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A Continuing Reign of Incoherence

How EPACT fails to address key industry issues.

Fortnightly Magazine - December 2005

policymakers to accommodate (and, occasionally, withstand) the demands of larger and more powerful utility incumbents seeking to bend market reforms to their own advantage.

Incumbent utilities and institutional investors will have an enormous advantage in the coming wave of consolidation, and some may perceive this as an easy road to higher margins. However, without credibly competitive markets to discipline the unfettered exercise of market power, incumbents must be careful to avoid aggravating socio-political pressures for “re-regulation.”

Finally, a regulatory end-game seems to be forming around the emerging consensus that vertically integrated utilities may not be such a bad thing after all. According to this view, oligopolies can be managed through the proper use of real-time pricing and incentive-based regulation.

Competition has in some cases led to fragmented spot markets, an absence of forward markets, and a lack of incentives for long-term investment, while vertically integrated companies (facing less competition) often have operated quite efficiently. While a smaller population of electric companies might hold prices above marginal cost, they also would carry surplus capacity to meet demand growth and provide a basis for long-term investments. As in other matters, the success of this approach will turn on the creation and maintenance of efficient markets.

In short, EPACT contains only a few momentous provisions to hasten creation of efficient markets, but it does contain the seeds of additional reforms.

Pricing to Reflect Environmental Costs

Environmentalists have long argued that if pollution costs from thermal power generation were factored into the price of power from thermal generation facilities, non-emitting technologies like solar and wind power quickly would become price competitive with power produced from hydrocarbon combustion. The run-up in oil prices has only strengthened this argument.

Equally important, the Bush administration’s decision to reject the Kyoto accords is being superseded by events. Nine Northeastern states recently announced their voluntary decision to implement a “cap-and-trade” program covering carbon dioxide emissions from more than 600 electric generation facilities. 7 More broadly, at least one recent survey indicated that a majority of industry executives believe that Congress will implement regulation of carbon-dioxide emissions within the next five to 10 years. 8

Oil price spikes stimulate innovation that creates economic alternatives to hydrocarbon fuels. This effect, combined with the trend toward internalizing the cost of power plant smoke-stack emissions, promises to have profound consequences for the way we produce, transmit, and use electricity.

The growing consensus regarding the link between greenhouse-gas emissions and climate change confirms that this approach represents a long-term trend and not a passing fad. It also confirms the central role of efficient markets in reforming the electric sector.

Going Forward

The energy industry is experiencing an extended and chaotic transition to competitive markets. Some competitive pressures have been eased by market inefficiencies and regulatory interventions, while others have resulted in significant economic challenges for a variety of stakeholders. The regulatory framework has been modified to incorporate market forces without much attention to understanding either the market forces themselves or the markets in which they operate. Producers and consumers of all kinds have been insulated from