Should advocates of electric industry restructuring have not promised lower rates?

Michael Giberson

In an article to appear in the March 2009 Electricity Journal, C.K. Woo and Jay Zarnikau point out that “to win public support, proponents for electricity market reform to introduce competition often promise that post-reform retail rates will be lower than the average embedded cost rates that would have prevailed under the status quo of a regulated monopoly.”

They follow-up with, “Unfortunately, the promise of lower rates has failed to materialize….”

Of course there is a small slip in the concepts here. In the first phrasing they identify the relevant counterfactual – post-reform retail rates are compared to rates that would have prevailed under the status quo – but in the second phrasing post-reform rates are implicitly compared to pre-reform rates instead of the relevant status quo counterfactual.

They know the difference between the two comparisons, but it doesn’t matter much because many advocates for electric power restructuring overlooked that subtlety and promised plain simple lower rates if you restructure. But bumper sticker slogans make more appealing political rhetoric, and it gets to sell counterfactuals. In retrospect, it would have been better to promise that, post-reform we will get a more efficient allocation of ponies, rather than promising that everyone gets a pony. But the promise was made, and now not everyone is happy to have received a more efficient allocation.

After touching on that debate, Woo and Zarnikau jump to the substantive question of whether electricity market reform will likely reduce retail rates. In what they admit to be “a simple analysis,” this question gets reduced to whether the post-reform system marginal costs are likely to be higher or lower than system average costs. They consider a “high demand” case and a “low demand” case, and in the former marginal costs are higher than average costs, but in the latter marginal costs are lower than average costs. Finally, they note that the high demand case seems a better description of at least the ERCOT market experience, so electricity market reform in ERCOT has led to increased retail rates.

They admit a few qualifications to the simple analysis and then jump into an examination of rates in the ERCOT and non-ERCOT parts of the state of Texas (the ERCOT region features wholesale and retail market restructuring, while the non-ERCOT areas are mostly still served by vertically-integrated regulated monopolies). Their analysis demonstrates that, in fact, prices in the ERCOT-served portion of the state has increased more than prices in the non-ERCOT portions of the state.

They sum up the analysis with “electricity market restructuring heightens the sensitivity of retail electricity prices to marginal costs,” and conclude the article saying, “unless one is very confident that the post-reform marginal costs are less than average costs, electricity market reform will be unlikely to deliver the promised benefit of lower retail prices.”

Excellent advice to political orators opining on the benefits of restructuring the industry, I’m sure, but incomplete as analysis of public policy. Where is the concern for economic efficiency?

Of course during a time of rising marginal cost, a backward-looking average embedded cost rate will be lower than the efficient market price. And therefore, at the margin, consumers will consume more than they would have had they faced efficient prices, and therefore the regulated rate is wasteful. I’ll admit, too, that mine is “a simple analysis.”

If it is true, as they say, that “electricity market restructuring heightens the sensitivity of retail electricity prices to marginal costs,” then we should expect restructured regions to become more efficient users of energy.  The result should count as a plus for electric industry reform.  Woo and Zarnikau don’t emphasize this point.  Rather, they focus on the issue of whether or not consumers will get the ponies that politicians and policy advocates have promised.

But as economists examining public policy, shouldn’t we aspire to go beyond offering advice to overly-enthusiastic political orators, and actually try to say something about the net benefit or costs of policy reforms?


3 thoughts on “Should advocates of electric industry restructuring have not promised lower rates?

  1. I do not agree. Let’s review – I own two houses. One in Plano (deregulated) one in Frisco (CoServ – not deregulated). Plano – I just signed up for a 1-year contract for 11.4 cetns per kWh – in CoServ we pay 13.6 cents per kWh. How is deregulation not better for me? My friend owns 4 Subway restaurants – all but one are in Dallas – the other in Frisco. Guess what – he pays twice as much for the one in Frisco as he does in the other locations. If people wouldn’t be so darn lazy and actually shop around – you would have a lower rate. Liberal people like you that want our government to control every aspect of our lives are just plain lazy. According to a recent story in the Houston Chronicle – nearly 2 million people are still on the same rate plan with Reliant Energy and/ or TXU. Are you on the same cell phone plan as you were when you originally signed up? If that’ s the case – and these people are just going to sit around and pay the same rate – why would these companies lower their rates? That’s not good business. If you have stupid peole – they should pay stupid rates. This is not “fosterng competition and lower rates” – it’s simply being stupid and lazy. Do you want the government to control your cell phone plan minutes? It’s the same darn thing – get off your butt and shop around for lower rates. Why do you think every single big business (as quoted by the Dallas Morning News) in deregulated markets in Texas has switched to a different/ lower cost plan than the one they were on before deregulation? They want lower rates and they are not lazy. If all of those 2 million people got off their butts and changed providers – don’t you think Reliant and TXU would get more competitive?

  2. It is possible that the analysis is based upon rates that are a few months old. When dealing with regulated rates, which change with all of the nimbleness of a hippopotamus swimming in molasses, data a few months old is probably pretty good. But with the competitive retail market in Texas, the best available prices change much more frequently (up and down), which given the usual lags in publishing peer reviewed articles* means they may not be completely up to date.

    (*Though compared to many journals, the Electricity Journal is pretty fast.)

  3. The not-regulated (regulated by it’s board) CoServ is an electric cooperative owned by the consumers they serve. CoServ is supposed to operated at cost and is not taxed like for-profit investor owned utilities. CoServ should be offering electricity at a much lower rate than investor owned utilities, who have to generate a profit and dividends for their investors.

    Municipal owned utilities operate like cooperatives, provide electricity at essentially cost, and are largely untaxed. So how come CoServ and some non-profit utilities are higher than for-profit utilities?

    The CoServ members that are sueing CoServ under a class action filed in February think it is because CoServ has financially engineered a way to take money away from the owner-consumers (aka members). There are many other issues as well contained in the lawsuit.

    The consumer advocate website for CoServ members is http://www.CoservWatchdogs.org. The lawsuit is posted there, with a lot of other information. The Texas Legislature has a bill in committee to correct these type of problems with electric cooperatives (SB 191).

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