Posts Tagged ‘competition’

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Innovative retail competition: is it finally starting … and in Chicago?

March 21, 2012

Lynne Kiesling

This may be the beginning of what I’ve been arguing for over the past decade plus … today in Smart Grid News, Jesse Berst reports that Constellation Energy has teamed up with Best Buy to enable customers to come into the store, switch their retail provider, and buy home energy management devices (see also the brief note in the Chicago Tribune). Jesse observes that

It has been fascinating to watch power retailing develop in areas such as Texas and the United Kingdom. In the early days, we thought it would be all about price. As it turns out, price is important but it is just the table stakes. To become a market leader, you have to establish brand trust. You have to bundle the power with other products or benefits. And you have to make that bundle ultra-easy to find and purchase.

Absolutely correct. This is the kind of Schumpeterian retail innovation that is a value-creating hallmark of competitive rivalry.

At first blush it also has some similarities with mobile phone retailing — I presume that the retail provider to which a customer can switch is Constellation, and not Direct Energy or any of the other retail providers in the Illinois residential market. I’ll be interested in seeing if Best Buy is willing to make similar arrangements with those retailers. If their contract with Constellation precludes such arrangements, then we run into the murky area of whether or not exclusive dealing contracts are anti-competitive. But if, say, Target strikes a deal with Direct Energy, and Costco and Walmart get in on this innovation, then the retail landscape really starts to look like mobile communications retailing, and things get very interesting.

Note also that this type of market channel is a way for consumers to learn, which is a crucial process in the liberalization of retail sales in an industry that has been vertically integrated and regulated for over a century. Regulation defines product characteristics and boundaries and thus determines the type of product that the consumer is purchasing, so for over a century residential customers haven’t had to think about what they are buying and whether there are ways for them to get more value out of the transaction and relationship. They had no choice, so why give it any thought? Now starts the process of individuals learning how and why they may create more and different value from changing their retail relationship and changing the technology they use in the purchase and management of the electricity they consume.

As it happens, the Best Buy in this pilot is my neighborhood store, so I’ll check it out and report back what’s interesting and important. Free the electricity consumer!

Posted in Economics, Electricity | Tagged , , , | 1 Comment »

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Good news and bad news from price-spike induced failure of retail power company in Texas

February 12, 2011

Michael Giberson

We know that several Texas generators were unprepared for the possibility of severe cold on February 2, and now comes word that at least one retail electric provider was similarly unprepared for the possibility of price increases. ERCOT real-time power prices jumped to about $3000/MWh for most of the emergency period that morning. Abacus Resources Energy has defaulted on its financial obligations to ERCOT, reportedly unable to cover costs due to the spot power price spike. More, from the Fort Worth Star-Telegram:

[Abacus Resources] General Manager Mark Angell said last week’s unprecedented spike in wholesale power costs, when numerous generating stations were out of action because of the weather, overwhelmed the company’s financial resources.

Buying power for its 7,700 customers, most of them residential, typically cost Abacus from $11,000 “on a good day” to $25,000 “on a bad day,” Angell said. “You take that to $300,000 a day, and it doesn’t compute.”

Abacus needed to come up with $750,000 to pay its energy bills and also meet cash collateral requirements required by ERCOT. That wiped out the company’s reserves.

“It was a once-in-20-years occurrence, and we got caught,” Angell said.

A couple of observations:

  • Any retailer that was severely bit by the price spike was a retailer that hadn’t secured enough power to meet its customers’ demand for that cold morning. Forward contract prices for the time period were likely in the $50/MWh range. In short: The cold was forecast, retailers have means to hedge themselves against financial exposure, retailers who were short that morning will pay.
  • And, by the way, generators who were contracted to deliver power and failed to deliver will also be covering their shortfall at the spot market price. The only generators that will be paid the seemingly exhorbitant $3000/MWh are those who had capacity not already under contract and were capable of delivering that uncommitted capacity to market.
  • Profit and loss is a great motivator, but only especially motivating when companies can actually go out of business.
  • Unlike the case in 2008, when a few companies went out of business and simply dumped their customers into the default “Provider of Last Resort” service, Abacus has arranged for its customers to transition to one of two other retailers that serve the same area. I don’t think that this transitioning is required of Abacus, but it is an improvement over last time.  It suggests that the retail provider industry can learn from past mistakes.

Who pays?

News items suggest that various consumer advocates are worried that, ultimately, consumers will have to pay for whatever losses retailers suffered last week through higher prices. One of the beautiful things about the relatively open and competitive retailer marketplace in the ERCOT region is that this isn’t true in any general sense. Prices on retail supply contracts should be forward looking, based on the expected cost of the supplier fulfilling that contract over the contract period. Since any future contract period won’t include February 2, 2011, future customers can’t be made to take that hit.

A local Starbucks had its roof cave in after heavy rains revealed a structural flaw. When the store re-opens, will they stick consumers with a surcharge to cover the cost of rebuilding? No, coffee consumers have alternatives, and because consumers have alternatives the coffee company will take the hit. Same for retail power consumers in ERCOT.

A few ways that last week’s power emergency can lead to higher prices for consumers: (1) if all companies become a more cautious, and contract-up extra power in advance or otherwise add to their hedges against rare power emergencies, then rates will creep up to cover the higher cost of operations.  But this only works if all companies become more cautious, including any new company that may want to join the market. Otherwise some company will have lower rates and take customers from the newly cautious; (2) if changes to Texas PUC or ERCOT regulations on retailers force them into excessive financial commitments, raising all retailers’ costs and so all retailers’ rates; or (3) if ERCOT decides to carry (or is forced into carrying by legislative or regulatory action) substantially higher amounts of reserves or to make other changes to operations to cover the possibility of rare power emergencies.

In case 1 the competitive market will yield higher prices to reflect the adjusted risk perceptions of participants in the market. In case 2 it is the residual monopoly transmission grid that will lock consumers into higher prices. By the way, when ERCOT’s retail market finally grows to its smart grid potential, events like the February 2nd power emergency will look a lot different. They might even look like non-events. Probably the subject of a future post.

In sum, a company has been driven from the market. Bad news for the company, the management, employees, and especially the owner. Not especially bad news for consumers in the short run, and ultimately good news.

Profit and loss can be a powerful motivator.

Posted in Electricity, Energy markets, Regulation | Tagged , | Comments Off

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Elinor Ostrom interview

April 1, 2010

Michael Giberson

YES! magazine presents an interview with Elinor Ostrom, “The Woman Who Just Might Save the Planet and Our Pocketbooks.” The sub-head teaser – “What if our economy was not built on competition?” – is a little over-heated. Nothing in Ostrom work, so far as I know, is opposed to competition. Rather, in the work for which she is now famous, she’s all about understanding cooperation in the face of common pool resource problems. But don’t let the framing of the article put you off if you are looking for an easy and very brief introduction to Ostrom and her ideas.

Other interviews with Ostrom, for those who want more:

HT to Marginal Revolution for the YES! magazine link.

Posted in Economics | Tagged , , | 1 Comment »

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Court dismisses price fixing and price gouging claims filed against four Martha’s Vineyard gasoline retailers

February 26, 2010

Michael Giberson

A federal court in Massachusetts has dismissed a class-action claim filed against four Martha’s Vineyard gasoline retailers.  The suit claimed the stations engaged in price fixing over several years and in price gouging after Hurricanes Katrina and Rita in Fall 2005.  Defendants argued that pricing patterns observed by plaintiffs were insufficient to support either the price fixing or price gouging allegations.

The Martha’s Vineyard Times has provided thorough description of the case, including articles on the plaintiff’s expert testimony (by Boston College economist Frank Gollop) and the defendant’s expert testimony (by Michael Quinn of the Analysis Group).  In addition, the Times posted selections from expert testimony online.  (Links below.)

My general reaction from reading parts of Gollop’s testimony was that it was very basic industrial organization analysis - all comparative price movements and changing margins – and neglected completely the extensive economics literature on retail gasoline pricing. The law likely makes no special distinction for gasoline pricing cases, so the analysis wouldn’t have to address what is known about gasoline prices, but neglecting the literature may have led plaintiff’s to mistake common retail gasoline price patterns as evidence of price fixing.

The main surprise from looking at Quinn’s testimony for the defense was the revelation that there are nine gasoline stations on Martha’s Vineyard, not just the four defendant stations. Gollop managed to produce a 36 page affidavit, including a discussion of market shares, barriers to entry, the relevant market area and economic substitutes for the defendant’s gasoline with – so far as I was able to find – just one incidental reference to just one of the five non-defendant retailers.  Gollop compares the defendants’ prices to prices on Cape Cod, nearby but obviously less relevant than the five other on-island gasoline retailers. I assume that the plaintiffs studied the behavior of the other on-island stations and found it not helpful to their case, but it looks like a pretty big hole in the plaintiff’s analysis.

The price gouging claim rests almost entirely on Gollop’s calculation that gross margins on gasoline sales at the four defendant stations increased by more than five cents after Katrina, comparing margins in September, October, and November to the margin in August, 2005. Gollop said the five-cent standard was suggested by the FTC’s report on gasoline prices post-Katrina and Rita.

Quinn, for the defendants, observed that patterns in retail prices surrounding Hurricanes Katrina and Rita were similar to patterns in retail prices at other time of wholesale price volatility. And, interestingly, price increases at the defendants’ stations were smaller than the price increases at the five non-defendant stations on the island.  In general he finds the price patterns to be typical of “price-cost dynamics inherent in this industry,” including the rockets-and-feathers effect that has been studied at length by economists.  In short, nothing surprising here (at least to someone familiar with the economics literature on gasoline prices).

Additional information (posted online by the Martha’s Vineyard Times):

Posted in Economics, Energy markets | Tagged , | 2 Comments »

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How valuable will a monopoly be to Lubbock Power & Light?

January 31, 2010

Michael Giberson

After over 90 years of operating in competition with a rival electric utility in town, late last year Lubbock Power & Light and Xcel announced a deal in which municipal electric utility LP&L would buy out Xcel’s distribution assets and customer accounts in the city for $87 million, leaving LP&L as a monopoly electric utility in the city.

Regulatory filings with the state reveal much more of the details of the deal.  A newspaper story in the Lubbock Avalanche-Journal notes, for example, that the $87 million will buy assets that Xcel values at $64.2 million.  Lubbock’s electric power consumers may wonder what the city is getting for that extra $22.8 million payment.

It is a complex deal that, in addition to paying Xcel to get out of town, accommodates changes in numerous existing contracts between the two companies.  For example, a few years ago when LP&L was on the brink of bankruptcy, LP&L and Xcel entered into a deal under which Xcel controls operations at LP&L’s generating plants and LP&L began buying all of its power supply needs from Xcel.  That deal expires in 2019, but under the acquisition plan Xcel would continue to make available some wholesale power to LP&L.  Xcel purchases waste water from the city for cooling a power plant, and that agreement would be revised as well.  All the complexities make it hard to evaluate what, exactly, the deal is worth to citizens of Lubbock – putative owners of the municipal utility – and the value to be created by the deal (if any).

One question to be asked, as a starter, is why LP&L needs to pay anything above scrap value for the Xcel distribution system in the city.  After all, the city claims its existing system is sufficient to serve the entire city and that maintaining two utility systems is town is wasteful.  So LP&L doesn’t need Xcel’s distribution assets to take on current Xcel’s customers, and adding the distribution assets will simply result in a costly, wasteful, and over-built local distribution system.

Scrap value would be too low, since some of the Xcel distribution system may be incorporated into LP&L’s system (in cases in which the Xcel system is superior to the LP&L segment that it duplicates), but book value on the assets seems a reasonable upper limit.  In any case it is hard to believe LP&L should pay a premium over book value for Xcel’s assets.

Is having a monopoly going to be so valuable to LP&L that they are willing to pay Xcel a $20+ million bonus to get out of town? What does that imply for future electricity rates in the city?

BACKGROUND – Earlier posts on electric utility competition in Lubbock:

Note that, technically speaking, one or two small neighborhoods will still have a choice between LP&L and South Plains Electric Coop, but otherwise LP&L becomes the monopoly provider in the city of Lubbock.

ADDED: The related regulatory filings at the PUC of Texas can be found via the PUCT’s Interchange document system.  Start on this page, enter 37901 as the “Control Number,” and press the “Search Now” button.

Posted in Electricity, Energy markets, Regulation | Tagged , , , , | Comments Off

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Vero Beach Florida could become a hothouse of dynamic competition in retail electric power

August 10, 2009

Michael Giberson

Vero Beach, Florida, could become a hothouse of dynamic competition in retail electric power, if only the city would follow the recommendations of economist Dom Armentano.

According to the Vero Beach [Florida] Electric Utility, they aim to provide “reliable, cost competitive electrical energy and services to our customers in a manner that exceeds their expectations.”  They aren’t meeting this standard.  Dom Armentano reports that his local municipal power monopoly offers rates that are “an incredible 58 percent” higher than rates available from the state-regulated monopoly serving the surrounding area.

Most of this economic nonsense started back in 1979 when state and federal agencies stopped a referendum-authorized city sale of the electric utility to [Florida Power & Light]. Then in 1981 a notorious “territorial agreement” was crafted to divide up the electric grid between the city and FPL. Finally, in 1983, the state Legislature removed the bulk of the PSC’s regulation of Vero’s electric system, including rates.

Since then, customers of the city’s utility (61 percent of whom live outside the city) have been at the mercy of whatever service and price structure the utility determines is appropriate. As one could predict, this has proven to be a recipe for inefficiency and price gouging.

Armentano recommends several possible ways forward:

One way is to simply require that the city of Vero Beach sell its utility operations to any willing buyer. A second alternative would be to force the city utility to charge “competitive” rates or, third, allow customers to switch to a competitor. This latter proposal would create “competition” between utility providers and would tend over time to lead to lower rates generally.

In addition, in order to encourage non-traditional suppliers of electric power, any and all supply restrictions on the sale of electricity in Indian River County should be removed.

The first option would likely result in a sale of the utility to FPL and prices equal to that available in the surrounding area.

The second option would likely gain the same lower price level, but leaves the city with significant cost management issues.

The third option, depending upon just how it is implemented, could result in FPL competing for customers by building new distribution wires, eventually producing duopoly like Lubbock, Texas; or, by unbundling the city’s wires and power supply businesses, could allow for a “retail choice” environment.  I’m not aware that anyone has tried retail choice in such a small market.  Even many large states pursuing retail choice have had difficulty finding the right mix of policies. But the city’s current rates do offer a lot of “headroom” for potential competitors, so maybe this approach could work.

Armentano’s last suggestion is most radical and offers the most potential for consumer benefits.  Simply by removing “any and all supply restrictions on the sale of electricity,” Vero Beach would become a hothouse of dynamic competition in retail electric power. FPL could wire neighborhoods to offer duopoly distribution capability.  Retailers could negotiate for delivery of power over city or FPL wires (though negotiating with monopolies is fraught with dangers).  Most importantly, local businesses or real estate developers could invest in microgeneration and bypass the city grid, likely contracting with the city for backup power or building a wire out to FPL.  Likely, several distributed power businesses would link up to self-supply backup power capability.  Obviously, smart grid-based coordination would be vital to such an effort.

Even though these developments may take some time to emerge, the very possibility of competition emerging would motivate the city to reduce costs and cut rates.

Moves in this direction would be strongly opposed by both state-regulated and municipal power utilities.  The prospects of significant consumer value are likely no match for the status quo political interests that would rise up to defeat it.  Still, it would be interesting, even educational, to watch the parade of industry lobbyists pretending to be the consumer’s friend even as they argue against giving consumers the ability to escape monopoly suppliers.  I’m in favor.

Posted in Electricity, Energy markets, Regulation | Tagged , | 3 Comments »

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Origins of state electric utility regulation: Was it protection of quasi-rents not creation of monopoly rents?

May 20, 2009

Michael Giberson

There is by now a fairly established body of economic history work that challenges what might be called the mainstream view of the origins of state regulation of electric utilities and offers as an alternative a nakedly public choice view that state regulation was all about creation of monopoly rents. The mainstream view asserts that electric utilities were natural monopolies – therefore competition was wasteful – and state-level rate regulation was desirable to limit the economic harms that would otherwise accompany monopolization.

A contrary view drawing on public choice and new institutional economics asserts that state utility regulation was a special interest effort in the creation of monopoly rents. This line of thinking may start with Stigler and Friedlander and Demsetz and culminate in the work of Jarrell, who found that the advent of regulation in states was associated with higher electric power prices and slower growth compared to the periods before state regulation. A central implication of this line of work is that state regulation is a negative-sum game in which powerful concentrated interests are able to capture political benefits through regulatory processes at the expense of dispersed, unorganized consumer interests.

In the December 2008 Journal of Economic History, John Neufeld presents an alternative explanation for the emergence of state regulation, which also draws on insights from public choice and new institutional economics. A key point of his article is that state regulation can be seen as a positive sum activity instead of a purely negative-sum rent-seeking exercise. (You might say that the earlier line of thinking emphasizes public choice concerns, while Neufeld’s alternative emphasizes new institutional issues.) In the abstract for “Corruption, Quasi-Rents, and the Regulation of Electric Utilities,” he says:

Was the adoption of state utility regulation the result of a negative-sum competition among special interest groups vying for the monopoly rents created by regulation or a positive-sum elimination of corruption arising from appropriable quasi-rents? Previous empirical studies of the adoption of regulation have assumed the former. Using discrete hazard analysis, this study considers the latter and finds the data more consistent with the positive-sum protection of quasi-rents than the negative-sum creation and appropriation of monopoly rents.

In Neufeld’s telling, the problem with municipal franchising with private utilities – the dominant practice prior to state utility regulation – was that post-contractual investments by the utility created appropriable quasi-rents, and it was difficult to prevent the municipality from reneging on contractual commitments in pursuit of those rents. In this environment, utilities preferred the relatively stability promised by state regulation.

I like Neufeld’s view, but it doesn’t seem to address one very important issue: Why did state regulation seem to necessarily entail imposition of a state-enforced monopoly? Couldn’t the state offer effective protection from municipal predation to competing electric utilities? Also, what features of state-level regulation protected utilities from state government appropriation of the quasi-rents?

Maybe Neufeld addressed these points and I just missed them.* In any case, he presents a good case for considering the role of appropriable quasi-rents in the story of electric utility regulation.

CITATION: John L. Neufeld (2008). Corruption, Quasi-Rents, and the Regulation of Electric Utilities. The Journal of Economic History, 68, pp 1059-1097. doi:10.1017/S0022050708000818

*I don’t have an electronic version of the document handy for reference, the article is only available online to subscribers. I’m working from memory from yesterday’s trip to the library. (Yes, I actually had to bike over to the library to read a journal article! It felt so old fashioned.)

Posted in Economic history, Economics, Electricity, Regulation | Tagged , , | Comments Off

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Munson: From Edison to Enron to Casten

May 11, 2009

Michael Giberson

Richard Munson’s book From Edison to Enron provides a pretty engaging run through the history of the electric power business in the United States.  The title actually understates the scope just a bit on each end, with Munson touching briefly on developments before Thomas Edison gets involved and discussing developments after Enron’s 2001 collapse up to the book’s 2005 publication date. The book provides a good background for anyone seeking to understand the current state of the industry including the variety of state and federal regulatory experiments affecting electric power.  Advanced students of the industry will want to go much deeper than Munson does, but Munson’s book offers a good beginning.

David Sicilia offers a more penetrating and critical review of the book on EH.net, pointing out a few flaws and offering alternative interpretations of some episodes.

Sicilia highlights singles out for critique several issues related to monopolization in the power industry. He finds Munson “innaccurate or unpersuasive” on topics of economies of scale, utility regulation, and natural monopoly. I’ll agree that Munson’s discussion doesn’t compel the reader to believe, for example, that no additional economies of scale were available in the industry after 1967.  But Munson is telling a story, not arguing a legal brief, so I’m not concerned that Munson doesn’t beat every point to death with supporting arguments and data.

On this issue of economies of scale and central station power verses distributed power, however, it may bear mentioning that Munson has served as Secretary for the U.S. Combined Heat and Power Association. You can take this fact as indicating either that Munson surely knows what he is talking about, or that he has  may have some sort of financial conflict of interest. Reasonably, I think, you can conclude that his writing and his career reflect a consistent set of beliefs about the present and future of the industry.

Chapter Seven, Entrepreneurs, stands out in the book by being focused primarily on a single individual, Tom Casten, a serial entrepreneur in congeneration and perhaps not coincidently a harsh critic of monopoly regulation of electric utilities.  (By the way, both Lynne and I are fans of Casten’s entrepreneurism in electric power, e.g., see this post.) Perhaps also of note is that shortly after From Edison to Enron was published, Munson left his position as executive director of the Northeast-Midwest Institute to become a senior vice-president at Recycled Energy Development, a cogeneration project developer for which Tom Casten is chairman (and Sean Casten is president and CEO). Perhaps another reason for any reader suspicious of Munson’s narrative to see a potential conflict of interest. To me it just appears as Munson acting in concert with a consistent set of beliefs about the industry.

Whether the book tells a good story or not has little to do with Munson’s interests outside of the book. While the book has its flaws, I find it a good introduction to the history of the industry in the United States.

Posted in Economic history, Electricity, Regulation | Tagged , , , | Comments Off

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My favorite question on my electric power industry final exam

May 8, 2009

Michael Giberson

  • What is unusual about the retail electric power market in Lubbock? Is this regard is Lubbock a harbinger of the industry’s future or a relic of the industry’s past? Why?

This turned out to be my favorite question on the final exam I gave in my electric power industry class.

It wasn’t the most complicated of questions, nor did it elicit the deepest of answers. But most of the answers demonstrated mastery of the fundamental concepts involved in the question and put the Lubbock case into the broader context of industry restructuring. Some students cited possibilities related to distributed energy resources and referred to related readings in ways I had not considered when drafting the question.

Positive surprises are always good when grading page after page after page after page of short essays. Fortunately, I’m done now.

If you’re not from around here, you may be surprised to learn that Lubbock is served by two distribution utilities and most of the city is double-wired (a small part of the city actually can choose from among three distribution companies).  Some of the students who grew up in Lubbock thought it was normal to have more than one electric utility in town and to be able to switch if you were unhappy with your current service.

I didn’t keep score while grading, harbinger vs. relic, but the clear preponderance of responses argued that Lubbock’s competitive wires companies were a harbinger of the future. I’m sure most in the industry would regard double-wiring a city as unnecessarily wasteful, and therefore unlikely to happen.

Ten years ago, folks in the phone and cable industries probably thought the same thing.

Posted in Economics, Electricity, Energy markets, Regulation | Tagged , , , | 11 Comments »

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Overlapping transmission grids in West Texas will give power plants the power to choose

April 8, 2009

Michael Giberson

At the Gulf Coast Power Association meetings last week in Houston, Jay Caspary of the Southwest Power Pool (SPP) was discussing transmission expansion plans, and at slide 20 offered a map showing the overlapping transmission plans of SPP and ERCOT.  The purple lines are proposed 765 kV lines in SPP, the red lines are proposed 345 kV lines in ERCOT.

This slide was by far my favorite from among the numerous slides shown at the conference.

Caspary_GCPA_2009_p20

(Clicking on the image should bring up a larger view at Flickr. You can also download the full Caspary presentation from the GCPA website.)

Typically, neighboring transmission grids don’t overlap in this way. Usually at the transmission level grids have clear boundaries, meaning that generators (and transmission-scale load connections) don’t have much of a choice as to which transmission system to hook up with.  Or rather, more precisely, the choice of a site embeds the choice of the transmission system to link to.

The prospect of two separate, high-capacity transmission systems serving the same area means that generation units in the area will be able to choose which system – SPP or ERCOT – that it sells its power into. In fact, as in the case of the Tenaska Frontier generating plant, generators in the Texas panhandle might even connect to both systems and sell power in both directions at once.

Given the location – with its good wind resource and limited water supplies – it is likely much of the new generation resource development in the region will be wind power.  Having dual connections will not only add a strategic option to the wind power plant developer, but also aid the ability of the two power systems to accommodate the variable power supplies at lower cost.

And if you check out Caspary’s following slide, which shows a bigger area, it isn’t too hard to imagine a third possible delivery alternative for power plant developments in the area.

[ADDITIONAL NOTE: The ERCOT expansion plans are pretty established. Regulatory approval has been granted and contracts are being put in place to build the new lines. My understanding is the the SPP plans are at a more preliminary stage, and other options are also under consideration. But since SPP already has transmission infrastructure in place, the result will be overlapping transmission grids. The question is just how good the SPP transmission capacity will be.

For those of you wondering where Lubbock, Texas is, it is just south of the southwesternmost point of SPP's planned expansion, shown in purple in the image.]

Posted in Electricity, Energy markets | Tagged , , , , | Comments Off

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