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Generation, Deregulation, and Market Power: Will Antitrust Laws Fill the Void?

Fortnightly Magazine - October 15 1996

electric service industry displays three attributes that may encourage predatory pricing to a degree unparalleled in other deregulated industries: 1) sharply differing capital/operating cost ratios between established and new generators, 2) excess capacity, and 3) imperfect markets. Whereas price warfare eliminates the inefficient in most industries, structural anomalies in the electric service industry may eliminate the most efficient and accelerate the concentration of resources in the less efficient.

This potential for predatory pricing is hardly hypothetical. As noted by a recently retired utility executive, "With the advent of retail wheeling, prices can be expected to drop significantly for a number of reasons. In fact, utilities may actually choose to sell below cost."9 That executive cautioned that an unrestrained price war between neighboring utilities would be harmful to both, and accordingly counseled "cooperation among the participants. While collusion is illegal, there are strategies that will effect similar outcomes." Should a renegade utility or nonutility generator (NUG) break ranks, "a 'retaliatory strike' capability should be developed as a contingency plan. ... This will reduce revenue and profitability throughout a region. Utilities should try to maximize the monopoly rents they can extract for as long as possible under the current regulatory environment, recovering otherwise uncollectible asset values from those segments least at risk."10

Municipal entities have offered an interesting glimpse of future competition in comments filed before the FERC.

In an affidavit attached to the initial comments of Louisiana Energy and Power Authority ("LEPA"), on the FERC's Notice of Proposed Rulemaking (NOPR) on open-access transmission services, Sylvar Richard, a former general manager of and current consultant to LEPA, testified that the five utilities controlling 87 percent of the market in Louisiana rarely compete to gain load served by one of the others. However, while those utilities serve their native load with power priced in the range of 80 to 90 mills per kilowatt-hour, they would vigorously compete with LEPA to serve municipalities "at discriminatory prices far below the utilities average cost and, at least in one instance, easily shown to be below" the utilities' marginal cost.11

Commenters have argued that reliance on average variable cost to determine predation is inappropriate in industries that employ different technologies to produce the same product.12 One firm may use capital-intensive facilities with low variable costs, while its competitors may have substantially lower fixed costs but higher variable costs. The capital-intensive firm, which may not be more efficient, might attack its competitors with "predatory" pricing that lies above its average variable cost but below their average variable cost.

In Order 888, the FERC observed that new generation

facilities can produce power on the grid at a cost of 3 to 5 cents per kilowatt-hour (¢/Kwh), while costs for larger plants constructed and installed over the last decade typically ran 4 to 7¢/Kwh for coal plants and 9 to 15¢/Kwh for nuclear plants. Although not specifically articulated by the FERC, these figures appear to represent fully distributed costs. The marginal cost of the operation of these types of facilities is probably exactly the reverse. The high costs of nuclear power are