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Deregulation, Phase II

Recent electricity pricing argues for faster, more extensive deregulation.

Fortnightly Magazine - November 2007

the biggest opportunities for further liberalization. The approach taken by those states that did restructure excluded the largest opportunities to reduce the cost of electricity. To understand why, consider the following.

Thermodynamic Fact 1: In any fueled power plant, the majority of the fuel is converted into heat (rather than electricity).

Economic Fact 1: Transmitting electricity costs less than transmitting heat.

Economic Fact 2: Notwithstanding Economic Fact 1, the single biggest capital cost of the electric system is the grid itself.

Taken together, these facts mean that in all grids, the cheapest generation to build and operate will be that sited at or near the electric load, for rather straightforward reasons. Namely, such local generation can economically recover and sell its inevitable waste heat, thereby achieving two to three times the efficiency of central power. Second, according to FERC data, the average transmission and distribution network costs $1,300/kW of peak capacity, plus additional factors for line losses (7 to 10 percent) and reserve-margin requirements, driving costs to nearly $1,700/kW.

Local generation not only avoids the need for much of this upstream infrastructure, but also makes the existing infrastructure more efficient by reducing line losses and adding more nodes, reducing reserve-margin requirements.

Even more dramatically, these load-sited investments tend to be smaller, and the overwhelming majority of them historically have been made by unregulated entities. 2 Thus, ratepayers don’t bear the risks of their failure.

Nevertheless, these opportunities for cheaper electricity are not allowed to capture most of the benefits they create.

Siting generation at the load creates numerous benefits in deferred upstream investment, greater grid reliability and local economic growth—in addition to the environmental benefits associated with greater energy efficiency. With the exception of avoided retail-power purchases, the majority of these benefits cannot be realized directly by on-site energy projects due to the lack of market mechanisms available to unregulated generators. Moreover, such projects often are blocked or made needlessly expensive by obsolete regulations and other barriers to economic efficiency. Examples include discriminatory interconnection standards, standby rates, and the inability to gain market access at a fair price.

To obtain deeper savings beyond those earned to date, society must deregulate the downstream elements of the grid that have the most potential to lower the total cost of electricity.

Indeed, beyond the savings associated with fuel-switching and dispatch order, very little of remaining potential savings from deregulation can be achieved if limited to upstream, wholesale markets. And we have very nearly exhausted the potential of those two strategies, as Figure 4 illustrates.

Arguably “retail competition” exists, but the term is a canard, since this competition simply allows different players to buy upstream electricity and sell it to retail customers. No jurisdictions have provided grid access or fair pricing to generation sited at the load, and retail competition therefore simply is a way to give wholesale actors access to retail customers. The fundamental limitation of this approach is that it fails to contemplate a grid architecture that is different from the (too expensive, too inefficient) central paradigm.

Society now faces massive