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PoolCo and Market Dominance

Fortnightly Magazine - December 1995


Stranded Cost Implications

PoolCo's determination of market prices will affect determinations of stranded cost, since estimation of stranded cost is ultimately an exercise in estimation of market prices. If the actual market prices that develop reflect limited competition, they may differ substantially from those that were expected when the compensation for stranded cost was originally set. Either ratepayers or shareholders could stand to lose enormous sums of money.

Figure 2 shows estimates of the cumulative stranded costs for each New York utility, given four different predictions of market prices under PoolCo.

With the price at $29/Mwh, potential stranded cost for the New York PoolCo could be as much as $25 billion.4 But if Con Edison would bid generation at two times incremental cost, the figure would fall substantially, to (a still enormous) $15 billion. In this case, the market price would rise to $40/Mwh, probably less than the cost of new capacity. With a somewhat more aggressive pricing strategy and a market price of $49/Mwh (probably less than the long-run cost of new gas capacity), stranded cost is reduced to "only" $7.6 billion.

Assuming Con Edison adopts an even more aggressive pricing strategy, our modeling indicates that prices can be maintained at $58/Mwh, which is probably less than the cost of new coal-fired generation. In this case, the stranded cost for the New York PoolCo as a whole goes negative. However, Con Edison would remain the one utility in the state that would still experience a positive stranded cost. Con Edison's stranded cost would fall from nearly $9 billion to "only" about $3 billion. Our results indicate clearly that Con Edison could set the pool price for power, and then mitigate its stranded cost by

bidding supply at far above its marginal production cost.

Mergers (em

From Bad to Worse

Now imagine how the New York PoolCo would work if Con Edison merged with one of the other major suppliers in New York, creating an even greater concentration of market power.

Such concerns emerged in the California proceedings, but PoolCo proponents argued that if all 60 utilities in the western U.S. grid participated, it would be

impossible for any one to dominate the market. However, this view assumes that regulators in other states will want to participate in this experiment and free their low-cost utilities from the existing customer base. Furthermore, like New York, most states and regions have (or soon may have) a few dominant suppliers and transmission constraints that would serve to limit the ability of a PoolCo to function competitively on a regional scale.

If mergers occur on a wide scale, and PoolCo is the primary restructuring model, the consumer benefits of competition may disappear even before industrywide restructuring ever takes place. Mergers may serve to allow some utility cost-cutting, but more significantly, may permit anticompetitive behavior that will be apparent only after the industry is deregulated.

While PoolCo is being proposed as a means to deregulate the utility industry, one should never forget that deregulation without true competition may be far worse than the current system of