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The Economists: On the Future of Energy Markets

The Power of Price Responsiveness
Fortnightly Magazine - April 1 2002

Uncertainty clouds direction of FERC's market engineering.

A boom-and-bust cycle has struck the electric power industry and economists are worried about its effect on industry restructuring. Many believe the latest boom period in power generation construction will now be followed by a period of insufficient generation capacity additions. If this prediction proves accurate, certain regions of the country could get hit with another generation capacity shortage in a couple of years, similar to the one that helped spark the price spikes and turmoil in California's electricity markets in 2000 and early 2001.

"The concern that should be on people's minds is whether we've set up a system that has an inevitable boom-bust cycle in it where we get these periods of demand growth, very tight markets and very high prices," says Paul Joskow, a Massachusetts Institute of Technology professor of economics and director of the MIT Center for Energy and Environmental Policy Research. "We see an over-investment in generation, so the market collapses. We then see companies going out of business and periods of no investment. I think that kind of a boom-bust cycle, as it emerges, is not going to be politically acceptable to many consumers and legislators."

Enron's meltdown also has had dramatic effects on the entire independent power industry in the United States. The independent generators' stock prices and credit ratings have declined and an enormous amount of capacity that has been in the development stage has been canceled. Joskow says he hopes the collateral damage to the independent power companies from Enron's collapse recedes and those companies can go back to doing their business.

"I'm now concerned that they are pulling back too much and that we're going to find ourselves in 2004 and 2005 back in a situation where we have too little generating capacity and find ourselves with price spikes again," Joskow explains. "I hope we can stabilize these markets so that investors can take a longer-run view and can respond to opportunities to enter into longer-term contracts and provide a more stable supply."

Marce Fuller, president and chief executive officer of Mirant, concedes the fallout from Enron has had a much bigger impact on the market than the California electric power industry restructuring fiasco. Enron "damaged confidence" in energy markets, she said at the CERAWeek 2002 conference in Houston in February.

The electric power industry isn't alone in its vulnerability to these types of cycles. Any other capital-intensive industry, including the automobile and steel industry, will go through cycles and will be dependent on general economic growth. Whether the electric power industry can avoid these types of cycles is open to debate.

"Very few industries can evolve out of a boom-and-bust cycle," says Mary Tolan, managing partner of the Resources Global Market Unit at Accenture. "And the bust part of the cycle tends to last two or three times longer than the boom periods." Tolan recalls that the most recent boom period in the electric and gas industry was very brief, lasting only two or three years.

Discouraging Results Not Enough to Deter Leading Academic

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