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Deregulation, Phase II

Recent electricity pricing argues for faster, more extensive deregulation.

Fortnightly Magazine - November 2007

most likely conclusion is the federal opening of wholesale-power markets. In a regulated, cost-plus environment, there was no particular incentive to shorten outages at nuclear plants or speed up maintenance, even though those facilities have relatively low marginal costs. Nor is there a competitive opportunity for strong operators to purchase poorly run nuclear plants at low prices and improve the up-time.

Before restructuring, fleet owners with multiple generation sources had no particular incentive to pay close attention to dispatch order, since all costs ultimately are reimbursed by ratepayers. Opening up wholesale markets favorably realigned incentives for economic dispatch. Strong owners were given a financial incentive to run their low-cost plants longer, and weak owners found they could sell their poorly run plants to better operators.

The same is true for coal, where marginal operating costs always have been lower than for gas-fired plants. Coal owners—with new market incentives—also received a financial incentive to drive up their capacity utilization. These changes translate into direct savings at the retail level.

Note this cannot be extrapolated to explain fully the state-differentials in electric prices shown in Figure 2. Wholesale market liberalization from the 1992 federal Energy Policy Act affected all states equally, and wholesale markets are national—or at least regional—in nature. So one cannot draw firm conclusions about state-level impacts from restructuring based on the dispatch of the fleet in a given state. However, national statistics illustrate the type of behavior that might be expected at the state level.

And so, contrary to conventional wisdom, U.S. consumers have enjoyed dramatic savings in real electricity prices as a result of state and federal deregulation. This suggests U.S. policy-makers should learn from, and expand, their hesitant first steps toward complete electricity market liberalization.

Poor Restructuring Policies

Any argument for deregulation is bound to be countered by the inevitable, “Yes, but what about California and Enron?” These questions are best addressed directly, in the spirit of learning lessons and moving forward.

Clearly, California’s markets suffered from manipulation, but this can’t be blamed on deregulation. Indeed, Figure 3 shows that the backlash against deregulation that started in 2000 with the California power crisis is particularly misplaced. Power prices rose during 2000, but customers in restructured states still were better off than their neighbors in regulated states, relative to 1992 prices.

Deregulation is not the opposite of regulation, but rather is a process by which a market transitions from a socialist model of regulatory oversight, in the name of the public good, and toward a capitalist model wherein regulatory oversight is replaced with the competitive pursuit of profits for creating the public good. Alfred Kahn, former chairman of both the Federal Aviation Administration and the New York Public Service Commission, aptly observed, “Deregulation shifts the major burden of consumer protection to the competitive market, and therefore, in important measure, to the enforcement of antitrust laws.” 1

This is a fundamental insight, and one overlooked by virtually every electricity deregulatory process.

In a regulated world with government-sanctioned monopolies, the government creates vast bureaucracies to review costs and ensure regulated utilities have