The weak case for continued regulation of the electric power industry

In today’s Wall Street Journal special section on energy issues, a pair of articles presents the case for and against restructuring the electric power industry to introduce more competition. In favor of reform is Andrew Kleit: “YES: It Is the Best Way to Lower Costs and Increase Innovation.” In favor of the traditional regulated electric utility is Kenneth Rose: “NO: The Evidence So Far Shows Little Benefit to Customers.”

We have two well-known and respected energy economists with a long history of grappling with electricity restructuring issues, so I anticipated a couple of hard-hitting articles. My conclusion? The case against reform seems incredibly weak. If these are the best arguments for and against reform, then by all means reform.

Kleit’s case for reform identified the many demands we are making on the industry and said a more competitive industry is the way to go. Very selective excerpts:

Creating a cleaner, more reliable and less expensive electricity grid is going to require new ideas and a great amount of technological development to lower costs. Unfortunately, these are things that run counter to the incentives of regulated utilities.

In a regulated system, government agencies make basic production and grid-access decisions, and set electricity rates in a way that guarantees utilities a certain rate of return on capital investments and other approved costs. Because utilities’ profits are a function of how much they spend, there is little incentive to cut costs and increase efficiency.

Kleit discussed various foreseeable challenges and suggests the traditional regulated monopoly utility is not well suited to take them on. He concluded:

Restructuring hasn’t lived up to all of its promises. Business customers in restructured states appear to have benefited more than residential customers in terms of lower power prices … But in terms of keeping the cost of energy production down, restructuring has worked. …

New technologies, innovation, green power and competitive markets all go together. To create a cleaner, more reliable and less expensive electricity grid, it is time to escape the dictates of government officials and free up competitive forces.

Rose, in opposition to reform, mentioned the promises made by advocates of reform and (like Kleit), pointed out “the effort to restructure the complex and essential business of electric utilities hasn’t delivered the expected benefits.” On the issue of prices, he said:

Turns out, it’s hard to see any clear benefit. Comparing the weighted average price for residential customers in the 14 jurisdictions with full retail competition to the 30 states that stayed regulated from 2002 through 2015 shows that rate increases for residential customers were about the same. Prices went up 50% in states that proceeded with choice and 52% in states that stayed regulated, according to Energy Information Administration data. [Link in source.]

Wait a minute. I thought the point of traditional monopoly regulation was to protect consumers from greedy businesses and yet prices have risen faster with regulation. And by the way the 50 percent and 53 percent are in nominal dollars. Adjusted for inflation electric power prices have fallen on average since 2002 in both regulated monopoly and customer choice markets.

Rose noted that the relative price advantage for choice markets depended very much on the time frame chosen for analysis:

However, time frame matters. From 2002 to 2008, commercial and industrial customers in choice states saw rate increases of 43% and 60%, respectively, due mostly to trends in the price of natural gas, while customers in regulated states saw increases that were 9 and 19 percentage points below that.

In addition, Rose wrote:

What deregulation has delivered so far is retail and wholesale price volatility, which has created considerable tumult for both buyers and sellers of power. When customers have complained (understandably) about price spikes, regulators and legislators have responded with price controls. When prices subsequently dropped, power sellers cried foul and in some cases received subsidies. Such concessions prevent the market from functioning well and have created a version of “deregulation” that doesn’t work for anyone.

Rose concluded:

Retail markets were given a chance, and it didn’t work out—no shame in that. But it is time to learn from our mistakes and find a balance between regulation and markets that is a better fit for this business.

To summarize, on price overall it looks like prices with customer choice have dropped a little more on average than with regulated monopoly, though prices  in customer choice markets had increased more than in through 2008. Prices have been more volatile with customer choice, and regulators and legislators have intervened in ways that have gummed up the works a bit.

Maybe it depends upon where you want to place the burden of proof. A good conservative puts the burden of proof on advocates of reform. The rallying cry is, “stick with the old ways unless there are good reasons to change.” The small price benefit from reform so far might lead a conservative to stick with the status quo in traditional states.

An individualist, on the other hand, puts the burden of proof on advocates for government intervention. The motto is more along the lines of “don’t take away my choice unless it is necessary to getting a much better result.” The regulated monopoly way of doing things is not providing substantial benefits, so individualists should demand the return of their freedom to choose.

We have had traditional monopoly regulation for over a century in this country, and can quite reasonably expect that the system is working as well as we can manage. Any further improvements in regulatory practice are likely modest. Add to that the demands for innovation and the traditional systems poor record on that score, and we have reasons to think the old system is not up to the challenge anymore.

If this is the best we can manage after over a century monopoly regulation, then it is time to give it up.

WARNING: As regular readers will know, I was in favor of customer choice before reading the articles. You should suspect I am reading the case against reform uncharitably. By all means, read the articles for yourself and make up your own mind whether you want utility commissioners to continue to play “father knows best” on electric power in traditional states or you want your freedom to choose back.

One thought on “The weak case for continued regulation of the electric power industry

  1. This is a short response to “Is It Time to Deregulate All Electric Utilities?,” one of Nov. 13, 2016, reports of the Wall Street Journal special section on energy issues. A long response is in the post “Minimalists governments with fair global free deregulated markets must arrive soon ( ),” where remarks [1]…[6] are available. Next are representative quotes from the two articles on the deregulation issue.

    YES: It Is the Best Way to Lower Costs and Increase Innovation, by Andrew N. Kleit: “Restructuring hasn’t lived up to all of its promises”.

    NO: The Evidence So Far Shows Little Benefit to Customers. by Kenneth Rose 1) “… a big factor is something policy makers have no control over—industry structure.” 2) “… electricity markets still need considerable economies of scale to operate efficiently, and restructuring hasn’t provided sufficient benefits to overcome the loss of efficiency that occurs when monopoly utilities are dismantled.”

    Most observers are dominated by the deep and widespread numbing ‘Groupthink’ effect of the industrial civilization based on Cartesian thinking [1]. This is another thought experiment. It is an approximation to the ‘Emergence’ scenario [2] under which ‘The Theory of the Business’ [3] of electric utilities is running away from industrial civilization reality. In our lingo, they were systemic and turning into anti-systemic [4]. Electric utilities restructuring was introduced in jurisdictions that were the most anti-systemic and the result was still anti-systemic because they depended on supply side economies of scale.

    Both Kleit and Rose are restricted under ‘Groupthink’ to the transition of the power industry. Under transformation [5], policy makers don’t need to control industry structure under systemic restructuring where considerable demand side economy of scale [6] will emerge as we leap into the systemic civilization. By being highly anti-systemic the Dominican Republic has a huge and urgent opportunity to transform.

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