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Revisiting the Keystone State

Rate caps have squelched competition in Pennsylvania.

Fortnightly Magazine - July 2008

generator profits seems calculated to incite populist indignation as customers begin to pay higher prices.

Market critics ignore the fact that the financial incentives provided by competition have spurred generators to operate plants very efficiently. As a lawyer at the Pennsylvania PUC in the 1980s, when most generation was owned by utilities and was not subject to competition, I recall investigations into lengthy outages at nuclear power plants. Now, nuclear plants in Pennsylvania operate 93 percent of the time because they do not earn revenue during outages. These efficiency gains have benefited consumers by reducing both the need to build expensive new plants and the number of hours that plants with higher fuel costs must be operated. 5

Most important, market critics overlook the hard truth that the cost of building and operating new infrastructure, not infrastructure built in the past, must drive prices for an industry to be self-sustaining. If prices are not high enough in the long run for investors to recover the costs of new plants, they will not invest and a shortage will result. Our society is willing to accept occasional shortages of most commodities, but not electricity.

Shortages of electricity were developing in parts of the PJM area before PJM filed its “Reliability Pricing Model” (RPM) with the Federal Energy Regulatory Commission in 2005. That filing was made because the “net revenue analysis” conducted by the PJM Market Monitoring Unit in its annual State of the Market Reports showed that revenues available to generators had not been sufficient to cover the fixed costs of new plants since PJM’s markets started in 1999. In fact, only in 2005, when wholesale prices spiked due to the Hurricanes, were generator revenues sufficient on average to allow recovery of the fixed costs of a new baseload plant. 6 However, RPM is beginning to work: Net revenues were sufficient to cover new plant costs (even baseload plant costs in some areas) in several constrained areas in 2007, and investors are adding capacity in response to these improved incentives. 7

In summary, the argument by wholesale market critics that prices are too high directly conflicts with the reality that prices have not been high enough to allow investors to recover the costs of building and operating new plants in the PJM area, although this situation is improving due to RPM.

In the short run, states have little ability to influence these conditions. The best they can do is to educate customers, allow them to phase-in higher prices, and give them the tools to conserve. In the long run, states can minimize price increases by maintaining their commitment to competition, by preserving a stable environment for investments in generating plants, and by encouraging development of needed electricity infrastructure. On the other hand, policies based on the mistaken notion that competition is to blame for higher prices will discourage investment and create even greater problems in the future.

Combating Climate Change

Many citizens are dissatisfied with the response of the federal government to the climate-change issue, and some state and local policymakers have stepped into