Heresy? The case against deregulation of electricity generation

Electricity Journal

Volumn 14, Issue 4, 2001, Pages 19-24

  Watts, Price C ^a  

^a NONE

Author keywords

[No Author keywords available]

Indexed keywords

ELECTRIC POWER TRANSMISSION;

CALIFORNIA; CAPACITY EXPANSION; CAPITALS COSTS; ELECTRICITY-GENERATION; GOVERNMENT IS; MARKET POWER; TRANSMISSION CAPACITIES; UNSOLVED PROBLEMS;

DEREGULATION;

EID: 0002617357     PISSN: 10406190     EISSN: None     Source Type: Journal    
DOI: 10.1016/S1040-6190(01)00193-2     Document Type: Article

References (12)

1. Harvey Averech and Leland L. Johnson, Behavior of the Firm under Regulatory Constraint, AM. ECON. REV., Dec. 1962, at 1053-69.
2. Compare, however, with Elizabeth E. Bailey and Roger D. Coleman, The Effect of Lagged Regulation in Averech-Johnson Model, BELL J. ECON. & MGMT. SCI., spring 1971, at 278-92.
3. Bailey and Coleman argue that regulatory lag can eliminate this incentive to overinvest. See also Gordon R. Corey, The Averech and Johnson Proposition: A Critical Analysis, BELL J. ECON. & MGMT. SCI., spring 1971, at 358-73. Corey denies the existence of the Averech-Johnson effect at Commonwealth Edison.
4. Under the regulatory "compact," utilities are guaranteed a normal rate of return in the absence of imprudent decisions on their part. All they had to do was make their investment "used and useful." For many years, the utilities had had little reason to fear prudence reviews or other disallowances by regulators. However, some particularly badly conceived and executed nuclear generating plant decisions by utilities in the face of slowing demand growth were subject to prudence-review-based disallowances. In this new context, utility management could reason that there were two possibilities with positive probabilities: either (1) there would be no disallowances and they would get a normal rate of return, or (2) there would be disallowances and they would get less than a normal rate of return. Even if disallowances are relatively unlikely, the probability weighted average of a normal rate of return and a subnormal rate of return is a subnormal rate of return. In addition, a utility might hope to cash in on its central role and make an above-normal rate of return in a deregulated environment. Finally, in a deregulated environment, executive compensation would not be subject to regulatory oversight.
5. The efficiency criteria is that the ratio of the marginal cost of extra capacity to the marginal cost of a capacity shortage equals the ratio of the probability that there is too little capacity to the probability that there is too much.
6. See Robert H. Litzenberger and Anerukuri U. Rao, Estimates of the Marginal Rate of Time Preference and Risk Aversion of Investors in Electric Utility Shares: 1960-66, BELL J. ECON. & MGMT. SCI., spring 1971, at 265-77. These authors found that even within the class of rateof-return-regulated firms, investors are sensitive to fluctuations in returns.
7. The higher cost of electricity will increase investment in conservation. This is desirable, as it helps offset the market failures that lead to underinvestment. See Anthony G. Fisher and Michael H. Rothkopf, Market Failure and Energy Policy: A Rationale for Selective Conservation, ENERGY POLICY, Aug. 1989, at 397-406;
8. reprinted in Environmental and Resource Economics: Selected Essays of Anthony C. Fisher (Northampton, MA: Edward Elgar Publishing Ltd., 1995), at 328-37.
9. However, as pointed out in Joseph Eto, Suzi Kito, Leslie Shawn, and Richard Sonnenblick, Where Did the Money Go: The Cost and Performance of the Largest Commercial Sector DSM Programs, ENERGY J., June 2000, at 23-49, deregulation also led to utilities dropping effective conservation programs. Hence, the net effect is theoretically indeterminate, but as a practical matter deregulation appears to have reduced conservation.
10. Alfred E. Kahn, Peter C. Cramton, Robert H. Porter, and Richard D. Tabors, Pricing in the California Power Exchange Electricity Market: Should California Switch from Uniform Pricing to Pay-as-Bid Pricing? Blue ribbon panel report, California Power Exchange, Jan. 23, 2001, at 16. The report is explicit about the insignificance, in the face of the deterioration of the California electricity markets, of the particular proposed remedy - pay-as-bid pricing - that the panel was commissioned to evaluate.
11. Severin Borenstein, James Bushnell, and Christopher R. Knittel, Market Power in Electricity Markets: Beyond Concentration Measures, ENERGY J., Dec. 1999, at 65-88.
12. Also, Steven Stoft's op-ed piece, The Market Flaw California Overlooked, N.Y. TIMES, Jan. 2, 2001.