8/27/2001

KUFM / KGPR

T. M. Power

Can the Electric Industry Be Safely Deregulated?

Regional electric prices have been easing and the cost of electricity has come down to a level that industry and businesses can afford, at least for now. The lingering regional electric crisis seems to be receding. Maybe that makes it a good time to think more carefully about whether the electric deregulation experiment, on which Montana along with California took the lead, can be made to work.

We boldly launched this experiment primarily on the basis of a weird brew of ideological wishful thinking and powerful special interests pursuing big bucks that they imagined were there for the taking. Of course nothing worked out as intended, but the anti-government ideologues have not lost their faith in markets, even failing markets, and even the big industrialists and utilities that hoped to make a killing but instead lost their shirts pretend they were right all along and nothing bad really happened. Meanwhile the critics of the whole experiment simply want to dismantle it and punish the political leaders who engineered it. None of this response suggests that a productive dialogue based on engineering and economics instead of wishful thinking and predator profit taking is about to take place even though it is badly needed so that we can learn from out mistakes.

The primary intellectual impetus for electric deregulation came from reasoning by analogy: Deregulation appeared to have worked, or at least not brought disaster in its wake, in the airline, telephone, trucking, natural gas, railroad, and oil industries. So why shouldn’t we take one more step away from government bureaucracy and regulation to reliance on markets and private businesses? The underlying assumption, often not discussed, was that the electric industry had no unusual characteristics that might make these analogies inappropriate or misleading.

In fact, the electric industry is unique in several different and important ways that will keep us from relying exclusively on competitive commercial markets to guide it.

First, electricity cannot be stored. We cannot build up inventories to serve periods of unusually high demand or when there are breakdowns in production. Electricity has to be produced on demand.

Second, electricity flows across all interconnected parts of the grid according to the laws of physics, not according to patterns of legal ownership. In addition, each connected producer as well as each connected consumer sends potentially disruptive forces out into the system. Because of that, the entire interconnected grid has to be closely supervised and regulated. That requires a great deal of close cooperation among different owners, generators, and customers. How one arranges for independent competitors to engage in this type of complex cooperation is not clear.

Third, complete deregulation and reliance on competition is not possible unless we want multiple electric lines tangling up our cities, neighborhoods, and countryside. Transmission and distribution of electricity continues to be a natural monopoly. That means that we cannot completely deregulate the electric industry; some monopoly and regulation has to continue.

In addition, privately owned transmission and distribution systems, as regulated monopolies, are likely to create regional bottlenecks, limiting the flows of electricity and access to certain areas by competitors. That assures that some electric firms will be able to exercise considerable market power to the detriment of customers. Montana may be in exactly that situation. It is not clear how we will arrange for the necessary investments in new transmission capacity to eliminate those bottlenecks. Who will put up the money, take on the regulatory battles, suffer the public relations damage, etc. ? Regulated monopolists have not shown they are willing or able to do this, especially those who benefit from the bottlenecks.

Fourth, a variety of factors are likely to lead market-based electric prices to be very unstable. We have just been through one cycle of this and should recall the damage it did to our economy even though, in Montana, we only got a little taste of it. The chaos in California shows what is possible. This instability is tied to two factors. First, electric generation is highly capital intensive. Before investors put down their money they want to be quite sure they will get their money back along with a profit. So they wait until electric prices are very high; then they all rush in and build. Often they over build and prices come tumbling down and all further construction ceases. So we lurch from shortages to surpluses and prices go from being “too cheap to meter” with “all you can eat” discounts to severe shortages and price spikes that cripple the economy.

This price instability gets exaggerated by the way we use electricity. In the short run, most of us cannot significantly reduce our usage when prices are high. Businesses have to stay open if they want to serve customers. Most of us have to leave the heat or air conditioning or water heater on if we want our homes to be livable. Our appliances take a certain amount of electricity when we use them and after investing in them, it is unlikely we will simply abandon using them. So as electric shortages develop, most customers cannot simply reduce use. As a result, it takes very high prices to force some customers to cut their usage. Those price spikes shut down businesses, lay off workers, and impoverish households.

Finally, the generation and transmission of electricity make heavy use of public resources, impacting our air, water, natural landscapes, and climate. Most of us are not willing to turn these environmental decisions entirely over to private, unregulated commercial interests. We would not be rational if, when someone wants to build a new large generator or transmission line near out community, we did not ask: Is this the best use of our air, water, and open space? Is there not a better alternative that commercial interests are ignoring? This means that the siting of electric generators and transmission lines as well as the type or portfolio of resources that are invested in are going to continue to be regulated by our governments. Again, a significant part of the regulatory apparatus will have to be kept in place.

This is not to say that we have to continue do things the way we “always have” or that we should not try to adjust the way we combine competitive markets with government regulation. The economy and government are not static institutions. They must change as technologies and economic opportunities develop. But as we try to pick up the pieces of a failed experiment, we need to push both ideological wishful thinking and predatory profit making away from the table and focus this time on the real world and the public interest.