The Electricity Blame Game


Confronted with economic problems, politicians always blame the privatesector first. The effort to accuse deregulation of causing localelectricity-supply problems, such as we are seeing in California at themoment, is but the latest example.

At a minimum the attack is off base for blaming the problem on the solution. Two decades ago, while teaching at Pennsylvania State University, I noticed that the then well-publicized cancellations of nuclear power plants were followed by generally overlooked cancellations of coal-fired plants. I subsequently arranged to visit many of the country's leading electric utilities. Everywhere the story was the same: Regulatory policies adopted as a response to the 1970s energy crisis made capacity expansion unprofitable.

After the plants already in the construction pipeline were completed in the mid-1980s, utility investment in additional capacity predictably declined. Smaller, gas-fired units were built in lieu of the conventional large baseload facilities, and an increasing proportion of that new capacity-80 percent in 1998, the most recently reported year-was provided by companies independent from the established electric utilities. Unfortunately, those third-party investments were not large enough to keep up with demand.

Regulatory reforms in the 1990s were undertaken in part to overcome thosedisincentives to invest. Given that those reforms have only been put inplace over the last four years and that conventional power plants can take a decade to build, however, it is too soon for those regulatory changessignificantly to affect capacity additions. Thus, the cure (deregulation) is now being blamed for the disease (energy shortfalls). In fact, one could argue that the slow pace of reform has added to capacity problems.

Then there is the problem of the regulatory reforms themselves. Instead ofthe sweeping (but still incomplete) deregulation that was applied to thetransportation industry, reformers are applying to electricity the far less successful telecommunications model of government-directed industrialreorganization. Utilities are treated like phone companies, receivinggreater pricing flexibility in return for allowing non-utility powergenerators access to their transmission and distribution grid. Many stateshave in fact gone further, requiring that utility companies sell all theirpower plants to independent entities to promote further competition and toconstrain any latent utility monopoly power.

Yet there is no proof that utility plant ownership has distorted markets. As any competent economist could tell you, unified ownership of facilitates often improves coordination and enhances overall efficiency. Should important coordination benefits exist in the utility industry, the forced breakup would prove harmful-not just to the companies, but to consumers as well.

Another problem reformers faced is how best to coordinate generation andtransmission among companies. Historically, only three "tight" power poolsoperated in the United States, all located in the Northeast. In a tightpool, member utilities maintain a continuously operating central dispatchauthority to optimize capacity utilization. Elsewhere, the interactionsamong companies were direct. While many of the companies in the "loose"pools generated far more electricity on average than the members of thetight pools and were thus less dependent on others, many have deemed thisinefficient. What is critical, however, is that those looser arrangementswere at least as effective at coordinating capacity utilization (and lessprone to capacity shortfalls) as the more formal ones.

To be sure, many considerations other than the choice of coordinationmechanisms affect electricity prices. The areas that use tight pooling, for instance, have special problems, such as long distances from coal fields and urbanized service territories, which greatly affect supply and demand patterns. Nevertheless, some states have concluded that tight pooling is desirable despite precious little evidence to that effect.

The bottom line is that restructuring proponents are shooting in the dark.Instead of relying on market forces to discover the best forms of industrial organization, they are imposing organizational structures that may or may not enhance efficiency. Doubts also arise about whether regulated restructuring has promoted promised claims of more flexible and, on average, lower prices.

We are still a long way away from having a free market in electricity. Weare also still a long way from having a deregulatory agenda. It is perhapstoo early to tell whether restructuring will remedy the capacity shortfallthat is helping to drive up prices, or whether reforms will enhance theoverall efficiency of the industry. However, it is not too early to pointout that the government, not the market, is currently in charge.

Richard L. Gordon (1934−2014)

Richard L. Gordon is professor emeritus of mineral economics at Pennsylvania State University and an adjunct scholar at the Cato Institute. He is the author of "Regulation and Economic Analysis: A Critique over Two Centuries."