Why New England Was Greatly Harmed by the “Deregulation” of the Electricity Industry Dr. Richard A. Rosen Tellus Institute – Boston, MA 100th Restructuring Roundtable March 30, 2007

The three main harms: Electric rates ended up being far too high – restructuring could not have worked to lower rates. Generally, led to more financial transfers from poor to rich. Climate impacts of electric generation became harder to control due to more federal regulation and less state control. Democratic input into planning and ratemaking became much more difficult. Tellus Institute

Stranded costs implied no savings. PV of rates after restructuring = stranded costs + PV of market prices Stranded costs = PV of cost-of-service prices - PV of market prices (definition) Therefore, PV of rates after restructuring = PV of cost-of-service prices Where’s the beef? Of course, we should have computed stranded costs correctly – and this is one cause of overcharges. Tellus Institute

Why deregulation causes the price of electricity to rise: Dismantling vertically integrated utilities is economically inefficient and endangers system reliability. Deregulated generation faces a much higher cost of capital and pressure for much faster depreciation (10 yrs or less vs. 30 yrs or more). Operating wholesale markets is more expensive than operating cost-sharing power pools. Markets hide new sources of cost. Tellus Institute

More reasons for higher prices: No one had a clear idea for a “competitive” market structure. Market clearing prices are likely to be much higher than embedded costs for some units – particularly with natural gas prices rising. (Negative stranded costs.) Single price auctions – the type of markets advocated - are inefficient for both energy and capacity, and send wrong price signals. They are also illegal! Typical sub-regional ownership concentrations for generation make competitive markets unlikely. Tellus Institute

Dismembering vertically integrated utilities was inefficient. Coordinated planning is difficult and more costly with separate distribution, transmission, and generation – and a regional transmission organization (RTO). Least-cost outcomes are unlikely. Direct costs tend to rise and environmental costs are harder to take into account. Energy conservation investment programs were undermined, further adding to consumer costs. Tellus Institute

Generation markets are unlikely to ever be competitive. Even three or four generation owners in a small transmission-constrained region will not allow for competition in electricity markets. Strategic bidding (manipulation) is easy in single-price auctions, partly because of different plant variable costs and changing demand. Cost-effective transmission constraints make market power easy to exercise. Generation capacity can also be withheld (retired) to make supply and demand tight. Tellus Institute

FERC regulation has been less effective than state PUC regulation. The Federal Power Act requires that rates be “just and reasonable” – precedents are cost-of-service based. This was not applied properly to wholesale market prices for generation. Monitoring markets for price manipulation was done improperly. FERC favored policies to support the ability of new generators to “compete,” even if doing so undermined state or regional least-cost planning. FERC could not promote cost-effective conservation or incorporating environmental externalities in planning. Tellus Institute

Deregulation adds many layers of new costs to retail prices. Vertically integrated utilities with cost-of-service regulation are economically efficient. This is why that had been the US tradition since the 1930s. Distribution, transmission, and generation can be better operated and coordinated by one set of utility managers. Cost sharing through power pooling makes sense as we used to do. Adding retail markups to cost-of-service wholesale prices drives up prices – and is a complete social waste. Monopolies make sense at the retail level with PUC regulated products. Tellus Institute

CONCLUSIONS The so-called “deregulation” of the electric utility industry could have been predicted to greatly increase prices for consumers. For example, several Tellus reports prior to 2000 made this prediction. Moving away from cost-of-service regulation for electricity has been a total failure. There is no way to save specific aspects of “deregulation,” nor should one want to. It must be reversed as soon as possible through re-regulation of generation plant, where possible, and new COS built units and/or publicly-owned units. Simultaneously, we must work hard to reduce demand, add many more renewable generation sources, and phase-out high carbon emitting plants. Tellus Institute