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

Fortnightly Magazine - January 1 1997

allow the monopolist to charge more than the competitive price.

This situation can be visualized as a monopolist facing a somewhat flattened but stepped demand curve (see Figure 2). The curve is flatter than the previous demand curve in Figure 1 since all customers enjoy access to a close substitute (em power from a new company that differs only for want of a contract. From the monopolist's perspective, there is some premium that maximizes his profits (see Figure 2). Some large customers might be willing to sign contracts, while others might prove unwilling to commit to long-term contracts with the new entrants.

Nevertheless, we still conclude that significant premiums are very unlikely.

First, as stated, relative to other industries, there is relatively very little room to raise prices because the rebuild price is below the likely competitive price. Second, many buyers will be ready to commit a portion of their supply to contracts of somewhat longer terms (e.g., 3-7 years), if only to hedge risk or balance portfolios. Third, the low capital intensity of the new gas-based power industry allows entrants to jump in, even without long-term contracts, as soon as the monopolist raises prices too high. A premium of $5/MWh (about 15% above the typical competitive price) would allow an entrant to recover capital costs within about 5 years.

Finally, the possibility of the monopolist mismanaging his position by excessively raising prices creates the potential for the opposite result (em i.e., entry by new competitors, producing excess capacity and lower prices at less than competitive equilibrium levels.

Regional Exceptions

The regions of the country most commonly considered to be at risk for monopoly (or oligopoly) price premiums all exhibit one or more of several key characteristics. First, one or two companies produce a very large portion of the power. Second, transmission constraints limit competitive sources of power.

Examples would include:

• South. The Southern Company system strongly dominates generation in Alabama, Georgia, eastern Mississippi, and the Florida Panhandle. It would be the only supplier capable of immediately supplying power to retail customers.

• Texas. In the Electric Reliability Council of Texas (ERCOT), two companies, Houston Lighting and Power and Texas Utilities account for 75 percent of generation. Further, this region has assiduously pursued a policy of relative transmission isolation.

• South Central. Like The Southern Company, Entergy almost entirely controls generation in the Louisiana, Arkansas, western Mississippi areas.

For reasons discussed above, even though their regions are more at risk, the overall risk is very low. Rather, the risk is primarily focused on exceptional cases with barrier to entry (e.g., lack of sites, costly sites). For instance, in micro-markets ("load pockets") that created by transmission constraints, and pockets of excess capacity where the competitive price is depressed. While we have not examined every market, we expect nearly all markets to be in balance within 3 to 6 years.

Implications for Would-be Competitors

This analysis predicts that monopolists in the wholesale generation sector should count on only a very small premium above the competitive price that would prevail in a wholesale power market in equilibrium.