Common Tragedies

Thoughts on Environmental Economics

The best laid plans…

Posted by Daniel Hall on October 10, 2007

A couple of energy economists at the Cato Institute wrote an editorial in the Wall Street Journal last month on electricity deregulation. (The full non-gated version can be found here.) It contains an excellent overview of the history of electricity deregulation, and a straightforward explanation of the primary economic forces that determine the price of electricity in regulated and deregulated markets. It’s well worth reading just for these aspects.

They also discuss why deregulation has worked so poorly in many places. Their argument is that deregulating electricity retail is non-problematic, but forcing apart transmission and generation — leaving transmission regulated but opening up generation to competition, including forcing incumbent utilities to legally separate their generation and transmission businesses — causes problems because these would very likely be vertically integrated in a ‘natural’ market structure. In other words, in a truly deregulated market, there would be considerable consolidation and vertical integration between generators and transmitters — making it look much like the regulated markets did before deregulation.

I don’t know enough about the electricity sector to evaluate this proposition; it’s an interesting idea.

Lynne Kiesling over at Knowledge Problem, meanwhile, is optimistic that deregulation of both generation and transmission will be good for consumers, because of increased innovation:

…in many other industries, technological change and economic growth have created consumer benefit through innovation, new products and services, and product differentiation. As long as the regulatory compact has retained the idea that consumer benefit in this industry derives only from low, stable rates, it prevents electricity consumers from having access to potentially valuable new products and services associated with electricity consumption, because it stifles innovation.

This seems like an important point. Deregulating electricity means that I don’t have to accept whatever generation profile my incumbent utility relies on. I can choose to support renewable energy if I want to, whether by switching to a provider that offers a different generation profile, or by using renewable energy credits to effectively ‘green’ my power. I can move to a time-of-use (TOU) or real-time pricing (RTP) plan that encourages less energy use in the peak afternoon period and so reduces the need for building excess generation capacity. Further, it seems that a deregulated structure should be more conducive to the entry of some new innovative energy technology that gets developed down the road. These long-term innovation effects strike me as one of the best reasons to think deregulation should be given a chance.

H/T: The Oil Drum.

One Response to “The best laid plans…”

  1. Tmoney said

    Spot on. We as a society have accepted that things like cell phone plans and airline travel can (and should) have peak pricing, so its not unreasonable to assume that we could handle peak pricing in electricity as well.

    Also, i think there will be an interesting incentive problem if utilities do start offering RTP or TOU. Lets say you have a mass of consumers who basically don’t use electricity when its expensive (i.e., people who go to work most of the day). Those guys pile on to RTP or TOU plans. LSE revenues go down, because a group of customers start buying electricity cheaper. Suddenly, for the LSE to be profitable, all the fixed price users will need to pay more for the consumption profile they enjoy. They then have 2 options – change their behavior and switch to an RTP/TOU plan, or invest aggressively in efficiency in their homes (better heating/cooling, CFLs, new appliances, etc). Both of these options should have the effect of pushing marginal consumers towards RTP/TOU over time. And both of these options provide many opportunities for innovation and competition.

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