[BETA] Fortnightly

The winds of competition are blowing. Some find them chilling; others find them exhilarating. Deregulation calls on competitive markets to stand in for regulatory decisions, giving more choice to customers, reducing costs dramatically, and requiring new capabilities.

Competition is already transforming major portions of the electric industry. Changes in federal and state regulation have introduced competition from independent power producers, and the 1992 Energy Policy Act (em

requiring open access to the transmission grid for wholesale transactions (em has aided competition in the bulk-power markets. High-cost electric utilities can no longer exploit their geographic market power by denying reasonably priced access to their transmission assets. Competition has also entered retail markets in the form of cogeneration, self-generation, district heating and cooling, industrial plant siting, municipalization, and demand-side management (DSM). Customers clearly have competitive options and they want more.

Competition will unbundle electricity into energy, reliability, coordination, transmission, and distribution services. Deep, liquid, pool-based spot markets will price commodity energy on an hourly basis; generation will become fiercely competitive. Customers will enter long-term capacity contracts for base-load reliability and may bid short term to determine peak interruptibility thresholds. The marketing business will package energy, capacity, DSM, and related services tailored to address specific customer needs. System control and coordination services will be provided by an independent system operator for a regulated fee. Transmission and distribution services will continue to be regulated, but regulators will introduce market incentives to enhance market efficiency.

The micromarket segmentation that reshaped banking, telecommunications, and other services will come to the electricity industry. Customers will then choose from a menu of fixed, floating, and indexed price combinations. They will be able to select desired reliability levels for each load segment. They will have the choice

of multiple electricity products (price, reliability, service packages) from competing marketers, reaping lower costs and better service.

Electricity service companies will need to develop new risk management tools in this competitive market. With unbundled products and services, both customers and electricity service providers will need to find new ways to price risk (such as futures) and respond to risk (such as adjusting demand to real-time pricing). These risk-management tools will allow companies to capture the full benefits of market competition.

The Power of Paper:

The Role of Futures

Futures markets in grains, metals, flowers, livestock, money, oils, and other commodities have flourished and perished since at least the 15th century. New futures contracts for housing prices, advertising space, computer chips, insurance, and pollution emissions allowances are under consideration or newly operating as futures markets around the world compete to bring new risk-management tools to market.

Futures can accelerate industry restructuring. Treasury, currency, and stock index futures now strongly influence macro-economic policy. Crude oil futures helped revolutionize the oil industry in the 1980s, inviting upstart Wall Street refiners into the oil business. Natural gas futures accelerated the development of a fiercely competitive natural gas industry, made spot contracts more efficient, encouraged the development of storage, and enabled new product development (such as capped gas prices to industrial customers).1 Likewise, electricity futures could help remake the