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Electricity Restructuring is No License for Central Planning

RTOs will perpetuate regional monopolies and political rate regulation.

Fortnightly Magazine - June 1 2002

Economists sometimes get confused - especially when the real world doesn't fit into their neat boxes.

Network industries like telephone and electricity are today's case in point. Economists have viewed these parts of the economy as requiring special attention from regulatory authorities. They're viewed as "natural" monopolies displaying "economies of scope" and characterized by risky "lock-in" or "path dependency" features. That supposedly makes them prone to abuse by their free-market owners, and therefore in need of impartial regulatory oversight.

Lost in the regulation-is-essential dogma is the reality that network industries have two major elements: the network itself, and the “stuff” that flows over it. Trains and tracks, oil and pipelines, electricity and wires. An efficient network depends upon wise investment and management of both elements. But, economists have focused almost exclusively on freeing up the “stuff,” and then enacting regulations to mandate open access to the network itself.

That approach has meant that the regulatory problems are simply reshuffled to determining a “fair rate” for allowing use of the network. In practice, that determination will rarely provide the incentives needed to upgrade the network itself. And, often it is the network itself that offers the best prospects for greater efficiency.

C. Wayne Crews, CATO

This error is particularly threatening with respect to deregulation of America's $200-plus billion electricity industry. In every high-profile debate over electricity deregulation - from California's restructuring to Enron's call for creation of so-called Independent System Operators by the Federal Energy Regulatory Commission - policymakers have focused on freeing up the electricity generation part of the system (the "stuff") but have actually increased the restrictions on the network element by imposing an "open access" requirement to the power grid. The plan for this industry according to its "deregulators," is to impose open access to allow businesses and consumers to select the electricity generator of their choice.

But while proposed in the name of efficiency and adopting the market's promised benefits of "choice" and "competition," this policy openly proposes to force grid managers to carry power from the generator to the consumer, and ultimately destroy the real market choice that we need to establish. But there is an alternative.

The Difference Between Restructuring and Deregulation

Deregulation of this sort is scarcely deregulation at all. Generators are freed to market their power to everyone, but the costs of transmitting that power to the customer are shifted to the grid managers. Of course, a charge is levied for that service, but the regulators, not the market, will determine that rate. Regulated rates are likely to fall below those needed to justify new investments. Moreover, the inability to charge freely will rule out the entrepreneurial profit opportunities necessary for technological improvements. Rather than removing regulations and paving the way for competitive entrepreneurship, mandatory open access policies actually increase political interference. The Federal Energy Regulatory