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Perspective

Fortnightly Magazine - December 1996

"Keeping the lights on," a noble and valued calling, need not remain a secret known only to a natural monopoly priesthood. Vows of poverty or monastic reliability are not required. The electricity industry will adapt quite nicely to competition. Any necessary adjustments required by the uniqueness of electricity can be designed via real contracts. Customers, reborn from ratepayers, will adapt ever more easily.

Recovery of bad investment (LOSSES) was never explicitly or implicitly guaranteed. Many obvious signals of the growing storm were sent and received. Energy market upheavals in the 1970s provided signals, as did the Public Utility Regulatory Policies Act of 1978 (PURPA). Cost disallowances in the 1980s and price disparities in the 1980s and 1990s threw up yet more signals. After 1980, everyone, including the cloistered priesthood, knew that investment might not be recovered.

Returns to electric utility investors over the last 25 years have equaled or exceeded those to other industrial investors. Utilities have already received compensation for risk that includes LOSSES and even the possibility of bankruptcy.

Risk happens! the market does not cause LOSSES, it merely reveals them. In fact, ratepayers have experienced LOSSES for many years. Cost-plus monopoly prices typically exceed market prices. Sunk costs are sunk. Bygones are bygones. Cut your LOSSES. If the price is too high, lower the price.

Old habits die hard, however. In this case, utilities, regulators, and central planners may all suffer LOSSES. Each may come to recognize the others as potential allies.

The Reformation (updating the old economicsu6d

A yarn of very recent origin has been spun in support of the economic necessity of the recovery of LOSSES. However, after having decided to approve recovery of LOSSES, regulators cannot then justify recovery after the fact by claiming that there may exist a least-offensive static method to redistribute such LOSSES. The argument's circularity is obvious. It takes no account of dynamic market adjustments. What remains is just another special interest piece-work that is not founded, as advertised, on economic principles. The FERC's advocacy of full recovery of LOSSES can be described only as a horrendous mis-step and a dangerous precedent.u7d

No economic rational warrants the recovery of LOSSES. However, several important economic reasons justify a denial of recovery.

First, recovery of LOSSES impedes market entry and exit, which serve as essential components for competition. To have successful businesses, some businesses have to fail. If failure is possible, businesses have a strong incentive to exercise care. Therefore, in this context, failure is good. Fortunately, neither a business failure nor bankruptcy has anything to do with reliability of the network, as has been shown in previous cases of electric utility bankruptcy and business distress.

Second, recovery of LOSSES rewards inefficiency and penalizes efficiency. Competitive markets operate in the opposite fashion. Recovery would send distorting signals to newly minted competitors, which might alter efficient outcomes.

Third, recovery of LOSSES fosters organizational schizophrenia. Are we a protected utility or are we becoming a competitive business? In this vein, it may be good utility strategy to threaten present and future captive ratepayers with recovery of