Investor Beware: Don?t Overestimate Financial Returns In a Restructured Electric Industry

Fortnightly Magazine - June 1 1998
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TODAY THE ELECTRIC UTILITY INDUSTRY HURTLES TOWARD massive restructuring. This fervor is not surprising as it appears society has become convinced that market forces can work better than a centrally planned, regulated environment. This conviction draws strength from deregulation in other industries, such as the airlines, natural gas production and telecommunications.

In the electric utility industry, however, this desire for markets is encouraged by a simple but powerful reality: For several years, the marginal cost of electric production has remained far below the average embedded total cost of production. The ground has been made more fertile by a substantial surplus in electric production capacity, especially in those regions where the greatest desire for restructuring has appeared. Because of this surplus, the risk to electric system reliability inherent in restructuring is perceived as low.

We see the rush toward restructuring most powerfully in California, New England and New York (em the regions where electricity tends to have the highest delivered price. In places where delivered prices are far lower, such as in the South and much of the Midwest, one hears talk of restructuring, but the discussion seems driven more by a need to be politically correct than by any real desire to move as fast as California or the Northeast. Any serious reflection leads quickly to a simple realization: The desire for restructuring directly correlates in intensity with the price of the delivered product.

A deeper investigation of the political, regulatory and social forces that drive restructuring initiatives can reveal some important conclusions about the consumer prices and investment returns that we will likely see in these 'leading edge' regions.

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