All versions of the "revolution" in the electric power industry seem to turn on the prospect of competition in generation. This indeed is the vision of things to come.1 The generation in question is either partly utility owned and partly independent or (em in the best of all possible worlds (em all independent, as a result of disintegrating the vertical utility monopoly.2
The startling disparities between the cost of delivered kilowatt-hours in the various utility service territories supply the driving force behind the demand for competitive opportunity and access. Many observers now claim that the "market" price of electricity lies somewhere in the 4 cents per kilowatt-hour (›/Kwh) range, while, in certain service territories, retail rates may range upwards of 10 to 12 cents per kilowatt-hour.3 In general, we are to believe that there is "efficient" generation, which is usually ascribed to more competent management, and "inefficient" generation, which is normally attributed to a correspondingly backward management.4 No wonder there is a demand for competition if good management and bad management can be so sharply distinguished at the bottom line.
The literature on competition, however, has mostly failed to address the specifics of efficiencies in electric generation or the ways in which electric generation will respond to a competitive environment.
Heat Rates, Efficiency, and Vulnerability
Some discussions of this subject have made passing references to heat rates (em the standard measure of power-plant thermal efficiency (in British thermal units per kilowatt-hour). On the face of it, heat rates seem the natural measure of a factor that would respond to competitive forces. Heat rate is a conventional standard and, of course, may be adversely affected by environmental requirements. Increasing plant reliability, lowering fuel costs, and lowering financing costs have also been mentioned as sources of competitive savings.5 But, aside from obvious measures like these, the generation most authors consider vulnerable to competition is nuclear power.6 The question is whether high-cost generation resulted primarily from managerial error or from global factors unlikely to be "corrected" by market factors alone?
Nuclear generation is frequently identified as inefficient or costly. Disparities in the rate levels in adjoining service territories are often attributable to a too-expensive or poorly functioning nuclear unit or units in the disadvantaged territory. Under a competitive regime, this situation may mean that, at best, a nuclear plant can be run to recover its variable cost of operation, hopefully with some contribution to fixed costs. At worst, in the unlikely event the "market" price will not cover even variable costs, the nuclear plant will be wisely shut down. How decommissioning costs will fit into this picture is not entirely clear.7
The number of nuclear plants continuing to run but failing to recover their total costs (including fixed costs) creates a national problem not unlike that of the railroads during the Depression. Utilities are expected to operate with substantial excess capacity and a chronic inability to achieve sufficient revenues to cover costs. The existence and extent of loss depend, of course, on how stranded assets, such as nuclear plants, are actually treated.
But all this is another subject. What seems most useful now is to work through the practical effects of competition as it might affect such likely victims as nuclear plants, and to discern what all this means for the specific areas where sunk costs would become unrecoverable in the face of competition.
The Nuclear Irony
We have all been brought up to believe (em and I think with some basis in history (em that competition is a wonderful stimulus to innovation. This is presumably what Joseph Schumpeter had in mind when he described capitalism as a process of creative destruction.8 His theory posits that a succession of waves of discovery of whole new ways of doing things creates the dynamism of competitive systems. The fact that the nuclear plant is the most radical innovation in electric generation (em at least since World War II (em is therefore a bit ironic. These plants now seem to have become the most obvious sources of loss and financial strain in the electric industry. Hardly the cutting edge of progress and change, many of the plants now vastly complicate any transition to a competitive mode.
Arguably the most spectacular and initially promising innovation in electric generation, nuclear generation was also fostered by a great deal of governmental encouragement and promotion. At one time, the peaceful uses of atomic energy occupied a very high priority in government and public thinking (em not only in the United States, but around the world. The nuclear power plant seemed an obvious and important avenue for hope for the future. As I recall, the late Shah of Iran favored it as a means of modernizing his country. I need not remind the reader of the promises of electricity "too cheap to meter," or the forecasts lauding the atom as a pollution-free substitute for coal.9
The Energy Reorganization Act of 1974 divorced the promotional aspects of nuclear power from its regulatory aspects and created the Nuclear Regulatory Commission (NRC).10 That legislation contained a provision for the study of "nuclear energy center sites," which were conceived as regional areas for locating a number of nuclear reactors and/or other nuclear fuel cycle facilities. (On a more bucolic note, these areas were sometimes referred to as "nuclear parks.") The study mandated by Congress extended to soliciting the views of officials and experts at all levels as well as those of "interested persons" and "citizens' groups."11 To facilitate the gathering of this information, the NRC convened several large conferences of interested citizens and responsible officials.
At that time, if memory serves, popular theory conceived a need for 800 nuclear power plants (em or possibly as many as 1600. A view that it would be better to build these plants in clusters of about
l0 or 25, possibly including reprocessing facilities and the like, also enjoyed some attention. Such a disposition promised to concentrate the safety and environmental problems in sites away from populous areas. The purpose of the conferences was to think through the problems of infrastructure, security, regulation, and other pertinent aspects of these proposed "nuclear parks." I attended one of these conferences in 1975 (em in Portsmouth, NH. The participants (em of whom only a minority were government officials (em thought that we were dealing in a frightening but possibly inescapable reality. We, and the agencies and experts that guided us, were, of course, wrong (em wholly misguided. But a belief in the need for nuclear power, as well as anxiety about its impacts, is what concerned agencies and "interested" citizens 20 years ago. And the electric utility industry itself certainly held no contrary view. Almost everyone (em not merely "government" or "management" (em entertained these ideas. Yet, after all that, we now view nuclear power, not as the energy giant on the horizon, but as the most obvious candidate to become a "stranded asset" in the new era of competition.
The Natural Gas Turnaround
Presumably, combined-cycle gas-turbine generation will establish the marginal cost (em and hence the market price (em of electricity under a competitive regime.12 Natural gas plants are both the cheapest and the fastest plants to build (em and the costs of fuel are currently favorable. I have heard no one predict that the output of these plants will be too cheap to meter, but, considering the enthusiasm of some prophets of a new order in electricity, I expect some such prediction any day now. Natural gas has, of course, always been a highly desirable fuel (em environmentally benign, yet chock full of energy. The only questions in the past have been "How much of it is there?," and "Can its price remain competitive?"
At the time nuclear power parks were drawing the attention of the "interested" community, popular thought placed natural gas on the endangered species list. The then current wisdom suggested that the supply of gas was shrinking and that prices were mounting in the face of all government efforts to suppress them. Natural gas was a "premium" fuel to be saved for home-heating or agricultural use; using it at a power plant was thought to verge on criminal behavior.13 In any event, the price of natural gas was rising so rapidly that the thought of competition with nuclear generation was absurd. Gas turbines were as cheap and as fast to build as they are now, but certainly no one saw them as a major factor in fashioning the energy future. All the emphasis was on coal and nuclear generation as best comporting with national security objectives (em not to mention cost. Almost everyone thought that dependence on Middle Eastern oil put the nation at risk (em if not of an actual embargo, at least of an exorbitant price. Then, all estimates of oil and gas prices for the future assumed a rising trend. In light of the bleak outlook for gas and oil, Congress passed the Powerplant and Industrial Fuel Use Act of 1978, which aimed at converting natural gas- and oil-burning power plants to coal, or to some other fuel with a future.14 These pessimistic views of the prospects for oil and natural gas were rather generally held by the electric power industry and the public, as well as the government.
The course of events since 1975 is, of course, well known. A number of huge baseload nuclear plants became redundant because electric demand fell far short of forecasts. Nuclear costs (em whether due to poor construction management or to regulatory waffling (em climbed out of sight. Meanwhile, natural gas, freed of an earlier regulatory regime, began to fill the interstate pipelines. Gas surpluses and price declines developed. Gradually, there seemed to be enough of the "premium" fuel to find a broad range of satisfactory uses (em even in power plants. In fact, in the last year or so, estimates of crude oil prices (and presumably natural gas prices) forecast a declining trend.15 Now there appears to be sufficient oil and gas to last literally forever (em and at cheaper and cheaper prices. In contemplating the competitive universe, the combined-cycle natural gas-fired turbine appears to be the plant at the margin (em setting the market price and exposing many nuclear behemoths as an embarrassment. In 20 years, conventional thought, which was by no means confined to government regulators or the electric power industry, has suffered a total reversal.
A New Pecking Order?
I wish I could believe that we are really smarter in 1995 than we were in 1975. But I think the real lesson of history is that prediction is a very imperfect science; it is virtually impossible to provide an accurate 20-year forecast. This is one reason a competitive regime faces what I consider unusual difficulties in the electric power industry. Perhaps these problems are no more serious in a competitive regime than in a regulated one. Yet these problems make one wonder just how different one regime may be from the other.
I make this observation because many of the cost differentials in generation hinge on choice of fuel. But the choice of fuel is dictated by a complex array of factors (em such as perceived national security, environmental, and available resource base considerations not necessarily reflected in the day-to-day market price. As I have pointed out elsewhere, these considerations, like externalities, potentially undercut decisionmaking in the electrical world.16
So the market for electric generation promises to be heavily constrained and regulated. Unless the past has no message for the future, we will find ourselves in a market where choice of fuel (em certainly a major factor in competitive performance (em will be heavily impacted, if not dictated, by government policy (and by public opinion). Government policy, in turn, will be determined by current estimates of availability of various fuels, fuel price trends, dependence on foreign sources, national security considerations, and other nonmarket factors. Perhaps current thinking about these matters will prove more durable than past thinking, but there seems to be no guarantee of stable views.
For instance, deregulation of natural gas and the unbundling of gas pipeline services partially prompted the trend toward natural gas as a boiler fuel. Some believe that deregulation will save us from repeating the "errors" of the past (e.g., substituting other fuels for gas). True marketeers hold that the substitution of market forces for "command and control" assures, if not infallibility, at least alignment with a wondrously reliable invisible hand. This is an act of faith that only experience can put to the test. But the historical record suggests caution.
Quite apart from public policy involving world and domestic supply and considerations of national security, we also face major issues of safety and environmental impact. Public opinion and the government's outlook on these matters changed the prospects of nuclear energy rather dramatically between 1960 and 1990. Markets will have to operate within these changing constraints (em presumably discounting them as much as possible. The fundamental question of electricity's place in the energy pecking order is also open. How many gasoline-powered automobiles will bereplaced by electric cars? Again, extra-market forces will be in play.
The Real Promise of Competition
Obviously, the builders and buyers and sellers of electric generation will try to take government policy and public perception into account in arranging long-term contracts. But the factors we have mentioned are matters that markets, with their short-run focus, do not adequately reflect. The cheapest source today may be unavailable tomorrow because of some shift in the politics or economics of world trade. All industries risk an uncertain future (em dress manufacturers must guess what may be in style next season (em but no industry is more fundamental to the economy, or to national security, than the electric industry, which has massively capital-intensive investments at stake.
Admittedly, competition in generation may take place primarily at the level of heat rates and the like; these do not raise such serious and fundamental questions. Choice-of-fuel questions may not be a major factor because the mix of competing generating plants will be uniform and optimal; then competition will occur at the margins.17 But this does not seem obvious to me, and such an assumption should not be lightly made.
As I have indicated, the real promise of competition is in Schumpeter's "creative destruction" (em the belief that whole new ways of doing things will emerge from the competitive struggle and, as a consequence, drastically improve quality, reduce price, or provide other benefits. On the whole, this has not been the story of electric power to date. Incremental progress (em bigger units and higher pressures (em has been the norm. The giant leaps we have seen (em such as the development of nuclear power (em have thus far produced more failure than success. Somehow the electric industry's record has not paralleled that of the telecommunications industry, where major innovation has been spectacularly successful.
One possible reason for this is the extraordinary impact of electricity on the world it pervades (em on the environment in the largest sense. One power plant may be narrowly more "efficient" than another, but should it raise havoc with the environment, national security, or any number of other matters external to the market, extraordinary complications will arise. We must be vigilant to ensure that our thinking about a more competitive electrical generation system addresses with realism the many important constraints that system will face. t
Richard D. Cudahy is a judge at the U.S. Court of Appeals for the Seventh Circuit. Previously, Judge Cudahy served on the Wisconsin Public Service Commission (1972-75), including a stint as chairman (1974-75). Judge Cudahy thanks law clerk Karen Chisholm for assistance in preparing this article.
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