Many Views on Competition in Electric Energy Markets

Michael Giberson

As Lynne noted, we have written a comment on the Electric Energy Market Competition Task Force Draft Report to Congress. [ Report PDF. ] About 45 comments have been posted online at FERC, and naturally I am curious as to what other people said. [ Link to comments. ] I thought that I could easily scan through a bunch of these and pass along some commentary.

No. It turns out that reading the comments is too much fun, and nearly every one of the comments could inspire a three page rant. I don’t have time, and you don’t have the patience, for 45 x 3 pages of my rants (and a few raves) on the state of commentary on the state of electric competition.

Most eye catching to me – but remember I am an energy economics policy geek – was the “open letter to policymakers? signed by Vernon Smith, Alfred Kahn, Paul Joskow, William Hogan, and a few other big names in the world of electric energy economics. (The letter was submitted by COMPETE, the Electric Power Supply Association, and the Alliance for Retail Choice.) Here is what the big names had to say:

As economists that have both followed and participated in the discussion on restructuring the electricity industry to support competitive wholesale and retail electricity markets, we prepared this letter to provide our views about the value of continued support for the development of competitive markets for electricity.

Among economists, it is almost universally accepted that well functioning competitive electricity markets yield the greatest benefits to consumers in terms of price, investment and innovation especially when regulated alternatives are no longer warranted. And, despite currently high electricity prices in many regions, driven by very high fuel input costs used to generate electricity, we are confident that well structured markets and robust competition are providing substantial benefits to electricity consumers. More importantly, these benefits will increase over time if an effective restructuring process and competitive market implementation program continue to receive support from policymakers.

Competitive electricity markets are relatively new and will continue to evolve. We urge policymakers to focus on making necessary improvements in market design and resist the temptation to reject competition for a return to heavy-handed regulation. We are persuaded that competition in electricity markets will stand the test of time and continue to provide visible customer benefits.

Not everyone is persuaded. In the rest of the post I remark on filings by the Electricity Consumers Resource Council jointly with other industrial consumers, the American Public Power Association, the National Association of State Utility Consumer Advocates, and a few others.

Industrial Consumers seem to have become increasingly pessimistic about competition, or rather, pessimistic about the current market designs:

Industrial Consumers believe strongly that the Draft Report presents compelling evidence that attempts to stimulate either wholesale or retail competition in electricity have failed. As an example, any basic economics text or course begins with an assertion that competition requires an interaction between supply and demand. Industrial Consumers commend the Task Force for pointing out that such an interaction does not exist in the electricity “markets? in the US. … At an absolute minimum, the Task Force should state in its Final Report that to be competitive, electricity markets must be double-sided….

Unlike many critics of the current state of affairs, Industrial Consumers don’t wax nostalgic for the regulated world of yesteryear. Their comments are “friendly fire? of the best sort: harsh, but constructive criticism of the existing markets by folks who have to work in the markets every day.

In other comments, the American Public Power Association (APPA) notes that the discussion of industry trends…

[D]oes not include any discussion of the California and Western energy crisis; the bankruptcy of Enron and subsequent revelations of market manipulation; or the glut of generation capacity in 2002–2003. These events were a direct consequence of the attempts to introduce increased competition into wholesale markets, and should be included in any comprehensive discussion of industry developments.

Seems reasonable to me. If we want to understand competition in electric energy markets, we should not exclude circumstances in which competition failed. The California crisis actually provides ample material to illustrate one of the major themes in the Draft Report – the importance of the retail market–wholesale market connection and the damage that can be created by mismatched regulatory policies.

Of capacity market designs, APPA says, “These markets should not be evaluated in isolation, under the assumption that they are merely incremental improvements to a basically sound, centralized spot-market design. It is equally likely that such proposals are being put forward because the underlying RTO market is substantially flawed and has not produced the results promised.? APPA also discounts the “energy only market? approach to providing resource adequacy, and instead seems to suggest old-style rate regulation should govern. What can I say? Been there, done that, doesn’t work. However, overall, the APPA comments look thoughtful.

PJM Interconnection wants the Task Force to take note of its most recent efforts to redesign its capacity markets. PJM observes that “the Draft Report articulates a number of issues surrounding the development of effective capacity markets,? and “does not dispute that issues have been raised concerning the structure and efficacy of capacity markets in these areas.? However, PJM says the report should reflect recent efforts to reform capacity markets in its region and in New England. In short, it seems, what PJM is saying is that they have tried and failed to get a capacity market to work, but they are still trying.

According to the comments of the National Association of State Utility Consumer Advocates (NASUCA), their members “do not see any benefit to exposing the majority of residential customers to volatile short-time prices.? The ensuing remarks suggests to me that the state utility consumer advocates lack an appreciation for how markets function, but I think the significance of their remarks is as a challenge to people who think we should move to more dynamic retail pricing. We forward-looking, market-oriented, dynamic-thinking types need to acknowledge the real costs of changing the rules of the game, acknowledge that not all consumers are equally positioned to benefit from the change, and propose policies that can get us from the flawed present to a better future.

At the same time, is it too much to ask advocates of the consumers-should-be-forced-to-be-passive-ratepayers position to accept responsibility for the consequences of their policies? To mention one narrow, arcane, economic issue that is central to much of the discussion, consider the inelasticity of demand for electricity. NASUCA (among others) repeatly cites inelastic demand as a reason to limit consumer exposure to variable pricing. They seem not to realize that the current, relatively inelastic demand for electricity at retail is substantially the result of past policy choices: the decades of regulated flat retail rates, and the investment choices and habits that have grown up under regulated rates. Maybe if prices were allowed to vary at retail, consumers would think about responding in reasonable ways.

The many other comments promise even more fun to the energy economics policy geek, but that is all the fun I can take at the moment.

Now I’m looking forward to the final report to Congress, due on August 8, 2006. Given the good start represented by the Draft Report, and the extensive and quality comments submitted, it should be an interesting read.

2 thoughts on “Many Views on Competition in Electric Energy Markets

  1. Including a description of the Western Energy Crisis of 2000-2001 would likely have caused an uproar because the popular interpretation and the physical interpretations are so different. Many people have generally accepted that it was Enron’s manipulation that caused the whole thing, but it is virtually impossible for Enron to have been the physical crisis. [And as you know, I have data…] It is debatable whether Enron’s manipulation really had much to do with it at all.

    However, if it is appropriate to go through the dirty laundry of history, then the report really needs a better analysis of what really happened in the 70s and 80s. Man, the report just skipped right through that without even discussing the various lessons we should have learned, and how we got into the position where competition came into the industry.

    I also had a problem with the bifurcated description of the dominant market forms. You (Mike) complained about the “organized” markets. I object to describing one as depending on bilateral contracts versus the other depending on organized spot markets. That’s the wrong line to draw. The industry uses bilaterals everywhere, though many of them are standard products rather than negotiated at length. The difference is the existence of an open spot/balancing market versus a vertically integrated, parochially operated balancing area. I’ve run into this before, and it seems to be resident in utility executives who have no experience in the open spot markets.

  2. D.O.U.G: I see your point about the division into bilateral/”organized” categories.

    If the difference is primarily in the balancing energy arena, do you think FERC’s proposed OATT reform rule changes with respect to balancing energy will improve the efficiency of markets in parochially operated balancing areas?

Comments are closed.