Evaluating Electricity “Deregulation” in a Period of Rising Fuel Costs

Lynne Kiesling

Periods of rising costs make it hard to be a market process supporter. Nowhere is this more true than in electric power, where a century of regulator-regulated co-dependency has created a culture of price control.

Right now Maryland is the center of this debate, triggered by economic and political motives, including rising natural gas prices and the impending merger between Constellation and FPL. This Baltimore Sun article from Thursday gives a thorough overview of the situation:

Proponents of deregulation say the consumer and political angst is an overreaction to rising global energy prices that have clouded the debate over whether free-market reforms have benefited consumers.

But those voices have been increasingly shouted down by lawmakers, academic scholars and some regulators, who are raising questions about whether complex rules governing wholesale power markets are structured in a way that does more to line the pockets of power generators than save money for ratepayers.

Though contested by many, the debate directly challenges the contention of electric industry officials and others who say that rate increases sweeping the nation are solely the result of rising fuel prices and are not exacerbated by the rules creating free markets.

Such claims have bolstered consumer watchdogs, who say Maryland and other states would be better off if they hadn’t deregulated.

OK. Let’s be clear. What the states like Maryland have done in the past decade should not be called “deregulation”. In almost every case, legislation that allowed wholesale market transactions and perhaps (perhaps) some measure of retail choice of commodity provider has been accompanied by retail rate caps. This compromise has been part of the political dynamic in most states. So as soon as people start complaining about “deregulation”, bear in mind that they are playing fast and loose with the terminology to suit the objectives of their own arguments.

Note also in the above excerpt that this debate conflates wholesale market liberalization and retail market competition. Because of the aforementioned retail rate caps, retail market competition has been slow to evolve in most states, and particularly slow for residential and small commercial customers. Even in Maryland, where the restructuring and market design analyses were performed more carefully and thoroughly than in most states, retail competition has been more vibrant for large industrial and commercial customers.

The political challenge is that fuel costs have been rising for the past three years, and regulators don’t do their constituents any favors by artificially imposing rate caps that ignore those fundamentals and disconnect the prices that customers face from the true, underlying costs of electricity. But if policymakers allow politics to trump economics, as so often happens when decisions like these are so politicized, that is exactly what happens, and customers will be worse off in the long run because they are not making decisions that take into account the real cost of electricity.

Market opponents often counter that high prices don’t only reflect rising fuel costs, but also reflect supplier market power in wholesale power markets. They then go on to recommend rate caps, such as the dynamic in place right now in Maryland (and Illinois, for that matter).

That’s the wrong answer. If so-called consumer advocates really want to empower their constituents and enable them to discipline the exercise of market power in wholesale markets, then they should advocate retail choice for their constituents. Retail choice integrates customer preferences with wholesale market fundamentals, and provides an invaluable route for the expression of consumer preferences and the communication of that important information into wholesale power markets. If you want to control the exercise of market power in wholesale power markets, then active, empowered demand and retail choice is the most-bang-for-your-buck policy option.

Sadly, not enough people are making that argument forcefully enough; it doesn’t even come up in this otherwise very good Sun article.

The article also points out the benefits of what limited restructuring we’ve had:

Some energy consultants and researchers argue that politicians are being shortsighted by declaring deregulation a failure just because energy prices have increased. Ratepayers in deregulated states nationwide saved a combined $34 billion since the late 1990s, according to Cambridge Energy Research Associates, an independent research firm that gets its funding from a mixture of utilities, state regulators and other clients.

Most of that savings came as a result of rate caps put in place as part of the move to free markets. But the firm says deregulation has benefited consumers in other ways, such as by shifting the financial risks associated with building power plants to utility shareholders and away from ratepayers. More benefits – including new energy products – will come in time, they said, just as was true when phone companies, railroads, airlines and other industries deregulated.

“Often, it takes decades, not years,” said Dalton Perras, associate director of Cambridge Energy Research Associates.

This is precisely the healthy direction in which change happens with real deregulation. It’s about shifting risk, and empowering consumers to choose how much price (and outage, if you sell differentiated reliability contracts) risk they are willing to bear. Retail energy providers reflect that information into the wholesale market through their purchases from generators, and if consumers aren’t willing to pay those prices, they will change their behavior. That dynamic disciplines prices to the maximum extent possible in a period of rising fuel costs.

Instead of re-regulating through extending price caps, policymakers would create long-lived, resilient, meaningful benefits for their constituents by removing the artifical barriers to choice that exist.

One thought on “Evaluating Electricity “Deregulation” in a Period of Rising Fuel Costs

  1. Price caps are only one of the signs of non-deregulation. Must serve requirements, prohibition of mid-term and long-term contracts, mandatory bidding into next-day markets, etc. compound the problem.

    Any attempt to manage a market requires, at a minimum, that the managers be as smart as the market participants. The California fiasco was a very clear example of what happens when the managers don’t at least meet that criterion.

    One could argue (and I would) that legislators and regulators cannot design effective markets; effective markets are designed and redesigned continuously by the market participants to suit their needs.

    In Herman Wouk’s play, The Caine Mutiny Court Martial, the Navy is described as a system designed by geniuses for execution by idiots. The Navy works! The inverse was tried in CA. It failed spectacuarly.

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