| Has Electricity Deregulation Been Successful . . . | ||||
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For the past two years, deregulation of the electric industry has challenged industry leaders as the market experienced periods of boom and bust. A culmination of unfortunate circumstances brought industry uncertainty and instability to investors and consumers.
2002 marked the demise of Enron and caused many major energy-trading companies to redefine themselves. At the same time, Texas became a deregulated marketplace and the Federal Energy Regulatory Commission issued their Notification of Proposed Rulemaking (NOPR) for Standard Market Design (SMD).
In 2003, FERC’s SMD was floundering, the economic recovery was slow, and the credit issues, which began for the electric industry in 2002, were not quick to disappear. To make matters worse, on August 14, North America experienced the largest blackout in its history.
In context of the past two-year’s events, I often hear the question, “Has electricity deregulation been successful?” The answer to the question is often couched by the individual’s bias toward deregulating electricity. Those who support deregulating electricity, of course, speak to success. Those who are opposed to deregulating electricity, for reasons, such as electricity being an essential service or its volatility, find examples from the marketplace to support their position. I believe to answer the above question; one must first ask and define, “How is success measured?”
During the early days of electricity deregulation conversations, four global drivers of deregulation were discussed with clients:
If you were to use these drivers as a measure of success, one might be able to conclude that deregulation of electricity was successful, if each of the drivers proved to be true.
Technological Advancement: Pre-deregulation, almost all of the generating facilities were large-scale hydro, coal or nuclear plants. From concept to full installation took at least 10 years. About the time that deregulation conversations were beginning to take place in North America, gas-fired generation, both simple cycle and cogeneration were becoming viable options. This type of generation can be installed within 12 to 18 months, and have changed the face of generation in North America today.
Customer Choice: Pre-deregulation, large electricity users were frustrated in dealing with electric utilities that were operating as monopolies. These utilities had a defined service territory and an obligation to serve. There typically was one rate that a class of customer was offered and there was limited flexibility. In deregulated electricity marketplaces the structure exists for multiple suppliers with the expectation that customer choice and flexibility is incumbent.
Regulatory Burden: Pre-deregulation, electric utilities were a cost of service business. Rates were typically set through a two-step regulatory process. First, they would determine what their costs would be, as well as a reasonable rate of return. The utility would defend their costs to a public utility commission or a public service commission, with representatives of customer groups questioning the evidence. Once cost and rate of return were finalized, the second step would be to determine how to apply the costs to the customers in the form of rates. Along with many other costs involved in running an electric utility, the costs of the hearings were passed on to the customer.
Today, pro-deregulation camps support the concept that market based pricing is cheaper than specialized rates set through a regulatory process.
World Wide Trend to Replace Government in Business: The list of deregulated businesses almost always begins with the trucking industry, which was deregulated in the 1930s. The three most common illustrations of deregulation, particularly for North America are the airlines, natural gas and telecommunication.
Proponents of competition strongly support market competition as the best method for driving costs out of a business. Successes in deregulation of natural gas and the telecom industry led supporters of a competitive business model to look at electricity as the next energy commodity to deregulate. While electricity has two unique attributes: you cannot see or touch it and you cannot store it, there are similarities to both telecom and natural gas: you need an interconnected system to use it.
So, if you defined success by proving the drivers of deregulation to hold true, then electricity deregulation is a success. Each driver can be argued or proven accurate in a competitive environment. Yet, I would argue that the “customer choice” driver has not been satisfied.
In today’s transitioning electricity marketplace, price certainty is the real issue with consumers. Price, at least in the design phase, was not on the radar screen; particularly not by the proponents of deregulation. Which leads us to one of the largest uncertainties of electricity deregulation, “Is there a solution in an evolving market to address end users concerns with price?”
In a perfect scenario, a state would have all equipment in place, before deregulating electricity. By equipment, I mean that the market must have time of use meters installed at all end user sites. This would allow all electricity consumers to see the impact of price signals in the marketplace and more importantly, be in the position to take action; reduce electricity usage when supply is low and prices are high, and take advantage of times when supply is high and prices are low. As there is no way to store electricity, prices can and do change in real time, but with the price signal and action available to the end user, retailers can offer price plans to support differing levels of market participation and consumers will be in a position to positively affect the price they pay for the electricity they consume.
Unfortunately, almost all deregulated electricity markets in North America set up a default price for consumers who opt out of choosing an electricity provider or retailer. This price is almost always a flat rate or fixed price which leads consumers to support the “no choice” option. So in a market designed to have supply and demand set prices, you have the majority of consumers not reacting to price signals in the marketplace, because they are on a fixed price rate.
Offering end users time of use meters, creative price plans from retailers and providing a “no choice” option, which over time becomes more expensive, could create a stronger market environment. Granted, designing a market in this manner would require educated consumers, as well as, capital expenditure that would likely be recovered through distribution tariffs to install time of use meters.
The benefits of an educated population, who respond to price signals, would create an efficient market, where generation and transmission were maximized and ultimately the consumer felt in control. The retail market would have the opportunity to support end users by creating an innovative product line of smart homes and appliances that continually make price response an easier choice for the consumer.