Common Tragedies

Thoughts on Environmental Economics

Deregulated thinking

Posted by Daniel Hall on November 8, 2007

The blogosphere lit up on Tuesday after a New York Times’ article concluded that deregulation leads to higher electricity prices. Mark Thoma lays the blame with the design of electricity auctions, while Free Exchange wonders if supply conditions account for much of the prices increases and muses further that higher prices might not be such a bad thing in the long run. Felix Salmon, meanwhile, is unequivocal, claiming, “There’s no way to spin this: electricity price regulation is good for consumers, and electricity price deregulation is bad for consumers. End of story.”

My vote for best response so far goes to Michael Giberson, who in a short but nuanced post seems cautiously optimistic about the future prospects for deregulation but acknowledges that it is hard to design competitive electricity markets and that fuel costs have played a role in price increases. He also makes an intriguing prediction:

…an interesting comparison will emerge when fuel costs fall, my expectation is that deregulated states should see prices fall faster while regulated states will continue to increase before they, too, begin to fall.

My main disappointment in the discussions so far of the article however, is that none have bothered to take a serious look at the report which serves as the basis of the claim that deregulation is causing the higher prices. It appears to literally just compare prices in regulated and deregulated states over the last 15 years — surely a useful starting point for showing correlation, but hardly a definitive end point for demonstrating causation.

In addition to the points raised by the commentators above, here are some of the things I wonder about:

  • Endogeneity — Currently deregulated states started with higher electricity prices prior to deregulation. Were regulators more likely to deregulate because they saw the writing on the wall? California had refused to permit new generation in … well, essentially, an entire generation prior to deregulation. That was going to prove problematic regardless of the regulatory structure.
  • Generation portfolios — Deregulated regions tend to have far more natural gas-fired generation, making them more susceptible to changes in natural gas prices.
  • Investment — What is the current pace, scale, and nature of investment in deregulated regions compared to regulated? As touched on previously, how had investment proceeded prior to deregulation?
  • Renewables — Almost all deregulated states also have Renewable Portfolio Standards. Many regulated states do as well, but many of these states have large existing hydro resources. Further, almost none of the states in the southeast — where coal is king and electricity is still cheap — have an RPS.
  • Market power — Deregulation could be allowing large incumbent generators to exercise market power by withholding resources from the grid during peak demand. There are cases proceeding on this issue, and further, because a market power case can be hard to prove, there may be smaller instances going undetected.

It is certainly possible that the central claim of the article is correct — deregulation could be causing higher prices. But I suspect it’s only one factor among many, and would look relatively small if you could effectively control for many of the other factors.

If this proved to be the case, the question would move away from a simplistic notion of whether deregulation was good or bad, to more nuanced considerations of whether its benefits outweigh its costs. Here I would return to Michael’s question above, and add one of my own: How will deregulated regions will fare under climate policy? From here they seem better positioned to cope with a price on carbon in the near term, and better poised to respond dynamically to new market realities over the long haul.

Update: My blog colleague points us to some academic research that suggests deregulation has had a negligible impact on electricity retail prices while it has promoted efficiency at the producer level.

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