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

Fortnightly Magazine - October 15 1996

be forgiven if they approach the subject of active intervention in a dynamic market with some degree of trepidation. Yet, a strong case can be made that the appropriate means to mitigate predation would lie in fixing a price floor equal to long-run incremental cost, below which sales are proscribed. Easy to say, but perhaps devilish to administer. Setting the floor price too high may provide an unacceptable safe harbor for the inefficient. Setting the floor price too low would defeat the objective of the exercise. Moreover, even if the floor price were set just right, periods might occur in which it would be both economically rational and nonpredatory for utilities to sell below short-run marginal cost (em i.e., to avoid temporary shutdowns in nonpeak periods.

Regulators have been down the path of calculating long-run incremental costs before. In implementing PURPA, the FERC held that "avoided cost" (em i.e., incremental cost (em includes both energy and capacity cost.15 Energy costs are variable costs associated with the incremental cost production of electric energy (em in antitrust parlance, approximate short-run marginal cost or average variable cost. Capacity costs are those associated with providing the capability to meet the demand for electric energy. The FERC specified that capacity costs must be based upon "those costs associated with a new kilowatt of capacity addition and the next kilowatt-hour that needs to be generated."16 Accordingly, historic and sunk costs are excluded. The combination of energy and capacity cost approximates long-run incremental costs or average total cost, as those terms have been defined in the antitrust context. However, many in the industry blame the miscalculation of avoided cost as the principal contributor to overcapacity and above-market obligations to QFs.

Although fraught with peril, the effort may still be worth the candle. If the objective is to promote long-term generation diversity, but only among the most efficient, regulators might consider setting a floor price at the long-term incremental cost of the most efficient new generation technology available. Such a price would not protect the inefficient, but might prevent the elimination of existing or potential efficient competitors that simply lack the deep pockets necessary to survive a price war of attrition. Moreover, the floor rate could be applicable only to some measure of long-term sales, and only during defined periods. Finally, the floor sales price could be adopted either formally or practically as the lowest "market price" upon which stranded-cost recovery could be predicated.

New Jersey, for its part, has elected to establish a regulatory constraint upon predatory prices. In legislation establishing the predicate to retail competition, the New Jersey legislature established guidelines that allow electric utilities to negotiate "off-tariff" rates with individual retail customers. An "off-tariff" rate may not exceed the cost-of-service rate, but can fall no lower than the sum of "the utility's marginal energy and capacity cost over the term of the off-tariff rate agreement, the per-kilowatt-hour contribution to demand-side management program costs ... and a floor margin to be specified by the Board [of Public Utilities]."17

The Last Dance

They say you should "dance with the