In this situation, it is perhaps those payments that should not be made.

That said, it is a 340 page report that I haven’t read in its entirety. And the authors do realise the implications of their proposal for competition in electricity retailing.