Power deregulation saved $34 billion; benefited majority of U.S. consumers over past 7 years says a recent CERA study

Washington, D.C., October 24, 2005 — The majority of U.S. consumers have paid less for electricity since the onset of power system deregulation in 1997, achieving total savings of about $34 billion compared with the costs if traditional regulation had continued, according to a new Cambridge Energy Research Associates (CERA) study titled Beyond the Crossroads: The Future Direction of Power Industry Restructuring.

“Despite the conventional wisdom that deregulation did not lower prices for consumers, the average US real price of power declined over the era of deregulation from 1997 to 2004.” said Lawrence J. Makovich, project director and CERA managing director, Gas and Power Group. “This gap between perception and reality suggests that power price trends are widely misunderstood, a misunderstanding that can lead to poor decision-making.”

“However, lower real power prices in the deregulation period compared with the regulated period do not prove that deregulation was successful,” according to Makovich. “Power prices ought to signal the real resource cost of consuming an additional amount of electricity. If power prices are held above or below this level, then economic distortions and inefficiency result. When power prices send the wrong signal, distortions and inefficiencies are more than just theoretical. Someone has to shoulder the costs of economic inefficiency.”

“The expectation embodied in the conventional wisdom—that for deregulation to be considered a success, power prices in nominal terms should have decreased continuously over the period under consideration—is inappropriate. Power prices needed to fluctuate in order to convey the appropriate signal for economic efficiency,” he added. CERA’s current analyses shows that the rapid increases in fossil fuel prices over the past year mean real power prices will increase in the near term—whether power prices are regulated or deregulated. Makovich concluded, “These real power price increases in the years ahead should not be misinterpreted as a failure of deregulation.”

The savings from deregulation reflect many of the expected gains from introducing more competitive pressures into the power business—greater efficiency, more innovation, and cost discipline. Yet a significant portion of the gains are due to power customers’ not shouldering the cost of much of the capacity added in the post-1997 period, according to CERA’s analysis. Instead of the costs of new supply going into ratebase and thus regulated prices, deregulation shifted the costs to investors who held the market risk.

The cumulative estimated savings in non-western regions over the deregulation period in 1997 is $42 billion. Although the South has the largest savings in absolute terms ($24 billion), it works out to about $5.20 per megawatt-hour (MWh). The highest per-unit savings is in the Northeast, where spreading $8.5 billion savings over sales yields at $7.30 per MWh difference. The Midwest is the smallest in both absolute and per unit terms: $9 billion and $4.20 per MWh. In the West, on net, had regulation continued, residential power customers would have experienced the shortage but spent $7.3 billion less on electricity than they did with a shortage and deregulation.

One implication is clear—deregulation reallocated risk in the power business. The risks associated with a shortage fell on consumers (the outcome in the western region), whereas the risks associated with a surplus (the outcomes in the other regions) fell on investors.

The report grades US deregulation and finds that “After nearly a decade of restructuring, progress in moving to competitive electricity markets is mediocre at best. Although workable markets are developing in some regions, and in some cases are performing well, power industry restructuring across North America overall earns an aggregate grade of C+.”

Interested parties can find the report card at www.cera.com/news/details/1,2318,7660,00.html

Despite the critical importance of the power transmission grid, the CERA report finds increasing underinvestment in transmission, with rate freezes, regulatory uncertainty and uncertainty about the load serving entity obligation contributing to gridlock. While the grid is called on to support much larger volumes of regional trade over a larger footprint than in the pre-competition days, most aspects of transmission expansion — aside from the formation of regional transmission organizations — have not changed.

In CERA’s view, five steps are necessary to attract the investment needed to create the robust transmission grid backbone the industry needs:

* Rationalize transmission planning by integrating the evaluation of economic and reliability criteria and clearly assigning responsibilities for building new infrastructure;

* Regionalize transmission siting to align with regional transmission boundaries;

* Default to system wide cost allocation for regional transmission projects;

* Implement formula-based transmission rates to reduce regulatory lag for transmission investment; and

* Combine long-term transmission rights with transmission expansion planning to assure certainty of access and costs in the next round of countrywide base-load capacity decision-making.

Resolving issues of resource adequacy – keeping supply and demand in balance – is one of the most important challenges facing the power sector, according to CERA’s analysis. With the power supply surplus disappearing in most regions of the U.S. between 2008 and 2012, the country faces a potential repeat of a California-type energy crisis. And the window of opportunity for building new generation or transmission facilities is rapidly closing. The study identifies nine different mechanisms currently evolving in the U.S. power sector to address resource adequacy in a spectrum from public power to unfettered energy markets.

CERA expects a wide variety and combinations of mechanisms to be adopted with varying degrees of success. CERA also expects short-term political pressure to prompt intervention and distortions in resource adequacy mechanism implementation that may be difficult to reverse in the future, and concludes that a persistent crisis in confidence will surround the power sectors ability to build adequate new supply in a timely fashion in the years ahead.

In the hybrid mixture of regulated processes and competitive forces that is likely to be the dominant state of the U.S. electricity industry for the foreseeable future, creating stability in this hybrid becomes a policy challenge, according to CERA. This will require more fact-based decision making, better setting and tracking of goals and performance metrics, restoration of confidence among investors, regionalized approaches to resolving federal and state conflicts, proactive resolution of distortions produced by unlevel playing fields, and recognition that policy needs to be tailored to the various industry models that have evolved in the power sector.

Restructuring, the product of a collaborative process involving various stakeholder groups, provides specific recommendations to contribute to the policy dialogue at a time when power industry restructuring has lost momentum. Nevertheless, action is required to bring stability to the industry’s hybrid structure. “Policymakers, legislators and regulators need to work together to ensure that directional changes at the federal, regional and state levels are informed, coordinated, sequential and measured,” the report concluded.

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