Two Articles on Maryland’s Electricity Price Increase

Lynne Kiesling

On Friday another retail electricity rate increase took effect in Maryland, bringing the total increase in retail rates since the removal of price caps to 70 percent. This increase has occurred during a time when natural gas prices have risen by almost 100 percent, so the cost of generating power (particularly peak hour power) has risen, but no matter; for the past year this rate increase has been a political football in Maryland, bringing down an incumbent governor and leading to the Maryland Public Service Commission being used as a scapegoat in an ugly political battle. Yet, the new governor, the one who gained office by decrying the rate increase approved by his opponent, has approved an increase almost as large.

Two articles in Friday papers discussed these events. Steven Pearlstein’s Washington Post column on Friday cast the situation as one resulting from “deregulation’s unkept promises” in a context in which fuel costs have risen and customers just don’t see enough value to get them interested in competitive supply, although operating efficiency has increased:

Consumers, it turns out, just aren’t very interested in shopping around for electric power. The difference in price just isn’t worth the hassle. And because of the rate caps that many states, including Maryland, imposed during the transition period, it was difficult for new companies to enter the market with rates lower than those offered by the traditional utilities. …

Under deregulation, individual plants are indeed operating at lower cost and greater efficiency. That’s the good news. But it turns out that in a deregulated market, the incentive is for generators to build too few plants rather than too many, creating periods of tight supply and very high prices that can have a very distorted effect on wholesale markets.

Do you see the connection between these ideas? Customers who still faced transition rates caps clearly had little incentive to shop around, which led to little competitive entry and no product differentiation or innovation of different value propositions to present to consumers (except for perhaps green power), which led to unresponsive demand, which led to few incentives to invest in capital that would reduces retail prices. It all goes back to the inability of retail customers to realize value by changing their behavior in response to dynamic pricing and product differentiation.

But here’s my question for Mr. Pearlstein and others who are skeptical about market processes: given the connection I drew in the above paragraph, why do you think that this outcome is the consequence of market processes? I look at the chain of events and I see “restructuring’s unkept promises”, because under the guise of protecting the consumer with transition rate caps, the Maryland legislature stifled the dynamic process through which consumer choice leads to better investment decisions, better capacity utilization, and lower overall long-run costs. How can this be the fault of market processes, when market processes have not been allowed to occur?

I give Mr. Pearlstein serious snaps, though, for his closing paragraph:

Market-oriented types, on the other hand, prefer some system of variable pricing, where the cost of electricity goes up during peak hours and peak days. Such a pricing scheme would require a huge investment in expensive new meters that can record how much power is consumed, hour by hour. Whether that investment will be worth it, however, depends on whether customers will have enough interest or incentive to turn off lights and adjust thermostats when prices are high. And like much about deregulation, that remains an open question.

I’m thrilled that someone in the MSM is mentioning the vital importance of dynamic pricing! And what helps create enough consumer interest or incentive to reduce their use? Technologies that can automate responses to price signals. If I don’t have to expend a lot of effort to get the cost savings, then I’ll do it. These technologies also make those expensive meter investments more worthwhile, because they increase the potential value created by sending prices to consumers.

The second article is a Baltimore Sun commentary from Thomas Firey at Cato. He usefully points out that liberalization of wholesale power markets unmasks the cost differences over time in producing power, and shows that there are lots of hours where power is relatively cheap (even though the fuel cost increases have masked this fact). Problem is, with such rigid, limited, stultified retail choice restrictions arising from legislative limitations and the transition price cap, competing suppliers have had little incentive to come in and offer them products and services that enable customers to access that relatively cheap power. Ongoing retail rate regulation has prevented customers from being able to buy at that low price.

He also points out the uncomfortable political reality that we face tradeoffs and that there is no silver bullet, regardless of market design:

What does this mean to consumers? It means that neither regulation nor deregulation is a miracle cure for electricity problems – politicians cannot magically deliver lower electricity prices, at least not in the long run. Instead, both market designs bring benefits and problems.

Some consumers will fare better under a deregulated market, others under a regulated one. But we can’t switch back and forth between the two, because neither investors nor consumers would know how to plan for the future. You can’t guarantee returns on generation investment and then stop guaranteeing them when the guarantee is costly. And you can’t guarantee lower prices through regulation during peak periods but not pay for them when gluts exist.

What I would add to Mr. Firey’s comments is this: what will deliver the lowest possible long-run electricity prices is a market design that enables technological change, including technological change in end-use customer devices that allow automation of customer response to dynamic price signals. Moreover, shifting the policy focus to dynamic innovation incentives reconciles two policy objectives that are in tension: getting the best value for consumers, and promoting environmental quality. Using price caps and command-and-control regulation to attempt to get the best value for consumers neither induces them to reduce their use when producing and delivering power is costly nor induces them to reduce their overall energy use and conserve resources. Shifting the policy focus to dynamic innovation incentives through market processes and retail choice aligns economic objectives and environmental objectives, creating a more viable, forward-looking electricity industry that focuses on consumers.

UPDATE: Baltimore Sun link fixed. Their dynamic xtml/php/whatever makes for an unwieldy url!


5 thoughts on “Two Articles on Maryland’s Electricity Price Increase

  1. I found the intro to Firey’s piece informative (and amusing):

    Marylanders gained some insight into their new governor last week when the state’s Public Service Commission, controlled by Gov. Martin O’Malley, approved a 50 percent rate increase for residential customers of Baltimore Gas and Electric Co. The approval comes less than a year after a bitter gubernatorial campaign between Mr. O’Malley and incumbent Robert L. Ehrlich Jr.

    Recall that Mr. O’Malley lambasted Mr. Ehrlich’s PSC for approving a 72 percent BGE rate increase – an increase that the Maryland General Assembly later scaled back to 15 percent. Mr. O’Malley told voters that Mr. Ehrlich and his commission were in the pockets of BGE. If Mr. O’Malley were elected governor, he promised, his administration would stand up to greedy energy companies and protect consumers.

    Doing the math reveals the conceit: When the O’Malley PSC’s 50 percent increase is layered on top of the General Assembly-approved 15 percent hike, the result is a 72.5 percent BGE rate increase. (Example: On a $100 electricity bill, the original 15 percent increase raises it to $115. Add 50 percent of $115 – $57.50 – and you get a total bill of $172.50.)

    The article sets up, but then doesn’t exploit, a useful point in the comparison between fixed/regulated rates and dynamic/market based rates. It is true, as the article says, that sometimes prices will be higher under one approach and sometimes higher under the other approach. But isn’t a point worthy of making that a fixed rate is too low when costs are relatively high (and so wasteful excess consumption is encouraged) and too high when costs are relatively low (wasteful under-consumption, i.e. too much substitution into alternative goods). Under market prices you should see better coordination between the price signal and the value of the good, leaving the consumer better able to use resources economically.

  2. Exactly, Mike. A fixed price is almost always perverse. Likewise, a non-locational price signal is most always wrong in almost every location. [In fact, my hedging here is related to the fact that a stopped clock is correct twice a day.] But [as you know, while I preach to the choir] the dynamics of regulated prices over long periods of time are perverse to scarcity and reliability. When regulated utilities over-build, creating a surplus, prices go up! When regulated utilities get behind, letting reliability suffer, their prices are lowest. Markets price 180 degrees out of phase with regulated utilities as the system grows and cycles through its long and short periods, thereby creating price signals that encourage rational responses! It’s so simple. 😉

  3. Exactly, Mike. A fixed price is almost always perverse. Likewise, a non-locational price signal is most always wrong in almost every location. [In fact, my hedging here is related to the fact that a stopped clock is correct twice a day.] But [as you know, while I preach to the choir] the dynamics of regulated prices over long periods of time are perverse to scarcity and reliability. When regulated utilities over-build, creating a surplus, prices go up! When regulated utilities get behind, letting reliability suffer, their prices are lowest. Markets price 180 degrees out of phase with regulated utilities as the system grows and cycles through its long and short periods, thereby creating price signals that encourage rational responses! It’s so simple. 😉

  4. A stopped clock is guaranteed to be right twice a day, but I don’t think fixed prices come with any particular guarantee.

    “Stopped clock” speculation on non-locational prices may be of some actual theoretical interest. My intuition is that if the grid were complete (so that each node was uniformly connected to all of its neighbors), that via some sort of fixed-point theorem and as long as the fixed price was between the true locational price extreme points, it must be the case that the non-locational price is correct for some locations.

    Or maybe that’s just my DC-based thinking, and one of you engineers will tell me its all different in an AC-based world.

  5. A stopped clock is guaranteed to be right twice a day, but I don’t think fixed prices come with any particular guarantee.

    “Stopped clock” speculation on non-locational prices may be of some actual theoretical interest. My intuition is that if the grid were complete (so that each node was uniformly connected to all of its neighbors), that via some sort of fixed-point theorem and as long as the fixed price was between the true locational price extreme points, it must be the case that the non-locational price is correct for some locations.

    Or maybe that’s just my DC-based thinking, and one of you engineers will tell me its all different in an AC-based world.

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