Finding the Short Circuit in Electricity “Competition”

 

 

Henry Thompson

 

 

What is the lesson to take from the California electricity crisis?  Some suggest markets need more regulation so energy companies from Texas cannot collude to manipulate markets and extract profit from California.  The truth is that California regulators and legislators set an electricity price ceiling as well as environmental regulations that created the high wholesale price.  The shortage of electricity was due to poor government policy. 

 

During the crisis in California utilities had to pay over $.25 per kilowatt hour for electricity and then had to sale it for $.07.  Clearly the politicians had little background or interest in the business.  Their regulatory structure illustrates the pitfalls of government involvement in the electricity business. 

 

The same California lawmakers that created the crisis then confiscated the property of the utility company as collateral for paying the $12 billion debt created by the regulated price scheme.  It should be clear that the electric industry in California was never deregulated and now is partly nationalized by the state government.  Taxpayers will have to pay the bill. 

 

For the past 75 years, states in the US have granted monopoly status to electric utility companies.  No other firm could generate, transmit, distribute, or sell electricity inside their franchise area.  The history is that during the early 1900s competing electric companies grew tired of local municipality taxes and petitioned state governments for monopoly franchises.  State politicians were happy to oblige in return for regular state tax revenue on the profits.

 

Public service commissions regulate these utility monopolies and aim to make them behave like efficient competitive firms.  The utilities have been inefficient but with abundant energy sources the price of electricity has remained low.  Energy sources are now becoming scarce, energy prices are rising, and the energy industry will assume increased importance.  Lawmakers and local politicians with little idea about the energy industry are in now the political process of “restructuring.” 

 

Part of the proposed restructuring is “retail competition” that would allow electricity customers to choose suppliers.  Customers in high price states such as California, New York, and Florida would like to buy from suppliers other than their local utilities.  With retail competition, however, electricity producers will also be free to choose customers.  Neighboring low cost suppliers will choose to sell to customers in high price states.  The result in the low price states will be higher prices. 

 

California and Alabama present opposite cases.  California effectively imports most of the electricity exported from Washington, Oregon, Utah, Arizona, Montana, Wyoming, and New Mexico, not to mention Canada and Mexico.  This interconnected region has been forced by the federal government to increase exports to California even though prices increase for their local customers.  Florida buys electricity from Alabama and South Carolina.  On the East Coast, New York and New Jersey import from Pennsylvania and West Virginia.  Retail competition pits customers in the importing high price states against customers in the exporting low price states.

 

Meanwhile, halfway around the world OPEC leaders decide whether to loosen or tighten the world oil supply.  A higher price of oil climbs induces people to demand other types of energy and all energy prices rise.  As oil is depleted over the coming decades, its price will continue to rise and at an increasing rate.  Welcome to the future of the energy markets where the only certainty is that someone will have to pay the bill.  

 

The push to restructure arises from rising energy prices and increasing energy scarcity.  Energy comes in various raw forms.  Oil and coal remain the fundamental energy sources but they both cause air pollution when burned.  Aside from the ambiguities of global warming, fossil fuel pollution definitely causes serious local problems.  There are ample supplies of coal, still the main fuel for electricity, but pollution concerns may limit coal burning or require expensive scrubbing.  Either way, get ready for higher electricity prices. 

 

Natural gas is a popular fossil fuel because it burns cleanly.  Natural gas from the Gulf Coast comes up the expanding pipeline system to a new generation of efficient gas turbine generators.  But the pipeline system is expanding more slowly than gas demand and natural gas prices will climb steadily due to increasing demand and scarcity.  California is presently importing liquid natural gas from South America.  To complicate matters, gas is a fossil fuel that releases carbon dioxide which may be limited by international agreements to fight global warming. 

 

Nuclear reactors run on cheap uranium fuel but the radioactive waste creates a problem.  Nuclear generators are getting older and no new ones are planned due to regulations on industry.  There are $13 billion of mothballed nuclear plants in the Tennessee Valley Authority, sitting idle due to ambiguous regulations.  Hydroelectricity has been a reliable energy source but there is no discussion of building new dams due to environmental concerns. 

 

Be wary of proposed government solutions to the pending energy shortage.  Any energy “plan” would be doomed to failure.  Consider for instance the oil tariffs of the 1950s designed to keep domestic oil fields in operation but amounting to a policy of draining America first.  Remember also the price caps on gasoline during the OPEC oil embargoes of the 1970s and the long lines at the gas pump.  As for energy subsidies, do we really want government officials deciding which potential energy sources to develop?  Experienced market professionals with profits at stake would do a much better job.

 

There are thousands of people working in the competitive energy industries trying to innovate and develop more efficient electricity and energy systems.  Innovation will lead to alternative energy sources and efficiency as long as markets remain competitive and patents are respected.  The main requirements of competition are reliable price signals to ensure the payback for long term research and development. 

 

Competition will work in the electricity market just as it does in every market.  As consumers face higher prices they will economize.  To ensure the future of energy, all markets should be deregulated.  Electricity prices ultimately depend on investment.  California has not invested due to government regulations, accounting for their energy crisis.    

 

Electricity prices will continue to rise as energy sources become scarce and generation switches to more expensive backstop resources.  Final consumers will have to pay these higher prices for the market system to work.  Economics and history teach there is no feasible system other than the market system to produce and distribute energy.  California’s energy crisis is an example of failed government market manipulation.  The last thing we want is more misguided government regulation and interference in energy markets.