[BETA] Fortnightly

Technological advances in electric generation and telecommunications make utility competition both possible and inevitable. These economic forces will eventually break down the regulatory structure of the electric industry. However, public policy should play a crucial role in molding and nurturing competition.In recent months, regulators in a majority of the states have opened proceedings to study electric competition. But little agreement exists on how to restructure the industry. I suggest that we now know enough about the issues to take some positive steps. I offer a plan that should introduce the essential elements of competition, while providing recovery of potential stranded investment and flexibility in choosing the final industry structure in the future.

Technology: Cause and Effect

Electric industry restructuring must take advantage of technological improvements in electric generation and telecommunications.

Generation. Technological advances, particularly combined-cycle gas turbines (CCGTs), have sharply reduced the cost of generating electric power and dramatically shrunk the scale required for efficient plant operation. While they cut the cost of producing power by increasing efficiencies in fuel use and operating practices, CCGTs also decrease capital intensity and shorten the period needed to bring a new plant on line. For instance, CCGTs with 200 megawatts (Mw) of capacity cost about $550 per kilowatt (Kw), are capable of 90-percent capacity factors, and have heat rates in the area of 7,500 British thermal units (Btu) per kilowatt-hour (Kwh). With gas priced at $2 per million Btu and a pretax capital cost of 12 percent, the full cost of producing power with these plants is about 2.9 to 3 cents per kilowatt-hour (›/Kwh).

Moreover, CCGT technology is improving rapidly. Thus, the long-run marginal cost of generation should remain favorable even if natural gas prices should rise substantially over the next 10 years. Fuel efficiency can be expected to improve sharply. (Fuel expense now accounts for almost 60 percent of the cost of power of CCGT units.)

Equally important is the efficiency achieved with small CCGTs. A decade ago economies of scale were achieved with coal-fired units that had capacity of 700 to 1,000 Mw and cost $1 to $1.5 billion. New CCGT technology captures most economies of scale with units of 100 Mw that require an investment of only $50 to $60 million. Consequently, CCGTs that serve only a small part of a local market are cost effective. Capital needs no longer represent a barrier to entry.

These small scales evoke a competitive industry, not a natural monopoly. The ease with which small low-cost producers can enter the generating business undermines the monopoly position of the utilities. The emergence of competition in generation is inevitable.

Telecommunications. Technology that permits two-way communication between customer and supplier has become vastly more sophisticated and much cheaper in recent years. Customers can now play a key role in determining the services they buy (em something not feasible until recently. Electric power can be marketed, not just provided on a take-it-or-leave-it basis.

New communications technologies will afford freedom of choice to customers in selecting the electric services they buy. This new freedom will cast both customer and producer