[BETA] Fortnightly

The financial community's focus on utility competition has been riveted on the proceedings now in progress at state regulatory commissions. The fear that something immediately damaging will come out of these proceedings seems to have diminished in recent months, and the stock market has reacted favorably. However, regulatory developments are only one of four paths leading to competition; the others are the marketplace, the legislatures, and the courts. Each could play a critical role in the emergence of competition.

Marketplace

The engine that drives competition is the marketplace. It is fueled by technological progress that has greatly reduced the economies of scale from electric generation. In the past, large central power plants were far more efficient than small plants, which provided a rationale for granting monopoly franchises to utilities. The new technology has taken the cost advantages of large-scale production away from the utilities and created forces that make the emergence of competition inevitable.

Ten years ago, the efficient generating unit had capacity of 800 to 1,000 megawatts (MW), a unit cost of $1,200 to $1,500 per kilowatt, and involved an investment of $1 to $1.5 billion. By contrast, combined-cycle gas turbines (CCGTs) offer efficient production at one-tenth the capacity and one-thirtieth the investment. A 75-MW CCGT costs about $550 per kilowatt and requires an investment of only $40 million. Such units achieve capacity factors of 90 percent, have heat rates of about 7,500 Btu per kilowatt-hour (Kwh), and can produce power at the buss bar for less than 3›/Kwh, assuming a gas price of $2.50 per million Btu and a generous pretax capital cost of 12.5 percent.

CCGTs make it possible to build cost-effective plants that serve only a small part of a local market. This flexibility is a characteristic of a competitive industry, not a natural monopoly. Moreover, capital needs are no longer an important barrier to entry. In short, the utility does not have a natural economic advantage over potential competitors, and its monopoly will break down. The only way a utility can prevent this is to somehow produce power more cheaply than potential new entrants. Unfortunately, cost-of-service ratemaking has given utilities little incentive to improve efficiency, and their costs in many cases are far above those of potential new entrants.

While economic forces make the breakdown of a utility's monopoly position and the emergence of competition inevitable, the institutional framework that polices a utility's monopoly position will greatly impede the progress of competition. Market forces alone offer a slow (albeit sure) path to competition.

Regulators

Regulators obviously have the power to speed competition by changing the rules that protect the monopoly power of utilities, but they have little desire to do so because competition threatens to shrink their authority.

Regulators are enjoying a golden age. Their role has expanded enormously in recent years with the growth of demand-side management, integrated resource planning, and environmental regulation. The original regulatory function of capping rates to prevent utilities from abusing their monopoly power is but a small part of the current agenda. The new regulatory agenda would wither under competition.

Regulators