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Deregulation, Phase II

Recent electricity pricing argues for faster, more extensive deregulation.

Fortnightly Magazine - November 2007

Was restructuring a success? Prices provide a dispassionate analysis, showing that restructuring was poorly designed, badly executed, and focused on the wrong part of the grid. With those lessons learned, it’s time to explore ways to move forward.

Recent electricity price increases have prompted disparate organizations to issue self-serving declarations about whether deregulation is to blame. The Electric Power Supply Association, representing competitive power suppliers, claims market-oriented reforms have benefited consumers, while the American Public Power Association, representing municipal utilities that want to maintain their control of local markets, argues the opposite.

Fortunately, prices provide a dispassionate analysis. They illustrate that restructuring was poorly designed and badly executed, and it focused on the wrong part of the grid. An analysis of prices also suggests new directions for electricity market regulation (see sidebar, “A Model for Reform”) .

Restructuring Started to Work

Some state officials have blamed price spikes on deregulation, giving us a readily testable proposition: Have price increases in restructured states exceeded those in states that chose not to restructure?

The National Regulatory Research Institute (NRRI) at Ohio State University has characterized the status of electric restructuring according to the map shown in Figure 1 (see “Restructuring in the States”) . This map provides us with two differentiable populations to compare: The states that fully restructured (as the NRRI defines the term) and the states that remained traditionally regulated.

New Hampshire, California, New York, Rhode Island, and Pennsylvania in 1996 were the first state legislatures to pass restructuring bills. However, wholesale access began in 1992 with that year’s Federal Energy Policy Act. Political discussions at the state level over the next several years gave regulated utilities time to contemplate and plan for a restructured future, even before state legislation was official. Therefore, an analysis of changes in retail-power prices will focus on the period from 1992 to 2005 (the most recent year for which complete data is available). If deregulation caused prices to increase, we would expect to see a greater increase in prices in states that restructured their utility industries.

However, the data shows exactly the opposite (see Figure 2, “Retail Prices: Regulated vs. Restructured States, 1992-2005”) . Note first that in both regulated and restructured states, electric prices have risen at a slower rate than inflation. This is consistent with broader U.S. power trends from 1982 to 2000, where inflation-adjusted electricity costs have fallen every year. But specific to our comparison, the regulated states actually show a 30 percent greater increase in power prices than those that restructured.

This is all the more remarkable given the restructured (largely Northeastern) states long have been more dependent on natural gas than many Central and Southern states that remained regulated. Thus, price increases have been lower in the restructured states in spite of greater increases in power-plant fuel costs.

Specifically, as of 2005,