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The Fallacy of High Prices

We are better off under restructured electric markets.

Fortnightly Magazine - November 2006

however, that policymakers simply leave consumers, utilities, and other market participants to their own devices, even beyond the initial transitional phase of the restructuring process. Clearly, there needs to be a sufficient number of market participants or sufficiently low barriers to entry such that a market is likely to result in competitive prices and output rather than monopoly prices. Furthermore, we are strong proponents of institutional arrangements that monitor the behavior of market participants, enforce well-defined market rules, and ensure that the preconditions for competitive markets exist. Appropriate market rules and procedures should align market participants’ incentives with broader policy goals of increasing efficiency, encouraging the appropriate amount and type of investment, and ultimately lead to reduced prices—and price volatility—for consumers. 13

Our evidence shows that there have been significant benefits from electricity restructuring in the relatively short time since implementation. Not only has restructuring lowered wholesale and retail prices, it also has shifted significant risks away from customers to generators, which are better able to address those risks. There is no doubt that restructuring remains a work in progress, and that the transition to competition has had its painful moments. However, wholesale and retail competition should not be condemned based on the unprecedented increases in fossil fuel prices or rate shocks that were caused by political and regulatory pressures to guarantee benefits from day one.

Ultimately, for the full benefits of electric competition to be realized, the regulatory environment needs to become less politicized. Abrupt reactions to short-term circumstances, such as proposals for a return to traditional utility regulation, not only impede a rationale resolution of the challenges faced by policymakers and regulators, but also hurt ratepayers directly by creating uncertainty and increasing perceived investment risks, which ultimately lead to increased borrowing costs and higher rates. Given the volatility and uncertainty in fossil-fuel markets created by the conflicts in the Middle East and increasing demand in Asia, as well as uncertainty as to the ultimate policy resolution of important environmental issues such as climate change and mercury control, the last thing ratepayers need is to have politicized electricity markets.

 

Endnotes:

1. Promoting Wholesale Competition Through Open Access Non-discriminatory Transmission Services by Public Utilities; Recovery of Stranded Costs by Public Utilities and Transmitting Utilities, Final Rule, April 24, 1996.

2. Putting Competitive Power Markets to the Test, Global Energy Decisions, 2005.

3. Based on research performed by Dr. Axelrod using the inflation adjusted weighted per unit production costs (FERC Form 1 data) for a sample set of Northeast utilities representing the PJM/NY/NE-ISOs structured markets.

4. Dr. Axelrod found when projecting 2004 Energy Information Administration (EIA) statewide electric price data for the Northeast using actual fuel price increases during 2005, as if fuel-related expenses were automatically flowed through, production costs would have been 15 percent higher than actual production costs as reported in the FERC Form 1 for 2005.

5. GED and PJM, ISO-NE, and NY-ISO State of the Market Reports.

6. Dr. Axelrod’s analysis also found that the average standard deviation for the weighted production costs for the Northeast sample set