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The Fallacy of High Prices

We are better off under restructured electric markets.

Fortnightly Magazine - November 2006

the construction of new generation has been a boon for electricity consumers.

Under the model of traditional rate regulation, the full cost of investments, plus a return, are passed directly to consumers, with few exceptions. If electricity prices are lower because some producers are absorbing losses, this is a striking confirmation that, under competition, a significant component of long-term risk has been shifted away from consumers.

Our research provides several other important conclusions. First, fuel prices are pushing up electric rates everywhere. Customers, whether in restructured or non-restructured states, are seeing higher electric prices. In some cases, the end of artificial price caps is resulting in higher competitive procurement costs. In other states, fuel pass-throughs are resulting in increased rates. Either way, customers are paying more for electricity. One recent study focusing on non-restructured states showed that customers in Louisiana have seen a 47 percent increase in electricity costs while customers in Oklahoma have seen a 38 percent increase. 9

Perhaps even more interesting has been the effect of competition on regional price differentials. While a number of important factors—including fuel mix, labor costs, taxes, and cost of living—drive regional electricity prices, the gap between the PJM area, traditionally a high-cost area, and the Southeast, traditionally a low-cost area, has been shrinking. Our research shows that retail rates in five Southeastern states 10 rose 23.7 percent from 1998 to 2005, while rates in four “classic” PJM states 11 rose only 7.8 percent over that same period. 12 The 7.8 percent increase for the PJM states reflects continued rate caps for some customers in 2005, but the corresponding increase for New Jersey, which has had retail electricity rates set competitively since 2003, was just 9.6 percent (see Figure 3) .

There are limits to how far one can extend such a comparative analysis of rates across different regions of the country. For example, the state of Maryland recently was engulfed in a significant political controversy when bids to provide standard-offer service to Baltimore Gas & Electric (BG&E) residential customers were 72 percent higher than the then current retail rates, which had been frozen since 1999 at a 6.5 percent discount to rates in effect since 1993. Obviously, if one were to compare Maryland’s retail electric prices with prices in the Pacific Northwest (PNW), one would observe that PNW retail prices are significantly lower. Does that prove that there are not any benefits from competition? The answer is clearly no, since prices in the PNW reflect abundant, federally subsidized hydroelectric capacity not available in Maryland, which makes direct price comparisons between the two regions irrelevant and misleading.

To account for the difficulties inherent in a cross-regional comparison, we performed an econometric analysis of the effects of competition over a broad cross-section of the United States, using data for the years 1980 through 2004 for all states east of the Mississippi to estimate the effects of wholesale competition and state restructuring on the retail cost of electricity. We controlled for a number of factors influencing electricity prices, including generation mix, concentration of independent power producers,