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No. 320

October 6, 1998

THE DEREGULATION OF THE ELECTRICITY INDUSTRY

A Primer

by Peter M. VanDoren

Executive Summary

Several states have enacted and others are contemplat-

ing changes in the traditional industrial organization of

electricity markets.  Those changes involve the creation of

stock-exchange-like markets for the sale of electricity and

the treatment of transmission and distribution lines as

"common carriers" that deliver power from any generator to

consumers at regulated rates and under regulated condi-

tions.

Consumers in the Northeast and California have promot-

ed such changes because they do not want to pay vertically

integrated traditional utilities for their expensive elec-

tricity.  The electricity is high cost because some nuclear

plants are terribly expensive, as are some long-term con-

tracts signed with independent and renewable power produc-

ers.  In a competitive market for generation, some high-

cost facilities would not be able to earn revenues to pay

their initial capital costs.  Shareholders rather than con-

sumers should pay for that loss of wealth because share-

holders of utilities have already been compensated for the

risk created by changes in regulation.

The focus on generation has precluded thoughtful

consideration of the useful role played by vertical inte-

gration. Vertical integration, in which generation and

transmission services are jointly owned, is an effective

solution to the externalities that independent generators

impose on a transmission system.  Before we take apart ver-

tically integrated utilities, we should consider simple

deregulation, the elimination of state-granted franchise

monopolies.  We should let vertically integrated utilities

compete without state-provided protection from competition.

____________________________________________________________

Peter VanDoren is assistant director of environmental stud-

ies at the Cato Institute.