[BETA] Fortnightly

Electric restructuring weighs heavy on the mind these days. Drastic remedies are born more of hope than vision. Look at the April 20, 1994, proposal from the California Public Utilities Commission (CPUC) for mandated retail wheeling (the Electric Restructuring Order, often referred to as the "Blue Book").1

The Blue Book became a catalyst for national debate. But the Blue Book did not create the problem; it only reacted. The problem stems from a confluence of forces: the rise of nonutility generators (NUGs); the emergence of new smaller-scale generating plants; the rate impact of social engineering; and, for industrial rates in particular, the design of rates oblivious to markets or prices.

Destructive Wheeling

Retail wheeling by commission fiat is nothing more than a regulatory sanction of bypass: a means to make nonutility power available to large industrial ("direct access") customers. The initial California timetable, which was delayed again and again, would have made retail wheeling available to these customers by January 1, 1996. The presumption was that large customers could buy nonutility power at cheaper rates than the utility company could offer. But bypass under this mindset will only exaggerate (em not mitigate (em the enormously expensive issue of stranded costs. By any standard, a rush to mandatory retail wheeling signifies an extreme measure, an overreaction to a condition for which there is an easier and better remedy.

Mandated retail wheeling as proposed in California stemmed from a perception that electricity prices, particularly for large industrial customers, were too high (em that bypass would cut prices to "competitive levels." The economies of scale, the lower costs associated with bulk deliveries, and the economics of unutilized spare capacity have, more frequently than not, been downplayed.

California, for example, carries a surplus of electric generating capacity. Yet California fixes the generating cost component of regular tariff rates by adding in the assumed cost of an unneeded combustion turbine (to arrive at a "marginal cost" of generation) rather than looking at the savings in per-unit fixed costs achievable by improved plant use.

The simple remedy is to allow industrial prices to be set competitively at market value through incremental pricing. But it doesn't matter what words you use. Call it market-sensitive rates, market-responsive rates, market-based pricing, or just value pricing. For all practical purposes, these three terms are synonymous. Value-based rates geared to the market should replace cost-based rates divorced from the market.

Constructive Dealing

And it is neither iconoclastic nor radical to suggest a change of thrust from cost to value. The history of natural gas and electric prices is replete with examples of value-based or incremental pricing (em from natural gas pipeline ratemaking by the Federal Energy Regulatory Commission (FERC), to the "variable" rates that the Bonneville Power Administration charges its aluminum smelter customers.

The Department of Defense, for itself and all other federal executive agencies, in comments on new California telephone regulation, is emphatic: "Incremental cost is the only relevant standard for analyzing the price floors for services that face effective price competition or a highly elastic demand function. ... Incremental cost identifies