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Politically Inelastic?

Electric pricing issues are hard to overcome.

Fortnightly Magazine - March 15 2002

Do politicians really mean what they say when they call for competitive markets in electricity at the wholesale and retail levels? Rivals of California Gov. Gray Davis champion competitive electric markets. But what if, after elections, California markets are then fixed (with unanimous consent), and prices continue to be high? Will that politician still stand behind competitive markets?

How about economists? I attended a late January conference by the environmental group Resources for the Future where I spoke to Shirley J. Neff, staff economist for the Senate Committee on Energy and Natural Resources.

She was telling the audience that in essence, price volatility was a national security issue and that states should be given the power to mandate power plant construction.

I stopped her to ask about the philosophy-that price should be left free to be a market signal to indicate when power plants should be developed? Looking wounded, her answer was in effect, "remember California." I didn't get a chance to ask her by what criteria states would mandate plants, if not by price. Most panelists at that conference, however, agreed that the regional nature of power markets and short duration of price spikes does not qualify it as a national security issue.

But her philosophy, and what seems to be happening in the industry, is that "efficient pricing" seems to be the new code word by some for low prices. There is nothing wrong with this, except when policies designed to accomplish these goals create market distortions.

For example, many like Neff have called for an increase in distributed generation (DG) as a way to reduce our dependence on oil. Great. But many of these new technologies are not attractive in low-price, supply glut environments.

Naturally, it is a different question whether California would have had its problems if it had zero transmission constraints and enough capacity to satisfy its load. It's commonly touted that Pennsylvania's market overcame such issues because it had enough generation. Nevertheless, that market has had its growing pains-when retailers got priced out as wholesale prices jumped last year.

Vernon Smith, professor of economics at George Mason University, believes real-time pricing could cut off the high peak prices we see in power markets. I asked him what he thought of San Diego's experience. His response was that problems arose because customers were not adequately educated or given proper notice. In fact, in last year's Oct. 15 , Pennsylvania's Commissioner Fitzpatrick advocated the removal of price caps so retail electric prices could be allowed to "rise and fall according to market conditions." But Fitzpatrick wanted this not for peak shaving-an obvious benefit-but to correct perceived market distortions.

Certainly, in this post-Enron, post-California environment, it will be interesting to see whether politicians will let the demand side respond, or through their inaction, prove how inelastic the policies of electric competition seem to be.