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The Economists: On the Future of Energy Markets

The Power of Price Responsiveness
Fortnightly Magazine - April 1 2002

cases for them to easily put the toothpaste back in the tube," he says.

Appreciating Vertical Integration

That's not to say the vertically integrated utility doesn't have any merits. "I think that the traditional, vertically integrated utilities that emerged in the United States in the 20th century have been unfairly maligned," Joskow argues. "By international standards, on average overall, the U.S. electric power industry has performed very well. I think it's a mistake and it's actually inaccurate to characterize the old system as being grossly inefficient."

Stalon notes that the traditional utility companies that have yet to be broken apart continue to get stronger. Provisions in the Energy Policy Act of 1992 that altered the Public Utility Holding Company Act provided many benefits to electric utility companies, including the chance to invest more liberally on the international scene. "You can't walk in a foreign airport these days without bumping into somebody from Southern Co. or Duke. If you look at the AEP merger with [Central and] South West, and you think, that's an integrated utility? And yet the courts seem to be saying, that's okay. Well, what isn't okay? It strikes me at this point that any kind of merger is permissible under the law."

Efforts to create efficient energy markets similar to systems in place in PJM, New York and New England are not a top priority for large utility companies, Stalon contends. "If you're big, you don't have to have an efficient energy market because you can satisfy your contracts out of your great diversity of capacities. It's only the small generator who knows he is totally dependent on a free market."

The large utilities certainly have no right being unhappy with the way policy has evolved, Stalon says. "They've gotten bigger and bigger all over the world, bigger inside the United States. They have created new definitions of what constitutes competition and integration of markets. They've gotten what they've wanted out of this delay. I'm not at all sure what they would want at this point, and I think the last thing they would want would be someone saying we're going to spread PJM nationwide."

And yet, Stalon isn't convinced FERC's inclination toward larger transmission organizations is the right path to follow. "I guess I am a little skeptical about the wisdom of pushing for bigger and bigger RTOs," he says. "I thought it would be easier to create smaller-sized ISOs and then work on the seams issues than it is to create these giant organizations. FERC gave up what I thought was a tough issue for one that was twice as tough."

The goals of power merchants and generators often have conflicted with the development of efficient ISOs. These players have preferred a bilateral market and have not wanted an ISO that would manage the spot market at all, Stalon notes.

ISOs always will be an extension of FERC because the commission, with its limited manpower, can never police all of the markets across the United States without bringing in the ISOs as their agents, Stalon says. "That