A Prematurely Reported Death

by Dan Watkiss

Eulogies proliferate for “electricity deregulation.” A typical death knell comes from the Tellus Institute, burying deregulation as a “failed experiment” that “did not” and “could not work.” As with Sam Clemens’ reported demise, these eulogies are premature.

Even more off target are the lessons these obit writers derive from deregulation’s death: We must return speedily to the garden-the halcyon days of beneficent, fully integrated generation-transmission-distribution-retail franchise monopolies, operating under cost-of-service pricing for all of their services in every service territory.

Much of what these champions of the yesteryear call “deregulation” is no such thing. Rather, it has comprised different forms of regulation that overall rewarded consumers with large savings relative to the “good old days.” Granted, “deregulation” has experienced missteps and mistakes, particularly in state retail programs, but these are well-recognized today and carry with them lessons for the future as opposed to the rearview mirror.

Notable among the “failures” in the competition-naysayer catalogue is the wholesale power market. But in the past 15 years, the transition to that market saved consumers billions of dollars. According to the DOE, those savings today amount to nearly $13 billion per year.

The competitive wholesale power market cannot accurately be characterized as “deregulated.” To the contrary, since its inception it has been the product of sustained regulatory intervention that imposes standardized transmission tariffs and conditions market pricing on proof that sellers are, and will continue to be, price takers, lacking market power in generation, in-puts to generation (e.g., fuel and real estate), and transmission.

The “failure” of competitive wholesale markets is indiscriminately lumped under the rubric “deregulation” with “pernicious” marginal pricing of spot and short-term markets; demands that the transmission grid accommodate transmission from production to consumption areas, contrary to an undisclosed theology’s “original intent”; the separation of generation from the wires businesses, resulting in a power system “run not by engineers but by speculators,” and retail rate shock.

The answer to these failings, Tellus and fellow travelers argue, is a return to strict cost-based pricing of all utility services, including generation. Each of these critiques is wrong; if credited, they would lead to bad, and quite possibly disastrous, energy policy.Those who would jump backward have short memories indeed.

Despite being based on an economic model in which the more-you-spend-the-more-you-make, the investor-owned utilities and the government franchise monopolies regulated on a cost-of-service basis, reduced consumer risk and offered scale economies for the first half of the last century. But, the achievements of that form of organization began to reverse beginning with the Northeast blackout in 1965, increasing cost overruns on new generating plants, and the loss of scale economies. The Rocky Mountain Institute accurately reduced industry history thereafter: “Central thermal power plants stopped getting more efficient in the 1960s, bigger in the 1970s, cheaper in the ’80s, and bought in the ’90s.”

Since then, it has been innovators and risk-managers who have continued to innovate in smaller and more efficient generators, renewable resources, demand management, distributed generation and efficiency programs.

The complaint against marginal pricing has nothing to do with the bogeyman “deregulation,” but with the inherent volatility of both prices and investment cycles in the power industry. Offering spot and short-term clearing at a single price is anything but “pernicious.” Yes, in an industry where the cost of production capacity is less than the cost of inventory (i.e., the extreme difficulty and cost of storing electricity), single prices will be volatile, exposing unhedged buyers to potentially large price gyrations. What then can protect consumers without diluting essential price signals? Long-term (6 months or greater) contracts that levelize short-term seller or buyer windfall profits and loses.

Retail rate shock is cited as the reason that a number of jurisdictions have halted plans to introduce some form of retail competition. But is this rate shock a product of “deregulation”? In a word, no. Rate shock is what happens when default retail service is offered during a transition to retail competition, but is price-capped by local regulation at levels below prevailing wholesale prices. These rate freezes created a step function in cost to consumers where there should have been a smooth upward slope, irrespective of whether consumers were seeing market-based or regulated cost-of-service rates.

A more nuanced complaint is that “deregulation” makes undue demands on the high-voltage transmission system that was not built (and not intended by some priesthood of engineers) to sustain them. Whether those demands are accommodated by clear-cutting rights of way and stringing new high-voltage wires across the nation’s landscape or by distributing generation close to load centers and better managing peak demand are pressing public policy choices.

I agree that a laissez-faire trust in markets is unlikely to produce optimal choices. But we voting citizens and our political representatives, not one of Tellus’ utility clients functioning as both franchise monopolist and philosopher king, should dictate how we develop and price these limited resources.

Author

Dan Watkiss is a partner with Bracewell & Giuliani in Washington, D.C., representing power companies, exploration and production and mid-market companies, natural gas pipelines, power and liquefied natural gas project developers and lenders, as well as government agencies and regulators. Contact Dan at Dan.Watkiss@bgllp.com.

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