Electricity Deregulation: What Gives?
Posted by Rich Sweeney on November 8, 2007
I’ve been meaning to write about the NYTimes article reporting that deregulation has lead to higher electricity prices for two days now. Daniel already did a good job highlighting the lack of rigor underlying the chief source for the Times’ claims. Clearly a much more careful analysis is needed to isolate the price effect of deregulation. There are several academic articles in the literature which attempt such an analysis and find negligible or conflicting results. However, a 2006 Energy Journal article by one of the field’s leading researchers, Paul Joskow, finds mixed or slightly negative impacts on retail prices from deregulation. (Ungated draft here).
What I really wanted to add to this debate, though, is a discussion of how elecricity costs have been affected by deregulation, as opposed to customer prices. In September Kira R. Fabrizio, Nancy L. Rose, and Catherine D. Wolfram published a paper in the AER called, “Do Markets Reduce Costs? Assessing the Impact of Regulatory Restructuring on US Electric Generation Efficiency”. Using a large, firm level data set, the authors find,
Restructuring reduced labor and nonfuel expenses, holding output constant, by 3 to 5 percent relative to other investor-owned utility plants, and by 6 to 12 percent relative to government- and cooperatively owned plants that were largely insulated from restructuring incentives.
This suggests that while the jury may still be out on the end use electricity price reductions from deregulation, the market is working in terms of promoting efficiency at the producer level. In fact, this is theoretical justification for deregulation in the first place, to provide market incentives for producers to minimize the cost of generating electricity.
As to why these efficiency gains aren’t being passed on to end users, that involves a whole different set of issues. As a few other bloggers noted, market power certainly jumps to mind. As countless botched post-communist privatization schemes proved in the early 1990’s, its not enough to simply privatize a large monopoly, you also have to force it to compete. The study above indicates that deregulation is succeeding in its main objective, giving producers the incentives to minimize costs and infusing market signals into an atrophying industry. If politicians want to lower electricity prices they should examine existing barriers to entry and look to regulate the auction process that dictates flow on the electricity grid. I’ll save the discussion of producer surplus and societal welfare for another day, but for now, suffice it to say, that if our goal is to generate and use energy most efficiently, and if we believe the authors’ results, reregulation of electricity markets should be off the table.