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Razing the Regulatory Compact

Smart-grid technologies will dismantle the regulated utility business model, says economist Lynne Kiesling.

Fortnightly Magazine - September 2007

as a failure?

Kiesling: More than any other type of change we’ve seen in this industry, digital-communications technology has the potential to improve quality of service and reduce costs. We can start to think about the feasibility of remote sensing and fault detection. These distributed digital capabilities enable utilities to reach that Holy Grail—the self-healing grid. That’s why people shouldn’t be too jaded about the potential for this, because there are major operational benefits.

And obviously, from the point of view of an end-use customer, no one wants to wake up in the morning and think about how they’re going to manage their electricity use today. Technology has made it possible to cost-effectively automate that process. To the extent a retailer can integrate and bundle that automation together with other services, the distributed network will allow innovation and value that we couldn’t think about within a central-command industry.

Fortnightly: But many people would argue that competition hasn’t worked because electricity is a commodity. It can only be differentiated on price.

Kiesling: As digital technology changes our daily lives, we see it’s not all about price. But technology can’t do it alone. The rules shape the activity that happens. Where we’ve seen retail competition implemented well, we see suppliers coming into the market and offering differentiated products and services. They’re not just competing on price.

It’s illuminating to look at what’s happened in Texas since 1999. They had a transition period where they operated under a price-to-beat mechanism. During that period a lot of the new competitive activity involved incumbent utilities competing against each other in their territories, mostly on the basis of price. In January 2007, when the price-to-beat constraint expired, different types of competitors started coming into the market and offering more differentiated products. They’re not just competing on price.

Telecom is another great example. I pay more for my telecom services today than I did in 1985, even after adjusting for inflation. But I get so much more for my money! That’s part of the mental shift that happens when you reduce entry barriers and enable retail competition. It’s not just about price, but about the variety of services and how you bundle them together.

For decades Bell Telephone argued telephone service was a commodity and a natural monopoly. That’s a convenient argument if you want to maintain entry barriers. But the more experience we have, the more we realize the only part of electric service that’s actually a commodity is the physical energy. You have wires, which provide the transportation function, and then you have the retail function with potential for innovation.

If retail competition seems to be in limbo, maybe it’s because the restructuring we’ve done in the United States has overlooked the importance of sending retail price signals between the customer and the load-serving entity and the generator. Competitive markets require price transparency, but a lot of stuff has gotten muddied because of the political compromises we’ve made. The paradox is that when you protect customers from prices, you undercut the market’s ability to innovate