July 1, 2001
L.A. Loves a Loophole
There's no getting around it...
Who Will Regulate PoolCo-the FBI?
Eugene P. Coyle works as an energy analyst for Toward Utility Rate Normalization (TURN), a consumer advocacy group in California that claims 30,000 members.
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The January mini-forum failed to discuss a key underlying assumption made by PoolCo proponents. The assumption is that price competition will really exist in tomorrow's wholesale electric market.
The PoolCo vision calls for a neutral agency that will receive bids from multiple independent power producers (IPPs) and investor-owned electric utilities (IOUs) to supply energy. The proponents of PoolCo spin a tale of a highly competitive world, with the bidders shaving their prices very close to their costs. Bids must be as low as costs, it is claimed, because a competitor will be bidding low as well. Low-cost producers will succeed, and have their plants running at capacity. The high-cost folks will not win many, or perhaps any, bids. Technology will drive costs lower over time, with new, clever entrants taking their places in the dispatch order, and forcing expensive and dirty plants to turn to rust. This, we are told, is how "competition" will lower electricity costs for all consumers.
Unfortunately, however, the market really doesn't control prices in the U.S. economy. I will focus on two ways in which failure occurs.
The Cartel Problem
How do you tell the difference between a pool and a cartel?
The bidders into an electric pool are going to have fairly solid knowledge of each other's costs. They'll know, within narrow limits, what the others have invested and what they pay for capital. They'll know what the others are paying for fuel and other operating costs. Each will also have a good idea of the financial strength or weakness of the others (em whether they have a cash cushion, a strong line of credit, or a deep-pocket parent.
None of the bidders will want to bid low. The theory of competition is that they will be forced to bid low because the low-cost producers will bid low to ensure dispatch. But week after week and month after month, once the pool starts, the same set of bidders will get dispatched and the same poor wretches will fail to make the cut. And as the game gets sorted out, the winning bidders will realize that if they all bid just a little higher they can make higher profits. This tactic, however, would open the door for one or more of the lowest-bidding losers-those who can just barely cover costs and run a plant. At this point strategic issues emerge. Should the winners keep bids down until the losers disappear in some fashion? Or should they raise the bids and share some of the market with some of the (former) losers? The beauty of the pool is that the players can signal to each other, with their bids, how they will behave if operator X does this, or operator Y does that. We won't see textbook price competition; we'll see strategic gaming.
Relatively few competitors can reach detente through the bidding process and collude effectively on prices. We