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

Fortnightly Magazine - October 15 1996

of steam-electric capacity will have reached or exceeded 30 years of age. By 2003, the average age of the nation's coal-fired units (weighted by nameplate capacity) will be 32 years, and the average age of oil-/gas-fired units will be 36 years. Nuclear plants are somewhat younger, with an average age of 23 years in 2003, but their functional lifespan may be substantially curtailed by relicensing strictures.

Once the "capacity bubble" (not to be confused with the apparently immortal natural gas bubble) bursts, where will new competitive generation come from? It is highly unlikely that utilities will construct new generation facilities without regulatory assurance of capital-cost recovery, particularly given the unpleasant experience they face to recover "stranded costs" for their existing facilities. The FERC has largely vitiated the incentives under the Public Utility Regulatory Policies Act (PURPA) to construct new facilities, and Congress may well repeal prospectively the empty hulk that PURPA has de facto become. Without the mandatory purchase requirement of section 210 of PURPA, IPP developers will find it difficult to secure the long-term capacity-purchase obligations that form the sine qua non of project finance. That leaves future capacity additions largely to those willing to construct merchant plants and to finance such projects internally. However, the specter of predatory pricing by incumbent utilities may dull the ardor of the most adventurous developer. Moreover, to the extent that long-term contracts remain available for independent

project development, most opportunities will prove limited to existing utilities issuing requests for bids to replace retired generation capacity. Construction of such projects will not increase generation diversity, and will leave the decision of capacity supply largely in the hands of existing utilities. Thus, surviving utilities may not be required to take any affirmative action to reduce output; rather, they may find themselves the passive beneficiaries of an eroding capacity base. To avoid prospective capacity shortfalls, with the attendant risk of further concentration of generation resources and an increase in market power, regulatory authorities may wish to create an environment conducive to the orderly replacement of capacity by new entrants.

Stranded-cost Recovery. Third, the mechanisms for stranded-cost recovery may render utilities indifferent to contributions to capital cost and, in fact, provide an incentive to push prices in the competitive market as low as possible. Since utilities will be compensated for the difference between market price and embedded-cost rates, and since such recovery will be putatively guaranteed and may take the form of a lump sum based on a current spot-market price, utilities could achieve a triple whammy by adopting a bare-bones, marginal-cost pricing strategy: 1) eliminate competitors with high variable cost, 2) maximize recovery of fixed cost through stranded-cost recovery, and 3) create a stranded-cost amount sufficiently large to discourage existing customers from leaving the system. This course of action would not only skew the competitive market terribly, but would significantly drive up aggregate stranded costs, thus delaying the projected benefits of competition to most consumers.

If "Yes," Then How?

Given recent unhappy experience of directing the electric service industry, particularly as to matters of price, regulators may