About 30 states have begun (em
either through the legislature, the utility commission, informal working groups, or some combination of these (em to consider issues such as retail wheeling,...
most capital-intensive of our industries (with a ratio of fixed assets to annual sales of 3.41)8 and promises to remain such even if natural gas becomes a greater factor in the generation mix. Partly because of its capital-intensiveness, short-run marginal costs tend to fall below average total cost in the electric power business. Particularly when a great deal of excess capacity is overhanging the market, one would expect many industry participants to offer power based on marginal or incremental cost. This strategy would make sense from the point of view of their own immediate business needs: Incremental revenue will exceed incremental cost, and there will be a contribution to overhead. Inevitably, other producers will respond with more sales at incremental cost. But in the longer run everyone will have to make more than contributions to overhead in order to survive. Particularly if there continues to be excess capacity (and this is likely given the general unwillingness to actually retire or scrap capacity), losses may continue all around.9
This rather grim scenario might brighten a bit as regulators
consider arrangements to compensate utilities for uneconomic plants "stranded" in the transition (stranded investment). These arrangements will cushion the transition, but they will probably not affect the tendency to continue to run "uneconomic" capacity because it can make a contribution to overhead even though it won't cover average total cost. And the theoretical capability of the market to achieve equilibrium by discouraging supply through low prices may not be realized (see sidebar on p. 48). Rapid growth in demand for electricity would, of course, cut against this scenario and tend to alleviate any problem of overcapacity. This is why deregulation and competition are most successful in boom times when demand is vigorous.10 Rapid growth would, indeed, seem to militate against some of the factors moving the industry toward merger and consolidation. But rapid growth in energy consumption, in the form of rising electricity demand, might be a mixed blessing in terms of energy conservation.11
The Urge to Consolidate
Since deregulation appears almost universally to be followed by consolidation, a study of other industries could help forecast developments in the electric area.
When deregulation was undertaken in the airlines, many proponents expected a broad proliferation of new entrants, with many competitors active in the market. Instead, concentration in the industry markedly increased. A major part of the first generation of new entrants (em Midway, People Express, Air Florida, and so on (em failed, and the combined market share of American, United, and Delta grew to 60 percent.12 More recently, many additional new entrants, such as ValuJet, have appeared in the industry to broaden competition. However, the ValuJet crash suggests the fragility of these new factors.
Concentration in the deregulated railroad industry is even more dramatic than in the deregulated airlines. There are three major Eastern railroad lines remaining: Conrail, CSX, and Norfolk/ Southern. In the West, a merger between Southern Pacific and Union Pacific has been approved.13 The other Western line is Burlington
Northern Santa Fe. There is concern that approval of the Southern Pacific-Union Pacific