Public Utilities Reports

PUR Guide 2012 Fully Updated Version

Available NOW!
PUR Guide

This comprehensive self-study certification course is designed to teach the novice or pro everything they need to understand and succeed in every phase of the public utilities business.

Order Now

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

Fortnightly Magazine - January 1 1997

short, we conclude that the likelihood could run as low as one tenth of one percent that the ceiling price (the rebuild price) would run as much as $10/MWh (one cent/kWh) higher than the long-run equilibrium competitive price.4

Gas Price Uncertainty

The idea of a price ceiling for a rebuilt system depends in part on estimates of natural gas prices, since over half the costs will represent fuel costs from operations.

Recognizing that natural gas prices were particularly volatile during the 1970s, and that increased demand for gas-fired plants might drive gas prices upward, some observers might shy away from making any conclusions about a theoretical price ceiling. However, one should not go too far in allowing gas price uncertainty to discourage attempts to use economic analysis to predict future prices in electric generation.

In fact, the gas supply curve appears to be fairly flat, and for several reasons. First, long-run gas prices available in the market are not much higher than recent average prices. Suppliers do not anticipate major price increases. Second, over the last several years, annual average gas prices have remained relatively low and stable (with the Henry Hub running $2/MMBtu in 1996 dollars). Third, and most important, our own forecasts (developed from exhaustive analysis of gas demand and of North American gas supply reservoir by reservoir) indicate that gas prices are likely to remain stable, as expressed in real terms (inflation adjusted) on an annual average basis.

Moreover, as the futures and forward markets appear well developed for natural gas, independent power producers (IPPs) can contract for natural gas at known prices for extended periods (em up to fifteen years or longer. IPPs can sign contracts simultaneously with different gas suppliers and electricity customers facing the monopolist and lock up all components of a deal, eliminating uncertainty.

Nevertheless, to the extent the price ceiling remains sensitive to gas prices, the premium (i.e., the ceiling minus the long-run competitive price) is considerably less so. This distinction arises because one can expect the ceiling price and the competitive price to move in tandem, especially in the future. Today, many regions already exhibit a strong correlation between power and gas prices. The competitive price is not set by the average, but by the marginal fuel source. Over time, even those regions marked by a heavy reliance on coal, hydro, or nuclear resources will burn natural gas on the margin for most of the year.

Barriers to Entry

New power producers face one particularly serious entry barrier (em the need to sign contracts with customers.5

Private power developers have achieved a fair degree of success in recent years in permitting, financing, building, and operating new gas-fired combustion turbine and combined-cycle powerplants. However, this success has leaned heavily on long-term purchased power contracts (em either with host industrial customers or with electric utilities. These contracts protect entrants from a drop in prices following entry (em particularly from a fall in prices that might occur if too many entrants create excess capacity.6

Suppose the entrant is obliged to risk its own capital. That would