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Monopolists in Our Midst

What happens when economists and state regulators give up on electric restructuring?

Fortnightly Magazine - February 2005

and Van Doren explain, could have minimized the “needless political fighting (most notably, the eternal fight over more supply versus less demand) that inevitably arises in electricity markets because of the absence of prices as a signaling device.”

Alas, however, we are still waiting for such win-win results.

Destined to Fail

MIT Economist Paul Joskow late last year concluded that regulators have left electric restructuring doomed to failure by inserting so many non-market backstops and safeguards that the “deregulated” model becomes more complicated than the previously regulated one.

In a paper titled Reliability and Competitive Electricity Markets , Joskow and co-author Jean Tirole wrote: “Despite all the talk about ‘deregulation,’ a large number of non-market mechanisms have been imposed on emerging competitive wholesale and retail markets.

“These mechanisms,” the authors explain, include “spot market price caps, capacity obligations placed on load serving entities, … ancillary service requirements enforced by the system operator, procurement obligations … , protocols for non-price rationing of demand to respond to ‘shortages,’ and administrative protocols for managing system emergencies.”

Joskow and Tirole wonder why market mechanisms could not have taken over these functions, but find that consumer protections built into the system by the architects of restructuring to mitigate market power have rendered this desirable result virtually impossible:

“In some cases the non-market mechanisms are argued to be justified by imperfections in the retail or wholesale markets: in particular, problems caused by the inability of most retail customers to see and react to real-time prices … [plus] imperfections in mechanisms adopted to mitigate these market power problems.”

As the newspaper cartoon character Pogo was wont to say, “We have met the enemy, and he is us.”

The use of non-market mechanisms to counter perceived market imperfections was precisely the criticism leveled recently at the Ohio PUC, which, fearing a sharp rise in power costs, granted FirstEnergy a plan to freeze rates in 2006 through 2008, with some increases possible, such as for tax increases.

Alan Schriber, PUC chairman, said at the time to the local Toledo press that the rate freeze was necessary to keep customer bills from skyrocketing.

Joskow believes also that economists and engineers could do a better job of talking with each other to reconcile the design of markets with the physical complexities of electric power networks and the constraints that these physical requirements may place on market mechanisms.

He concludes in his paper that the conflicts from old-world and new-world policies make it “challenging,” at best, to achieve an efficient allocation of resources with retail and wholesale market mechanisms.

EEI: An Unlikely Champion?

Ironically, even as some economists find deregulation unworkable (or not to their liking), the Edison Electric Institute (EEI) issued guidelines in January on how to make markets more competitive. Far from being opposed to competition, EEI’s board of directors say the electric utility industry has “reaffirmed its commitment” to “vibrant wholesale power competition.” The board also has released a framework to help guide the development of wholesale power markets and reinforce generation and transmission adequacy nationwide.

“It is our hope that these