Another Waxman-Markey blemish: reinforcing the obsolete utility business model

Lynne Kiesling

Over the past few days Josh Blonz at Common Tragedies had a couple of posts (here and here) about the permit allocation issues in the Waxman-Markey bill, and yesterday Tim Haab picked up the conversation thread. They are both focusing on the welfare and efficiency implications of the proposal to allocate permits to “LDCs”, local distribution companies — in other words, regulated utilities. The social engineering objective of the bill’s authors is, apparently, to use the economic regulation under which such companies operate as a constraint to prevent the utility from using carbon pricing as a justification to raise the retail price of electric power service to, in particular, residential customers.

The posts and the associated comments flesh out two of the pricing issues here. First, Josh focuses on the fact that even with the allocation of permits to LDCs, pricing carbon will increase the price of all goods that use carbon-intensive production methods, so that means that the prices of consumer products will rise (Josh’s “indirect” costs) even if their retail electricity prices (“direct” costs) do not. Second, Rich Sweeney’s comment on Tim’s post points out the distinction between using the allowance revenue to reduce the fixed portion of the retail electricity bill (the wires charge) or the per-kwh electricity price. I think the idea is that if a LDC’s activity is sufficiently low-carbon that it can sell some of its allocated permits, how will they return that revenue to their customers?

But this discussion, and the (extremely flawed) Waxman-Markey bill on which the discussion is based, take some pretty serious regulatory and industrial organization questions for granted. For an extreme example, let’s take Texas, which is the only state in the US that has created a successful and competitive retail electricity market. The only regulated entities in the Texas market are the wires companies (transmission and distribution utilities, or TDUs, in the Texas lingo). Thus in the Waxman-Markey formulation, the entities that would receive allocated carbon permits would be these wires companies — the TDUs are the LDCs in Texas (they are also LSEs, or load-serving entities; this industry suffers from acronym proliferation that only an engineer or a bureaucrat could love!). This implies that any financial impact of the revenue from selling permits would show up as a reduction in the wires charge, not the electricity price. So far, so good, for keeping marginal incentives intact.

There are still two questions here. First, exactly how can a regulated wires company increase its carbon productivity/decrease its carbon intensity? The decisions it can make within the firm don’t really have much carbon impact, unless the wires company is allocated some right to the carbon effects of building transmission out to isolated renewables locations. But I think that whoever is building that wind farm or solar thermal installation would want to claim all of those rights, so there’s room for conflict (and/or Coasian bargaining) here. Second, Rich’s comment presumes that the wires charge is fixed, which has been the case for decades — but it’s not at all clear that a fixed charge for the transportation service is economically efficient. In fact, there’s a substantial congestion-related argument that the wires charge should be a two-part tariff, with a fixed component and a volume component that reflects congestion (and provides the signal for investment in wires capacity). With such a wires pricing structure, it complicates the permit revenue rebate transaction, particularly since this is still all intermediated through the state regulators.

At the other end of the spectrum, the relationship seems to be more straightforward in the states that continue to be vertically integrated and fully regulated, at least in the short run. In that case, regulators retain firm control over all of the decisions and pricing along the entire value chain, from generation through end use. But that’s actually where my biggest objection to the LDC proposal kicks in

My biggest objection to the LDC proposal is this: by presuming that the existing utility industry structure is going to persist and by conditioning what are meant to be long-lived carbon permit transactions on the continuation of the LDC-customer regulated transaction, the Waxman-Market bill actually entrenches the utility business model even further than it already is. Despite the fact that retail service provision can be a competitive industry and the only remaining “natural monopoly” network cost structure features in this industry are in the wires portion of the value chain, the obsolete vertically-integrated business model persists in about half of the states in the US. Smart grid technology, particularly the meter and myriad end-use applications and devices, reinforce the potential competition in retail electricity markets. Consumers and entrepreneurs would benefit from reducing entry barriers in retail electricity service provision.

The Waxman-Markey LDC proposal stifles that evolution of the electricity industry away from its historical, regulatorily-embedded vertical integration. By presuming the persistence of a regulated LDC with a retail relationship with end-use customers, the Waxman-Markey bill reinforces and exacerbates that persistence beyond its already overdue obsolescence. It contributes to regulatory and organizational inertia.

If you expect/hope to see more product differentiation and more vibrant retail products and services involving electricity service, the Waxman-Markey LDC proposal will work in precisely the opposite direction. I sincerely hope I am wrong, but the history of politics and institutional inertia in this industry suggest that I am not.

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6 thoughts on “Another Waxman-Markey blemish: reinforcing the obsolete utility business model

  1. I advise organizations in terms of their energy purchasing and other energy efficiency programs. We operate in every deregulated state. You’re blog has been a great resource for progressive thinking in energy economics and policy. I find many of them to benefit from the competition and would consider many of them successful so I’m interested in what makes Texas “the only state in the US that has created a successful and competitive retail electricity market.”

  2. Nice rant, well said. I hadn’t been paying much attention, but you’re right about the locking down of the old industry structure. Thanks for the wake-up.

  3. Couple of municipal utility directors commented that they probably wouldn’t give a lump-sum rebate to customers, but would rather reduce retail electricity prices, which I suppose would mean that customers aren’t going to get that price signal to consume less–but they will pay more for other goods.

    Seems that whether or not one agrees with the free distribution of allocations to LDCs (or w/ the bill in general), it just doesn’t seem like the regulatory mechanisms exist in current law to allow the federal gov. to ensure lump-sum rebates.

  4. Also, excellent point on the fixed-portion rebates or credits creating inefficient price signals for wire distribution capacity. And I agree that W-M perpetuates this state to LDC to customer vertical integration at the expense of electricity retail innovation, but the electricity distribution price regulation that already exists–given that it so completely separates distribution and generation (which I think is the result of the SO2 trading that came out of the acid rain act?) seems so well embedded, I’m not sure it would have ever changed even without Waxman-Markey.

  5. Tom,

    I have a pretty stringent definition of what constitutes successful competition, and it includes rivalrous retail competition for residential customers. Texas is the only state that meets that criterion in the US. Other states like NJ, IL, NY, OH, PA, MD, MA, have administrative rules or programs that interfere with that rivalry, such as default contracts or standard offer service (built on multi-year long-term wholesale procurement contracts) that essentially constitute an entry barrier for suppliers who might otherwise come in and compete for residential customers.

    You are right, it’s shades of gray.

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