Frontlines
Monopolists in Our Midst
What happens when economists and state regulators give up on electric restructuring?
February 2005
By Richard Stavros
It's not to be taken lightly when several high-profile economists reverse themselves on electric competition-giving up on policies they had pushed for years. It's also quite serious when regulators and legislators in pro-competitive states become willing to discuss a repeal of electric restructuring laws. And this flip-flopping has come from such bastions of free enterprise as the Cato Institute, MIT's economics department, and the heretofore pro-competitive Ohio Public Utilities Commission (PUC).
These developments, seen over the fast few months, have set the industry buzzing. They portend an ideological retreat from the dream of competitive markets.
Even at the federal level, speculation persists whether FERC's chairman and market champion Pat Wood III will be renominated to a second term (his first term expires June 30), or whether Wood's push for regional competitive markets will end with him.
Nevertheless, experts point out that a clear winner of the overall restructuring policy debate is anything but assured. That's why this debate is so intriguing, they say. What's even more interesting is that all this criticism, coming as it does from theoretical economists, does not necessarily discredit the general notion of deregulation, as much as the model the regulators have chosen to implement competition.
Consider the Cato Institute's Peter Van Doren and Jerry Taylor, who came out against
electric competition in their article, "Rethinking Electricity Restructuring," published last year in Cato's journal Policy Analysis. In essence, they said the patient had been ill for a long time, but the cure turned out worse than the disease:
"The poor track record of restructuring," they wrote, "stems from systemic problems inherent in the reforms themselves."
A second-best alternative, they said, would have been for those states that had already embraced restructuring to return to an updated version of the old, vertically integrated,
regulated status quo:
"It's likely," they explained, "that such an arrangement would not be that different from the arrangements that would have developed under laissez faire."
Van Doren and Taylor believe electric restructuring failed in its mission to provide price relief to high-cost states. That's not to say that the pair didn't have their criticisms of the old, vertically integrated model.
In the February 2004 edition of Public Utilities Fortnightly, they acknowledged the long-understood problem that traditional regulation had encouraged overbuilding and rate-base inflation, and explained how restructuring was supposed to fix the mess:
"Because investment in capital received a guaranteed return, total generation investment was excessive and skewed toward capital-intensive facilities. … Introducing market forces into the utility industry would eliminate the bias for capital-intensive projects by introducing uncertainty about returns."
More than that, Taylor and Van Doren cited the failure of restructuring to defuse the political infighting between the supply-siders and the environmentalists:
"Electricity prices were wrong all the time. They were too low on peak and too high off peak."
Market forces and marginal-cost pricing were seen as a way of leveling consumer electric demand, trimming the peak, and boosting consumption off the peak. This, as Taylor and Van Doren explain, could have minimized the "needless political fighting (most notably, the eternal fight over more supply versus less demand) that inevitably arises in electricity markets because of the absence of prices as a signaling device."
Alas, however, we are still waiting for such win-win results.
Destined to Fail
MIT Economist Paul Joskow late last year concluded that regulators have left electric restructuring doomed to failure by inserting so many non-market backstops and safeguards that the "deregulated" model becomes more complicated than the previously regulated one.
In a paper titled Reliability and Competitive Electricity Markets, Joskow and co-author Jean Tirole wrote: "Despite all the talk about 'deregulation,' a large number of non-market mechanisms have been imposed on emerging competitive wholesale and retail markets.
"These mechanisms," the authors explain, include "spot market price caps, capacity obligations placed on load serving entities, … ancillary service requirements enforced by the system operator, procurement obligations … , protocols for non-price rationing of demand to respond to 'shortages,' and administrative protocols for managing system emergencies."
Joskow and Tirole wonder why market mechanisms could not have taken over these functions, but find that consumer protections built into the system by the architects of restructuring to mitigate market power have rendered this desirable result virtually impossible:
"In some cases the non-market mechanisms are argued to be justified by imperfections in the retail or wholesale markets: in particular, problems caused by the inability of most retail customers to see and react to real-time prices … [plus] imperfections in mechanisms adopted to mitigate these market power problems."
As the newspaper cartoon character Pogo was wont to say, "We have met the enemy, and he is us."
The use of non-market mechanisms to counter perceived market imperfections was precisely the criticism leveled recently at the Ohio PUC, which, fearing a sharp rise in power costs, granted FirstEnergy a plan to freeze rates in 2006 through 2008, with some increases possible, such as for tax increases.
Alan Schriber, PUC chairman, said at the time to the local Toledo press that the rate freeze was necessary to keep customer bills from skyrocketing.
Joskow believes also that economists and engineers could do a better job of talking with each other to reconcile the design of markets with the physical complexities of electric power networks and the constraints that these physical requirements may place on market mechanisms.
He concludes in his paper that the conflicts from old-world and new-world policies make it "challenging," at best, to achieve an efficient allocation of resources with retail and wholesale market mechanisms.
EEI: An Unlikely Champion?
Ironically, even as some economists find deregulation unworkable (or not to their liking), the Edison Electric Institute (EEI) issued guidelines in January on how to make markets more competitive. Far from being opposed to competition, EEI's board of directors say the electric utility industry has "reaffirmed its commitment" to "vibrant wholesale power competition." The board also has released a framework to help guide the development of wholesale power markets and reinforce generation and transmission adequacy nationwide.
"It is our hope that these principles can help inform the ongoing debate over the future of competitive power markets," said Wayne Brunetti, EEI's chairman and also chairman and CEO of Minneapolis-based Xcel Energy.
"Wholesale markets offer substantial benefits to customers. The benefits of robust wholesale competition can be achieved only if a strong, effective state-federal working relationship is established on all regulatory matters that provide the stability and certainty needed to attract investment."
EEI believes competitive market rules "should not favor one corporate structure, business model, or retail regulatory model over another. Many different structures and business models can coexist in a competitive wholesale marketplace provided there are fair rules in place for all market participants."
No one will argue that development of fair rules has not been the biggest challenge of all. Finding equity in energy markets is what an equitable conclusion to electric restructuring will depend on-whether it is a regulated or unregulated solution.
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