Eugene P. Coyle works as an energy analyst for Toward Utility Rate Normalization (TURN), a consumer advocacy group in California that claims 30,000 members.

t t t t t

The January mini-forum failed to discuss a key underlying assumption made by PoolCo proponents. The assumption is that price competition will really exist in tomorrow's wholesale electric market.

The PoolCo vision calls for a neutral agency that will receive bids from multiple independent power producers (IPPs) and investor-owned electric utilities (IOUs) to supply energy. The proponents of PoolCo spin a tale of a highly competitive world, with the bidders shaving their prices very close to their costs. Bids must be as low as costs, it is claimed, because a competitor will be bidding low as well. Low-cost producers will succeed, and have their plants running at capacity. The high-cost folks will not win many, or perhaps any, bids. Technology will drive costs lower over time, with new, clever entrants taking their places in the dispatch order, and forcing expensive and dirty plants to turn to rust. This, we are told, is how "competition" will lower electricity costs for all consumers.

Unfortunately, however, the market really doesn't control prices in the U.S. economy. I will focus on two ways in which failure occurs.

The Cartel Problem

How do you tell the difference between a pool and a cartel?

The bidders into an electric pool are going to have fairly solid knowledge of each other's costs. They'll know, within narrow limits, what the others have invested and what they pay for capital. They'll know what the others are paying for fuel and other operating costs. Each will also have a good idea of the financial strength or weakness of the others (em whether they have a cash cushion, a strong line of credit, or a deep-pocket parent.

None of the bidders will want to bid low. The theory of competition is that they will be forced to bid low because the low-cost producers will bid low to ensure dispatch. But week after week and month after month, once the pool starts, the same set of bidders will get dispatched and the same poor wretches will fail to make the cut. And as the game gets sorted out, the winning bidders will realize that if they all bid just a little higher they can make higher profits. This tactic, however, would open the door for one or more of the lowest-bidding losers-those who can just barely cover costs and run a plant. At this point strategic issues emerge. Should the winners keep bids down until the losers disappear in some fashion? Or should they raise the bids and share some of the market with some of the (former) losers? The beauty of the pool is that the players can signal to each other, with their bids, how they will behave if operator X does this, or operator Y does that. We won't see textbook price competition; we'll see strategic gaming.

Relatively few competitors can reach detente through the bidding process and collude effectively on prices. We have seen how the airlines use their computer reservation system to collude, in effect, on price. The federal judge who just approved the settlement of a class action law suit alleging airline price-fixing summarized it this way, as quoted in the Wall Street Journal, Dec. 2, 1994:

"The four-year legal battle stems from allegations that airlines fixed prices by signaling proposed fare changes in the computer reservation system. The carriers didn't admit wrongdoing but agreed to settle for $458 million, which includes the value of the coupons plus legal and administrative expenses."

The Dominant Player Problem

PoolCo proponents will seek to rebut the cartel objection by pointing out that the pool will contain many players, so that a collusive price will not hold. There will always be many players eager to win a share of the market, the argument goes, so the cartel will inevitably break down.

The problem of the "many competitors" retort is that historically it doesn't have much credibility. There may in fact be many competitors. But the more competitors there are (em the ideal world of the PoolCo proponents (em the more weak competitors there will be. Many competitors will be small operators, with single plants and relatively small cash balances. These small players come highly leveraged, with no rich parent. Inevitably, we will see a few players with solid cash balances, untapped lines of credit, and perhaps a rich parent as well.

Against this background, the big player will be able to set the floor price for bidders. Let me make my argument easier by also assuming the big players are also low-cost players. These vendors will then gain enough leverage to win a bid every day. But they don't want to bid low, they want to win while bidding high. And they can force the weaker bidders to bid high. The acceptable floor bid can be dictated through a series of price signals (em low prices to force losses on those not behaving; higher prices to reward good behavior.

By bidding even lower than their own low cost, if necessary to win a large share of the market, the strong can force the weak to bid below cost to stay in the game. Bidding below cost when the bank balance is small cannot go on very long. Thus, the dominant bidder may can break, or threaten to break some of the others. But the dominant bidder may not want to put the weak bidders out of business. Instead, the goal may be simply to discipline the weaker players to bid higher.

PoolCo offers an ideal place to carry out price signaling. Price discipline of this sort is familiar behavior for vendors of electrical equipment (em the worst offenders already operate as partners with some of the bidders in the proposed PoolCo world. Thus, price control behavior could emerge even ahead of the learning curve.

The PoolCo proponents submitted their proposal as if "competition" actually works like the textbooks say. It is difficult to believe that Professor William Hogan really believes that. Even the Nobel Prize Committee repudiated the marginalists' theory of competition by awarding the latest economic prize to game theorists.

Let's discuss PoolCo in real terms: The question we need to address is, Who would regulate PoolCo: The Federal Energy Regulatory Commission, the states, or the Federal Bureau of Investigation? t

Articles found on this page are available to Internet subscribers only. For more information about obtaining a username and password, please call our Customer Service Department at 1-800-368-5001.