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Is Competition Lacking in Electric Generation? (And Why It Should Not Matter)

Fortnightly Magazine - January 1 1997

Incumbent monopolists won't command high premiums

if newcomers can rebuild capacity from scratch at a cheaper price.

At first glance, many of the nation's regional markets for wholesale electric generation appear monopolistic. In some of the 18 regional power markets we have identified, the leading companies account for 75 to 90 percent of the area's generating assets. In other markets, where the concentration problem does not yet seem as pressing, mergers and acquisitions threaten to raise levels of concentration of ownership in generation.

State regulators have not lost sight of these facts. They do not appear fully satisfied by attempts at the Federal Energy Regulatory Commission (FERC) in Order 888 to mitigate market power in transmission, and its affect in electric commodity markets, even though wholesale deregulation is already fairly advanced and blatant signs of market power are rarely seen, even in markets that show a high degree of concentration. California, for example, has required electric utilities to sell 50 percent of their fossil generation as part of the golden state's restructuring plan.

Perhaps regulators see the current situation (few concrete examples of market manipulation) as a temporary phenomenon. Today, few buyers can participate in the wholesale market; enough sellers can usually be found to create competition. But once retail customers can choose power supply directly and independently, regulators might see a huge demand chasing a dearth of suppliers.

When private companies asked us to factor monopoly power into market assessments, we sought economic approaches that avoid pinning the answer in whole or in part on regulatory and legislative action, which can prove difficult to predict and which can vary among states and regions, or among state and federal jurisdictions.

Thus, we have taken a practical angle: How bad can it be? How high would prices climb (long-run, wholesale prices) without any regulatory action in the generating sector?

Our analysis focuses on the economic incentives and cost barriers that affect the behavior of incumbents and market entry by newcomers.

We have developed an approach for estimating limits on monopoly prices1 and have found very little potential for higher monopoly prices to prevail. In fact, we have found that the cost of rebuilding the entire generation system (em a key factor constraining monopolistic behavior by incumbents (em is actually lower (by about 15 percent) than the predicted long-run, wholesale equilibrium price in a largely competitive generation market. This paradox occurs largely because of the low current cost of building gas-fired generation. Stated in a different way, incumbent power producers cannot likely sustain any price level for more than one to three years that would be a significant monopoly premium above long-run competitive levels, even if deregulation adopts a laissez-faire attitude toward concentration in generating markets.

This conclusion assumes that new natural gas-fired plants can be built (i.e., permitting, financing and operation is feasible), and that the FERC eliminates transmission market power, as promised by Order 888. This conclusion remains less sensitive than one might expect to assumptions about natural gas prices and the willingness of customers to sign long-term contracts with power producers.