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The Future of Fuel Diversity: Crisis or Euphoria?

The fragmented electric industry structure poses an obstacle to a more stable, diverse, and secure power supply.
Fortnightly Magazine - October 2004

lead times for investments in electricity infrastructure and large amounts of capital required, market forces in this sector tend to operate by a long deterioration in supply leading to supply disruptions and extreme price spikes, followed by a decline in economic activity, with a subsequent loss of jobs, personal income, and pubic tax revenues. This may lead to reductions in consumption and ultimately a lower price level. While this scenario appeals to some economics professors, few voters or elected officials would consider this a desirable course of action.

Free-market solutions depend on investors' willingness to supply capital. Uncertainty about future market outcomes creates a powerful disincentive for private investors to invest capital in future power supply initiatives for the public good, which may produce disastrous investment results. The record of the U.S. power and gas sector over the past 25 years has been punctuated by insolvency, credit distress, and bankruptcy brought upon individual companies due to their investments in fixed production assets or long-term supply contracts. Examples of costly power plant investments bringing about a financial crisis or bankruptcy include regulated utilities such as Public Service Company of New Hampshire, El Paso Electric, Long Island Lighting Co., and Gulf States Utilities, as well as competitive suppliers such as Mirant Corp. Cases of financial distress brought on by costly long-term supply contracts include Columbia Gas Transmission and Niagara Mohawk Power Co., among many others. The hazards of large investments in power supply affect monopoly utilities with conventional cost-based tariff regulation as well as companies that operate in a competitive market with market-based pricing, as illustrated in the accompanying simplistic example of the island continent of Euphoria ().

Public Policy Can Lower Investment Risk

Fortunately, there are ways that regulators and policy-makers can mitigate the investment disincentives illustrated in the foregoing example. A host of mechanisms is available to spread the payment for those investments that benefit all consumers across a broad consumer base ("socialize" the costs) and thereby reduce investment risks and the cost of capital for these activities. For example:

  • State legislatures and/or utility regulatory bodies can direct the regulated distribution utilities or integrated electric utilities to enter into contracts to purchase power or fuel from a particular type of source (e.g., new technology coal plants, LNG terminals, wind farms) under long-term contracts, by lease, or by direct investment, perhaps in proportion to customer load. It is critical that the law or regulation grant the utility a binding approval of its planned contract or investment plan at the time of initial commitment, not subject to subsequent disallowance based on later changes in market conditions.
  • State legislatures and/or utility regulatory bodies can direct the regulated distribution utilities or integrated electric utilities to enter into contracts to purchase power or fuel from a particular type of source (, new technology coal plants, LNG terminals, wind farms) under long-term contracts, by lease, or by direct investment, perhaps in proportion to customer load. It is critical that the law or regulation grant the utility a binding approval of its planned contract or investment plan at the