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Support Electric Competition—the Good Old Days Weren’t So Good
An analysis by Eric Stephens
Vice President of U.S. Government & Regulatory Affairs, Direct Energy
Breaking Down the Electricity Industry Restructuring
Unlike restructuring in other industries, which often occurred as a result of changes in federal legislation, restructuring in the electric industry occurred in a more decentralized manner. The key elements of the restructuring process include:
• providing utilities and non-utilities open-access transmission service
• splitting up vertically integrated utilities by separating control of transmission and generation assets
• the formation of Independent System Operators, Regional Transmission Organizations and centralized wholesale electricity markets
• developing stranded cost recovery mechanisms for past inefficient utility investments that regulators approved/required during regulation
• establishing transition periods and default service pricing to move from a regulated to a competitive market structure
• allowing customers to switch providers (including measures regarding customer protection, deposit and disconnect rules, and systems for processing retail market transactions)These changes both in the wholesale and retail electricity markets have occurred in stages that vary in form over time and often by U.S. region, state, service area, and even customer type.
For most of us, reflecting on the “good old days” brings back fond memories. But, when reflecting on the history of the energy industry, there’s one particular timeframe that wasn’t so good.
Think back to the 1970s and 1980s and the huge power plant cost overruns and regular rate increases that customers experienced—all courtesy of a regulated electric utility environment. In fact, we are still paying for some of those decisions today. These huge inefficiencies led many states to part with the ways of the past and to give customers the right to choose their energy provider—a process we often call restructuring—in the 1990s. It’s that process that has given companies like Direct Energy Business the ability to sell energy and related products to our customers for, in some cases, nearly 20 years.
Unfortunately, some policymakers will be hearing from those who propose turning back the clock in 2009, with legislative debates on retail competition brewing in California, Texas, Maryland and Pennsylvania. As we talk to policymakers about the value of energy competition to customers in today’s challenging times, the Northbridge Group, through the COMPETE Coalition, has provided a very useful study urging policymakers to “learn from history” in order to successfully navigate today’s energy environment and promote continued progress on retail competition. We concur with many points in the study and found it so interesting that we thought we’d share some of the highlights.
At a high level, the report supports the view that regulation is an inefficient and expensive substitute for competition, noting that using a regulated model is what ultimately led to higher costs to consumers and less-efficient resource allocation than would likely have occurred in a competitive framework.
The report goes on to identify that there are four inherent flaws of regulated electric markets that make a regulated framework unsuitable, and frankly unsustainable, including:
- a lack of clear price signals resulting in a reserve margin twice as large as necessary—which results in higher prices
- perverse capital incentives (such as the incentive to “gold plate” power plants) that unnecessarily cost consumers billions of dollars
- improper allocation of risks to consumers rather than investors
- a tendency for regulatory fixes to overcompensate
As a result of the negative effects of the regulated model in the 1970s and 1980s, the electricity industry turned to competition in the late 1990s, following the example of other industries like the airlines, trucking and telecommunications.
Choose Wisely
In the Northbridge Group’s report, the authors suggest that in order to determine whether a competitive or regulated market is the best model, we have to consider which model will produce more efficient decisions and ultimately better price and reliability outcomes over time and in varying market conditions.
More often than not however, casual observers assess the performance of competitive markets by comparing default service rates in a state before and after restructuring. The report supports our position that this is a false comparison. Though no one knows what the rates would have been without competition, our view is they would have been much higher. Just take a walk down memory lane in a state like Michigan to see how power plant cost overruns (paid for on the backs of customers) started to add up in a regulated model where customers have no choice. Those multi-billion dollar overruns did not happen in competitive environments.
Since restructuring has occurred in a more decentralized manner than other industries and it may exist at different levels with varying rules from state to state, it is difficult to make a direct comparison between regulated states and unregulated states. This means that some studies purporting to support the notion that rates go up more in restructured environments could be citing states where there is no real consumer choice (although choice might technically be available).
In addition, since restructured states have a much higher percentage of electricity being generated by gas and oil (41 percent) and regulated states have a much higher percentage of electricity being generated by coal (57 percent), any rise in gas or oil prices will have a disproportionately large impact—across the boards—on deregulated states. This variable is also often overlooked when comparing the restructured model to the regulated model.
The Northbridge report reinforces many points we have been making for a long time about the case for competition:
- Market prices provide the right price signals—over time, marginal cost pricing produces a more efficient and ultimately lower cost, relative to average cost pricing, because it provides the correct price signal for the new and existing generation and demand response resources.
- Competition promotes efficiency improvements in areas such as existing plant operations, plant investment and retirement, and customers’ energy consumption—one of the most significant areas of potential savings brought about by restructuring is more efficient long-term investments. Competitive markets also provide strong incentives to improve plant performance and administration in the short-term, including efficiency of power plant dispatch, enhanced pooling benefits and coordination across broader markets, and reduced plant operating costs.
- Retail competition is still developing and has the potential to provide additional benefits—in restructured states where the market design allows the default price to reflect market prices, retail competition has developed to the greatest extent. And, there are more benefits yet to come, including better utilization of resources, increased customer choice, access to new products and services, technical innovations, elimination of cross-subsidies and lower prices, according to the report.
In considering the future of the energy industry, it is expected that the magnitude of future capital investments will be unprecedented. And, with future electricity generation costs, pricing, demand, compliance and technology largely unknown, the risks with investments in long-lived generation assets are inherently higher. The Northbridge Group’s report warns that moving back toward a regulated market model and making billions of dollars worth of resource choices in a centrally-planned manner using ratepayer money could be repeating the same mistakes that were made in the 1970s and 1980s—mistakes that could potentially take years to recover from.
In the end, the report recommends that policy changes should focus on encouraging future investment, improving operating and consumption decisions, increasing efficiency, and providing customers with a greater choice of products and services in order to produce lower costs for them. And, we agree. In difficult economic times especially, the last thing we need is a trip back to an inefficient, expensive past that eventually led us to the decision to restructure electric markets in the first place. Now it’s more important than ever to keep our feet moving forward and our sights set firmly on the future.
We will be sharing this report and our views with policymakers in 2009 as we work to help preserve and enhance your right to choose a competitive retail energy supplier, and we encourage you to do the same.
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