Knowledge Problem

So I was catching up on my reading this AM over breakfast, and saw the header on Robert Prather’s post titled “beneficial complexity”. Very cool, I thought, sounds right up my alley. And then to find that the post was a link to me! Jiminy, that’s pretty exciting, thanks! I love the phrase beneficial complexity; it succinctly captures the myriad benefits attending market processes.

Now, to provide further enticement in this notion of possible competition in electricity transmission, think about this: the means of competing with a monopoly network grid are diverse. Building a parallel network is NOT, repeat NOT, the only option. Electricity illustrates this beautifully, because distributed generation technology that makes small-scale, local generation more feasible and economical for more consumers, also makes the grid contestable because it provides consumers with alternatives to using the monopoly network.

I’ve actually written some about this. The most extensive formulation of the argument is in this Reason Public Policy Institute study entitled “Movin’ Juice: Making Electricity Transmission More Competitive”.

Examples abound in telephony and computing too. I think the punchline is this: don’t make policy decisions based on static notions of what constitutes a natural monopoly. Technology changes those categories, and changes what types of economic activities fit into those categories, and because our regulatory environment is not sufficiently flexible and adaptive to be robust to the dynamic effects of technological change, we’re all worse off.

Slowly, but surely, things are looking up for competitive wholesale electric generators. Today Constellation Energy announced an 83 percent increase in profits in Q4 2003. Much of this performance was driven by its wholesale electricity division, Constellation NewEnergy:

The merchant energy business, or wholesale electricity marketing, posted earnings per share of 52 cents, more than double the year-earlier profit. The unit, Constellation NewEnergy, sells electricity and services in 15 states and two Canadian provinces.

Even the 800-pound regulated gorillas who want to keep things the way they are have had better performance. Southern Company has seen its demand increase due to increased industrial production:

After mixed signals for much of last year, Southern finally felt the telltale signs of the recovery in the fourth quarter: a spurt in demand for electricity from its big industrial customers who needed power to crank up their factories and plants.

And since Southern is in the business model of “sell more power, make more profit” against which I ranted yesterday, this is good news for them.

While we’re on the subject of energy innovation, please check out Randall Parker’s Futurepundit post on the potential for fuel cell vehicles to heat homes. I’ve discussed this potential with several industry folks, and it is truly exciting. Consider being able to drive up to your house and plug in your car in order to power your house.

OK, now the wet blanket part: our regulatory structure is a major impediment to the implementation of such cool options. Utilities view any request for customers to leave the grid, called bypass, as a reduction in their load and therefore a direct reduction in their profit. The nasty little incentive problem of cost-based rate-of-return regulation is that utilities have developed a “sell more power, make more profit” mentality over the past 85 years. In that mentality, keeping us as captive consumers is their business model, because the converse is “sell less power, make less profit”.

The challenge: get thought leaders in utilities to recognize that the difference in consumer preferences and demand elasticity over the day, week, and season creates opportunities for utilities to make more profit selling less power. Then we will be captive no longer, bypass will not be so vigorously refused, and we can apply the innovations in distributed energy technologies, using fewer resources along the way.

Many people argue that electricity transmission is a natural monopoly, defined as having a subadditive cost structure (roughly speaking, decreasing long-run average costs over the relevant range of demand). Based on that belief, competitive entry is not allowed. Historically this has arisen because of the vertical integration of the industry, which is itself a consequence of the technical difficulties of unbundling the energy flow from the wires during the formative years of regulation in the early 20th century.

But with economic and technological change, particularly in electricity generation, the prospect for competitive transmission became brighter. Then in the late 1990s a lot of policy changes at FERC tried to implement nondiscriminatory transmission access for non-owners, and opened the possibility of transmission owners organizing their assets into private, for-profit, standalone transmission companies (known as transcos in the biz).

Transcos have had a rough time of it these past two years, with all of the sturm und drang over regional transmission organizations and FERC’s proposed standard market design. Plus, utility accounting rules work against reorganizing and vertically dis-integrating the transmission part of the value chain; both depreciation rules and capital gains taxes on these large, and massively depreciated, assets make the economics of selling your transmission assets to a transco very problematic.

So I was pleased to hear at least a little ray of sunshine from Pat Wood, FERC Chairman, who said that he sees a future for Translink, a proposed transco that dissolved in the face of these many obstacles. I hope he’s right, because competing transmission is an important way to generate efficient investment incentives in a world that does not look like 1907 any more, the year on which our electric utility regulation is imprinted.

I think more people will explore the transco model now that it looks like the FERC standard market design will not go ahead as planned. The discussion about competing wires, other forms of competition for grid networks such as distributed generation, and the crucial issue of end-use customers being able to bypass the grid access of the government-granted monopoly is a healthy one, and long overdue.