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The Economists: On the Future of Energy Markets

The Power of Price Responsiveness
Fortnightly Magazine - April 1 2002

Policymakers tend to forget how all of the pieces of an electric power system need to fit together properly for electric markets to work with the least amount of friction, says Paul Joskow, the noted professor of economics at the Massachusetts Institute of Technology, who has authored a number of books and scholarly papers on the electric power industry.

In Britain, for example, regulators kept track of the relationship between all of the different segments of the electric power industry, to an extent that, when regulators did identify mistakes in the system, they were able to remedy the problems before restructuring was thrown completely off track. "I think the British did it the right way in the sense that they took a long-term view," Joskow says. "The most important part of the British system is they structurally set it up in a way that was very conducive to competition, to creating a very smooth and efficient platform for trading energy on the network, for eliminating congestion."

The success that other countries are experiencing with electric industry restructuring is exacerbating Joskow's frustration with the turn of events in U.S. electric power markets. Given his long career working on electric industry issues, Joskow expresses a certain sense of duty to prove that electric power markets in the United States are capable of functioning efficiently and smoothly.

"I've been working on electricity regulatory and deregulatory issues for 30 years and events of the past two years have been very disappointing to me," he says. "I feel like I have a responsibility to consumers in the United States and to people who've read what I've written and listened to what I've said to work with responsible regulators to make markets work and to find the best solutions."

Joskow, who joined the faculty at MIT in 1972, the same year he earned his Ph.D. in economics from Yale, says things are happening too fast in the industry to consider writing another book on electric power anytime soon.

But Joskow says he's looking forward to the next couple of years so that he can provide a "public interest voice" to assist FERC and state commissions. Later this year, he plans to file comments on FERC's anticipated "giga-NOPR" on standard power market design.

As for California, Joskow laments that if only the state had followed the British model, the electric power industry may not have received such a black eye.

"Initially, they were on the path of replicating the U.K. system and I think if they had done that, they'd be a lot further along," Joskow says. "One of the things that the U.K. system had when they divested the generation is they set up vesting contracts, which were forward contracts. If California had done everything they've done in the U.K., they wouldn't have had these problems."


Joskow contends the real question is how much of that cycle and the associated variance in spot prices are going to be borne by consumers-residential and small commercial consumers-and how much is going to be hedged away with longer-term contractual arrangements.