“Decade of deregulation felt in climbing bills”: Costs by category

Michael Giberson

As I mentioned yesterday, I thought the Washington Post‘s story (“Decade of deregulation felt in climbing bills“) on various costs embedded in electric power bills was reasonably good. But the article covers several aspects of the overall picture without always being clear about the role played by the charges. From the economics point of view, the vital element of any charge included in the consumer’s bill is whether it tends to contribute more or less to efficiency in the production and consumption of electric power. One step toward sorting out the issues here is to sort out the different charges depending on whether they arose under the old or new regulatory regime.

Re-reading the article, I counted about nine overlapping categories of costs or charges that feed into a consumer’s bill. Below I identify the nine types of costs and assign them to one of three categories: (1) Costs left over from the old regime, (2) Costs arising in the new regime, and (3) Continuing cost types. Each of the categories is illustrated by a quote from the article.

Of course the biggest factor of influence over the bill — fuel costs — is mostly ignored in the article by design. The focus was explicitly on elements of a consumer’s bill “that have nothing to do with the rising price of fuel.”

Costs left over from the old regime/Transitional costs:

  • Stranded costs – “Virginians are paying Dominion Power tens of millions of dollars a year for a nuclear plant the company planned in the 1980s but never built.”
  • Rate freezes (aka Performance-based ratemaking) – “The charges include $238 million for a new nuclear reactor at its plant outside Richmond. Dominion canceled plans to build the plant 26 years ago amid safety concerns about nuclear power. The last of the charges was set to expire in 1999. But when rates were frozen during the transition to deregulation, the charges stayed. They’ll continue until at least next year.

Costs associated with the new regime:

  • Congestion pricing – “Federal rules that accompanied deregulation also increase costs to consumers. Because of them, customers pay a premium for living in a congested region thirsty for power.”
  • Uniform marginal price – “Now, on hot summer days, for example, when the demand for electricity is high, the price is set by the last, most expensive plant that is needed to supply power. These are typically natural gas plants. But the rising price of natural gas has produced a windfall for owners of older nuclear and coal plants.”
  • Capacity market payments – “And although they began paying surcharges last year so power companies will invest in new plants, the charges have resulted in relatively few additional megawatts. These charges account for about 25 percent of the price of electricity in the District and Maryland and less in Virginia.”
  • Structural impediments to competition – “Critics say the supply has increased so little because the existing system not only benefits the companies in the region, it gives them an incentive to constrain the supply of electricity to keep prices high…”

Same as it ever was:

  • Funds for eventual decommissioning of nuclear plant – “More than 1 million residents of the Washington-Baltimore area paid $920 million to take the Calvert Cliffs nuclear … off-line in 2034….”
  • Continued political influence over rates – “The deal reached between Constellation and Maryland Gov. Martin O’Malley (D) this month blunted two years of recrimination over a 72 percent rate increase for 1.1 million Baltimore Gas and Electric customers. They will get a $170 one-time credit and relief from future decommissioning costs.
  • Flawed consumer incentives to use power economically – “PJM spokesman Ray Dotter said the Aug. 1 price reflected the cost to produce electricity that day. But customers pay a flat rate, giving them little reason to use less power, he said. “A more ideal situation would be that the price sends a signal that people conserve more.””
  • Hmmmm… – “Electric bills in Virginia are expected to climb when the state returns to regulation next year, although it’s unclear by how much.”

This is just sort of a rough draft approach at a sorting. I know we have some expert readers and I’d be happy to receive comments from them. Each of these topics could bear individual attention. I’ll post on some of them over the next several days.

You may have noticed I referred above to “the old or new regulatory regime,” and not to “the regulated or deregulated regime.” Yep. I am one of those wackos that prefers the ugly word “restructuring” to the apparently more catchy term “deregulation” when talking about the changes in public policy toward certain elements of the electric power industry over the last ten to twenty years.

6 thoughts on ““Decade of deregulation felt in climbing bills”: Costs by category

  1. First, my compliments for using the English language carefully and correctly. The left tributary media (LTM) prefers to attribute issues in the energy utility industry to “de-regulation”, since it prefers government regulation to competition (except for itself, of course). However, the examples of utility activities which were previously subject to regulation and now are no longer subject to regulation are both limited and relatively trivial.

    Second, I continue to be frustrated by the confusion among the concepts of efficiency, conservation and load management. Efficiency involves doing the same things, while using less energy in the process. Conservation involves doing less to use less energy. Load management involves doing the same things at different times, when the cost of power is lower. This is hardly rocket surgery or brain science!

    Third, I cringe at the expression “flawed consumer incentives to use power economically”. What we are dealing with, generally, is the absence of any consumer incentives to manage their loads; and, in fact, the absence of consumer direct knowledge that power doesn’t always cost what their bill says it costs on average. The only time many consumers know power is very expensive, or in short supply, is when they are directly asked to defer consumption to avoid brownouts or rolling blackouts.

    However, my slightly wierd sense of humor really focused on the following: “”And although they began paying surcharges last year so power companies will invest in new plants, the charges have resulted in relatively few additional megawatts.”” The suggestion that dollars collected beginning last year should already have resulted in the addition of multiple megawatts of capacity is truly high comedy. Consumers would be truly fortunate if either a certificate of convenience and necessity or a plant siting approval had occurred already, based on those funds. This is not to suggest that such rapid response is impossible, merely that it is highly improbable.

  2. Michael — Keep it up.

    On you last comment, note that the Public Utilities Commission (PUC) in California regulates water prices for investor-owned utilities (PRIVATE firms), while publicly-owned firms (i.e., municipal utilities) set their prices in agreement with their political masters. The irony.

  3. Uniform marginal price – “Now, on hot summer days, for example, when the demand for electricity is high, the price is set by the last, most expensive plant that is needed to supply power. These are typically natural gas plants. But the rising price of natural gas has produced a windfall for owners of older nuclear and coal plants.”

    It’s interesting that this is offered as a criticism in that it is an intended and natural feature of competitive markets. Prices at the marginal cost of the marginal supply increment is a pretty standard feature of basic microeconomics. This is how all private markets work.

    The profit made by units that are more efficient than the marginal unit is what drives optimal investment and operating decisions. And, the primary expected source of savings in a de-regulated market should come from more optimal investment decisions.

    If you take a static picture of the generation stack in place at the point of de-regulation, yes, it’s tautologically correct to note that the cost of the market clearing unit will be higher than the average cost of all the units that run for that hour.

    This completely ignores the two important points: 1)the stack that got built under regulation wasn’t necessarily the right stack to build and 2) as plants age and needs change the generation stack will need to change over time.

    The method by which new capacity additions are made in a de-regulated market involves observing the price signals, which include not only the prices set by inefficient marginal units, but occasional flyups when capacity in the system gets tight. These signals tell us “a more efficient baseload unit can earn a good return now” or “what we really need is a low capital cost peaking unit that runs 30 hours per year here”.

    On the regulated side, you do not have these price signals to guide investment decisions. Instead you have a utility that has only the incentive to spend whatever capital it can, because whateve capital it spends gets rolled into the rate base with a profit. Stranded costs are the manifestation of these bad investment decisions.

    The investment decision, I think, more than anything is what drives the different outcomes between regulated and de-regulated wholesale power markets. After 1 year of de-regulatioin the generation stack will look like the sort of stack that was created by regulation because that’s exactly what it is. After 20 years of superior investment decsions, you should expect to see a more efficient, more optimal of capital decisions produce a lower overall cost of power.

    Anyway, to question whether profit should accrue to the more efficent sources of supply is to question the very bedrock of the market system.

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