District Energy - 2007 Second Quarter

Thus, in the early 21st century, there are widespread differences among the states with regard to their electricity industries (fig. 1). In Texas, Maryland, New Jersey and New York, for example, competition seems to be flourishing or coming along nicely. In other states, such as Washington, Kentucky, West Virginia and Florida, traditional regulation remains; elsewhere, some amount of competition is occurring, as is the case in Pennsylvania, Ohio and California. Where competition exists, users are increasingly buying electricity from independent marketers that offer a variety of products, e.g., fixed prices, variable prices and some combination of the two. For those interested in buying ‘green’ electricity, that option now is available as well. Some universities particularly like that alternative.

In 2005, however, dissatisfaction with electric industry restructuring began growing in a number of states. There were a number of highly publicized incidents of high prices and projected high prices that made users – both industrial and residential – become wary of electricity competition. In Maryland, projections of an 85 percent increase in electricity prices (despite the fact that electricity prices had been frozen for more than 10 years) when combined with a gubernatorial campaign, led to an attempt to fire the Maryland Public Service Commissioners. The political outcry over high prices was also loud in Illinois and Ohio; and in the latter state, it led to an extension of rate caps. In Pennsylvania, as well as other states, it was the industrial community that led the chorus of users disenchanted with electricity competition and voiced many concerns about the coming of electricity ‘price shock.’ What was going on?

Though opinions differ, it seems that concerns about the effectiveness of electricity competition and the potential for electricity price shock have three origins: wholesale marketplace immaturities, rising raw energy prices and retail marketplace inadequacies.

Wholesale Market
Immaturities

While the FERC has been well-engaged in making wholesale markets work in those sections of the country where politics have allowed it to function, the very

newness of RTOs has led to criticisms of their governance, their decision-making processes and their operation. ELCON (Electricity Consumers Resource Council), a long-standing large energy-users’ advocacy group, issued a report in 2005 titled “Problems in the Organized Markets.” The report identified six preconditions to competitive wholesale markets – preconditions that have not yet been fully addressed by the FERC or individual organized wholesale markets:

1. RTOs with nondiscriminatory stakeholder processes

2. energy-only commodity markets

3. elimination of entry barriers to price-responsive loads

4. market monitoring and market power mitigation

5. adequate transmission infrastructure 6. federal-state regulatory partnership

Precisely because these preconditions don’t yet exist, many large users of electricity believe that electric utility generation affiliates are unfairly benefiting not only from market share dominance but also from a pricing structure (locational marginal pricing, or LMP) that seems to provide windfall profits to coal and nuclear generators.

Rising Energy Prices

The past couple of years have seen a major increase in crude oil, natural gas and coal prices. Since these are the primary raw materials of electricity generation, the cost of electricity itself is increasing. This literal doubling or more of raw energy prices from levels that existed just a few years ago, along with the projection of continuing raw energy price increases, is why many forecasters project high future electricity prices.

Users combine these forecasts with their criticisms of the wholesale market and conclude that the old world of cost-based regulation will provide lower prices than ‘market’ prices. They are forgetting, of course, that cost-based regulation passes through to consumers high raw energy prices as do markets, though sometimes a bit more slowly. Nonetheless, the user electricity-market critics would seek to ‘decouple’ themselves from energy markets through the use of vehicles such as long-term contracts or purchases from governmental entities. Alternatively, they

talk of moving their electricity-intensive manufacturing operations to traditional cost-based regulation states.

Retail Market Inadequacies

While wholesale markets are governed and managed by multistate entities (the RTOs), and regulated by FERC, and raw energy or fuel markets are neither governed nor managed nor regulated by any single entity, retail markets are created (and hence regulated, governed and managed) by individual state public utility or public service commissions. These commissions, long accustomed to com-mand-and-control regulation, are learning how to be stewards of competition. The task is made more difficult because most

Given all this criticism of elec-
tricity markets, it is interesting
that there are many users of
electricity who are not at all
critical about electricity markets.

states chose to create retail markets for residential, commercial and industrial customers all at once, something years of experience with natural gas competition should have argued against.

As a result, to ‘protect’ residential users from the ravages of an immature market (and there are indeed ravages in immature markets), commissions generally will tilt toward ongoing regulation rather than letting the marketplace work out its inequities. Another result is that the myriad of regulations (required for reliability and protection) imposes costs and unfamiliarity that cause the retail marketers to be dominated by electric utility affiliates. Once again, the user market critics see this situation, decry the amount of competitive products that they are offered and seek to retain the comfort of dealing with the known entity – the incumbent utility – under long-term contracts. Those with ‘iron in the ground’ will always be there, the argument goes; meanwhile, everyone knows what happened to Enron.