An analyst looks at prospects for emerging power technologies in light of the recent turmoil over deregulation.
Fortnightly Magazine - January 15 2003

Goodbye to All That?



An analyst looks at prospects for emerging power technologies in light of the recent turmoil over deregulation.

In mid-1997, electricity deregulation seemed on the verge of sweeping the country. Based on our prior experience with deregulation, in natural gas and airlines principally, I became convinced that deregulation would lead to profound changes in the power industry. These changes would lead, in this view, to significant opportunities for new entrants and for companies developing new technologies for the power industry. I based this conclusion on my experience in the early 1980s as a consultant to the power industry and on a close reading of the literature on deregulation, both suggesting that decades of regulation had a stultifying effect on industry generally and, at least in my experience, on the power industry specifically. Deregulation would change all that, bringing new entrepreneurial management to the industry, attracting risk capital, and sowing the seeds for investment in technologies that would change the way power was delivered, priced, and used.

Now, early in 2003, I am not ready to abandon this thesis altogether. The logic of the argument remains sound: History still teaches the benefits of competitive markets and deregulation, particularly in stimulating innovation. But times have changed. In the wake of California's problems, deregulation is stalled, at least for the near term. The current disclosures of greed and wrongdoing at the most senior levels of management among the new entrants to the industry-companies such as Enron that I myself viewed as exemplars of the "new breed"-have reinforced growing skepticism on the merits of deregulation. And, lastly, we seem to have an administration that can do no better than "your father's energy policy" when it comes to tackling America's energy problems.

All of this has worsened the prospects for emerging power technologies. The failure of deregulation means that, at least for the near term, consumers will not get price signals in the marketplace that reflect the true value of power at a specific time, in a specific location, and of a specific quality. These "true" prices become the basis for economically sound investment decisions, decisions that lead, irrevocably, to a system of power generation, transmission, distribution, and use that differs fundamentally from what we have today, insofar as today's power infrastructure is based not on prices that signal true economic value, but on regulated rates that often obscure real value, or hide it altogether.

Granted, not all markets, maybe very few, are characterized by prices that entirely reflect economic value. Some regulatory sleight of hand creeps in somewhere along the way, in the form of government subsidies, tax incentives, or other government intervention. But I don't think we can argue that moving toward market-based prices, even in some small, incremental way, doesn't have benefits to the consumer. Therefore, despite the current freeze on deregulation, we should root for success by the Federal Energy Regulatory Commission in implementing some version of standard market design in transmission: While it may not get us all the way there, it seems to be a step in the right direction.

At the height of the Internet technology bubble, it became popular among analysts to believe that demand-side forces alone were strong enough to pull emerging power technologies into the marketplace. The need for high quality and highly reliable power to support the digital economy would necessitate investment in new power technologies, particularly technologies like fuel cells and microturbines that could provide distributed solutions to generation and power quality, irrespective of the fate of utility deregulation. Thus, according to Peter Huber and Mark Mills at the time, the digital economy already absorbed 13 percent of all power consumption and was headed toward a 50 percent share of the market in 10 to 20 years.

Subsequent work at the Department of Energy's Lawrence Berkeley National Laboratory and Arthur D. Little came to more sober conclusions: Electricity consumed by computers and network equipment accounts for 3 percent of consumption, and, while growing, will not likely claim 50 percent of the market any time soon.

Even if the digital economy were to exercise the advertised demand pull on the power market, without deregulation this demand must be accommodated within the existing framework of the regulated industry. This would do nothing to remedy the defects in today's marketplace and would lead, in fact, to a round of investment decisions aimed at circumventing, not correcting, the current inefficiencies in the marketplace. In other words, it would add, rather than subtract, from the overall consumer disadvantages of the status quo in power.

In short, what looked rosy for the power sector in 1997 doesn't look so rosy now. The bullish case for power technology, in particular, was predicated on deregulation of the power market and on the economic consequences of deregulation. Demand-side forces may add to the stimulus to power technology provided by deregulation, but these demand-side forces alone are insufficient to ensure the success of new technologies.

There are two big "if and when" questions that could alter this pessimistic view for power technology. The first is the green thing-the inevitable shift, at the point of a gun or voluntarily, toward environmentally sound technologies. Many emerging power technologies have positive environmental characteristics. The green thing probably will not force rapid change in the power infrastructure, but it will contribute toward the long-term growth of the market for technologies such as solar, wind, and fuel cells.

The other big "if" is national energy policy. The Bush administration's proposals appear (to this writer) to be nothing more than a rehash of ideas that have been around for decades, and they have a decided bias toward the short term. Few elements of social policy are as critical to our long-term health and prosperity as energy, and what is needed is not a five to 10-year plan, but a 50- to 100-year view.

Staying the course on deregulation may be one of the best investments we can make in energy for the long-term. A national commitment to deregulation would go a long way toward a rational reawakening of investor interest in power technology.

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