Thanks for all this.
On 10/19/10, MJ<[email protected]> wrote:
> The Myth of Energy Deregulation
Monday, November 07, 2005
by Adam Summers
While the initiatives on the upcoming November 8 California special
election
ballot backed by Governor Arnold Schwarzenegger have been receiving all
of
the media attention, another initiative that addresses an important
issue
is
being overlooked. Proposition 80, the so-called "Repeal of Electricity
Deregulation and Blackout Prevention" initiative, would make some
significant and detrimental changes in the state's energy policy.
The fact that even a government regulatory body such as the California
Public Utilities Commission (PUC) is actually against a measure that
would
increase its regulatory powers should tell you something right off the
bat
about the merits of Prop. 80.
California energy consumers are currently served by one of three types
of
providers: investor-owned utilities (IOUs), local publicly-owned
electric
utilities, and independent electric service providers (ESPs). Before the
state's "deregulation" experiment of the 1990s was suspended in 2001
during
California's energy crisis, customers could choose to purchase their
electricity services directly from ESPs through "direct access"
contracts,
rather than through an intermediary such as the local IOU or public
utility.
Proposition 80 Would Reduce Consumer Choice and Increase Costs
Proposition 80 would permanently prevent all customers receiving
electricity
services from an IOU from switching to an ESP, effectively eliminating
any
new direct access (existing direct access contracts would be
grandfathered
in).[1] Thus, under Prop. 80, instead of having the option to buy
electricity directly from independent producers, consumers would have no
choice but to buy their electricity from utilities. By effectively
eliminating an entire class of providers, the state has stifled
competition
(and would continue to do so), thereby leading to higher prices and,
likely,
lower-quality service.
The effect of this provision on prices would be significant. ESP
customers
include hospitals, local governments, the California State University
system, several University of California campuses, community college
districts, and local school districts. The nonpartisan Legislative
Analyst's
Office (LAO) estimates that the UC system alone saves about $12 million
per
year by purchasing its electricity from a lower-cost independent
provider.
According to Mike Florio, an attorney for The Utility Reform Network
(TURN,
one of the chief proponents of Prop. 80 that helped craft the measure),
the
ability of consumers to purchase electricity directly from independent
service providers "destabilizes the whole business … and we'll truly be
at
the mercy of the gods of the free market."[2] How dare people be able to
choose whom they want to do business with! I suppose TURN hired Mr.
Florio
not for his legal expertise, but rather by the sheer providence of the
"free-market gods."
Proposition 80 Would Impede Innovation and Efficiency
Another provision of Prop. 80 would prohibit the broader implementation
of
"dynamic pricing" of electricity without the consent of the consumer.
Currently, all but the largest energy consumers pay a flat rate for
electricity that does not vary by the time of day. Clearly, energy use
is
not constant throughout the day, however. There are certain "peak" hours
of
the day when consumers use lots of electricity, and "non-peak" hours
when
they use very little. The costs of providing electricity vary
accordingly.
As such, the IOUs have submitted proposals to the PUC to charge all
consumers higher rates during peak hours and lower rates during non-peak
hours. This price discrimination would be accomplished through the use
of
high-tech "smart" meters.
In addition to making good sense one should pay more for something
when
it
is in higher demand dynamic pricing would encourage conservation via
the
pricing mechanism. Dynamic pricing would be a more efficient system
because
higher prices would discourage some from consuming such a scarce
resource
while ensuring that those who place the highest value on energy use are
still able to consume it. Similarly, those who have some flexibility
over
when they consume their energy would be encouraged to utilize it during
non-peak hours, thus placing less strain on the system.
Allowing the consumer to opt out of a dynamic pricing model would be
like
forcing a hotel owner to offer customers the choice of the nightly room
rate
or an average of the nightly room rates throughout the week. Since
significantly more people stay at hotels during the weekend, rates are
much
higher on Friday and Saturday nights. The average weekly rate, however,
would be higher than normal weekday rates but lower than normal weekend
rates. The cheaper "opt-out" weekend rates and higher weekday rates
would
encourage even more people to stay during the weekend and fewer to stay
during the week. The result would be a shortage of hotel rooms during
the
weekend and a loss of revenue for the hotel owner. No wonder demand
strains
the electrical grids during hot summer days.
Environmental Issues
Under current regulations, energy producers must increase the portion of
energy derived from renewable energy sources such as solar, wind, and
hydroelectric by one percent per year until 2017, when 20 percent of
the
energy produced must come from these sources. Proposition 80 would
accelerate this deadline to 2010. Interestingly, some environmentalists
oppose Prop. 80 because a provision requiring a two-thirds vote of the
Legislature to amend the measure could make it more difficult to
increase
the renewable energy standard in the future.
According to the LAO's analysis, Prop. 80 would also require that "the
first
priority for IOUs in procuring new electricity is to be from
'cost-effective' energy efficiency and conservation programs, followed
by
'cost-effective' renewable resources, and then from traditional sources
such
as fossil fuel burning power plants."[3] Of course, if renewable energy
sources and energy efficiency and conservation programs were truly "cost
effective," producers would already be utilizing them in higher numbers
because it would make them more profitable. This clearly is not the
case.
Forcing companies to invest significant amounts of their scarce
resources
on
more costly energy-production methods, which make up a relatively small
share of total energy production (for good reason), will only ensure
that
costs and, ultimately, consumers' electricity bills remain higher
than
necessary.
As new technologies and energy-production methods are developed, this
may
change, but for now, it is best for both producers and consumers to
focus
on
the most efficient means of producing energy. Of course, if consumers
demand
"cleaner" energy, in a truly free market, producers will have an
incentive
to provide it. Indeed, after Pennsylvania successfully implemented its
electricity deregulation effort in 1999 (without the pitfalls
experienced
by
California), 20 percent of consumers chose to switch to suppliers of
"green
power," despite the fact that they had to pay a small premium to do so.
Proposition 80 eliminates this choice, instead demanding that all
consumers
support the higher cost of investing more in renewable energy whether
they
want to
or not.
Misconceptions Over Electricity "Deregulation" in California
Some blame deregulation for the rolling blackouts, soaring spot market
prices, and utility bankruptcies that sprang from the energy crisis of
2000
and 2001. But this anger is misplaced. California has never experienced
true
deregulation. The "deregulation" implemented in 1996 left price controls
in
place and created "artificial" markets ripe for manipulation and
disparities
between supply and demand.
By setting price caps below market prices, California limited the
profitability of the industry. When wholesale energy costs increased,
the
price caps prevented energy producers from passing them on to consumers.
Wholesale prices rose dramatically for a number of reasons: natural gas
prices rose, hot weather in the Southwest increased demand, a relative
lack
of water in the Northwest minimized the production of hydroelectric
energy,
and pollution-control permits, which allow industrial companies that
produce
less pollution than allowed by regulations to sell the difference as
"credits" to higher-pollution-producing companies, rose ten-fold, from
$4
to
$40.
The price caps additionally discouraged potential producers from
entering
the market and increasing competition, and they discouraged existing
producers from investing profits in adding capacity, of which
Californians
were (and continue to be) in dire need. As a result of the price caps
and
pressure from politicians and environmentalists, the building of plants
and
transmission lines slowed dramatically and energy producers were not
able
to
keep up with demand, particularly in the Silicon Valley, where the
booming
computer and "dot-com" industries led to even sharper increases in
electricity demand.
After the big three investor-owned utilities Pacific Gas& Electric,
Southern California Edison, and SEMPRA (San Diego Gas& Electric) were
forced to sell many of their fossil-fuel-burning generators to private
firms, regulators prohibited them from entering into long-term contracts
with these firms, forcing them to rely upon the much more volatile
short-term and spot markets. In addition, California forced generators
and
utilities to trade power through the Power Exchange, a state-run pool.
While that requirement was designed to give every company the same
wholesale
price for power, it also guaranteed that they would be unable to
negotiate
lower-priced power on their own. The California rules essentially barred
utilities from buying power on the futures market, meaning they were
unable
to lock in supplies and prices.[4]
This is as if Wal-Mart and Marshall Field's were forced to acquire their
goods from a non-profit, state-run pool that would guarantee that they
would
acquire the goods for the same price. Wal-Mart never would have been
able
to
develop its efficient and innovative purchasing and distribution system,
meaning it could not generate savings to pass on to customers in the
form
of
lower prices.
At the time of the increase in wholesale prices, PG&E and Edison were
still
in the deregulation "transition" period, and thus still subject to PUC
rate
regulations. As a result, PG&E went bankrupt and Edison teetered on the
edge
of insolvency. To add insult to injury, when the government stepped in
to
purchase electricity on behalf of the struggling IOUs to try to quell
the
crisis, not only did it do so at the height of the emergency, when
energy
prices were highest, it locked in these prices with long-term contracts
costing billions of dollars.
The Natural Monopoly Justification for Regulation
The main argument against the full privatization of public utilities
such
as
electricity and water service is that such industries are "natural
monopolies." That is, they require such high fixed costs (it is easier
to
start a new restaurant than to invest in the infrastructure for a new
electric grid) that it is inefficient for there to exist more than one
producer in a particular location. This, it is feared, will lead the
producer to engage in price gouging.
There are several problems with this rationale, not the least of which
is
the notion that "public utilities" somehow constitute a unique set of
goods
that must be "protected" by government intervention. As economist Murray
Rothbard noted in Power and Market:
The very term "public utility" … is an absurd one. Every good is useful
"to
the public," and almost every good … may be considered "necessary." Any
designation of a few industries as "public utilities" is completely
arbitrary and unjustified.[5]
High capital costs certainly will limit the number of actual and
potential
providers, but there is still a profit motive in a free market that
creates
opportunities for lower-cost producers. In addition, it is important to
note
that markets are not static; technological innovations may allow for
additional competition in the future.
Another misconception opponents of free markets have concerns the very
understanding of the nature of competition. Even if there is only one
producer of a certain good or service in town, this does not mean that
the
producer is "gouging" customers through monopolistic practices. Indeed,
just
because he is the sole supplier today does not mean he will be the sole
supplier tomorrow. As economist Thomas J. DiLorenzo explains:
If competition is viewed as a dynamic, rivalrous process of
entrepreneurship, then the fact that a single producer happens to have
the
lowest costs at any one point in time is of little or no consequence.
The
enduring forces of competition including potential competition will
render free-market monopoly an impossibility.[6]
In other words, even if there happens to be only one current provider of
a
particular good or service, in a free market that provider is held in
check
by the mere threat of competition if he charges prices that are too
high
or provides poor service, there will be an incentive for a competitor to
come in and take market share from him by offering lower prices or
better
service.
The rules change, however, when government regulation erects barriers to
entry or otherwise suppresses competition. In addition to the many
government regulations purportedly enacted in the "public interest,"
there
are numerous instances where private-sector businesses have been able to
successfully lobby policymakers to use the power of government to
establish
barriers to competition and protect them from existing or potential
rivals.
Unlike the free-market case, there is no possibility of these
monopolists
losing out to lower-cost providers (barring the elimination of the
regulations), and they are able to "exploit" consumers. These are the
truly
harmful monopolies. Thus, the only "bad" monopoly is a
government-created
or
government-preserved
monopoly.
Conclusions
Proposition 80 would be a step backward for California. It would
restrict
consumer choice, discourage competition, and impose more of the kinds of
regulations that got the California power industry into trouble in the
first
place.
As awful as Proposition 80 is, however, there is good news. It is
trailing
in recent public opinion polls, and even if it should end up passing it
is
likely to be discarded by the courts. It was removed from the ballot on
July
22 by the Court of Appeals in Sacramento because the court found that,
according to the state constitution, the PUC's authority can only be
increased by the Legislature, not by initiative. The initiative was
restored
a few days later by the California Supreme Court, which did not offer an
opinion on the merits of the case but felt that the public should have
the
chance to vote on the initiative before the legal challenge is heard.
(Of
course, if voters reject the measure, this will be a moot point and the
courts will not have to waste their time on it a fact that surely was
not
lost on the Supreme Court.)
Politicians and regulators forced a sham of a "deregulation" scheme upon
the
energy industry in California, and then blamed the free market when it
inevitably failed! The problem was not too much free-market competition;
it
was too much regulation (despite the "deregulation" doublespeak). The
real
solution to California's energy problem is to eliminate price caps and
all
government regulation, thereby removing barriers to entry, fostering
competition, offering consumers maximum choice, and affording providers
the
greatest incentives to increase capacity and best serve their customers.
Adam Summers is a policy analyst for the Reason Foundation
([email protected]). Comment on the blog.
[1] This option was suspended during the electricity crisis of 2000 and
2001, but is scheduled to be reinstated when the last of the power
contracts
signed on behalf of the IOUs by the Department of Water Resources
expires
in
2015.
[2] Carrie Peyton Dahlberg, "Electricity proposition crackles: Will
prices
go up? Will it avert an energy crisis? It all depends on who's talking,"
Sacramento Bee, October 15, 2005,
http://www.sacbee.com/content/politics/story/13717834p-14560232c.html(free
registration required).
[3] California Secretary of State, Official Voter Information Guide,
Statewide Special Election, November 8, 2005, p. 52,
http://www.ss.ca.gov/elections/bp_nov05/voter_info_pdf/entire80.pdf .
[4] Terry Maxon, "Power Woes Unlikely in Texas, Officials Say," Dallas
Morning News, January 19, 2001, cited in Lynne Kiesling, "Getting
Electricity Deregulation Right: How Other States and Nations Have
Avoided
California's Mistakes," Reason Foundation Policy Study No. 281, April
2001,
p. 18, http://www.reason.org/ps281.pdf.
[5] Murray N. Rothbard, Power and Market: Government and the Economy,
(Kansas City: Sheed Andrews and McMeel, 1977), p. 76,
http://mises.org/rothbard/power&market.pdf. Now integrated into Man,
Economy, and State.
[6] Thomas J. DiLorenzo, "The Myth of Natural Monopoly," The Review of
Austrian Economics, Vol. 9, No. 2 (1996), p. 44,
http://mises.org/journals/rae/pdf/rae9_2_3.pdf.
http://mises.org/daily/1954
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