Monday, October 30, 2006

 

Governing mag pundit on why power dereg failed

http://www.governing.com/notebook.htm

Why Dereg Didn’t Work
Electricity and Economics 101

Deregulation was a great success in the airline and trucking industries. So why has it been such a flop among electric utilities? There are many reasons, but one stands out: It takes a long time and a lot of money to build a power plant. Why is that important? Glad you asked. Grab a seat. The Economics 101 class is about to begin.

As any economist will tell you, free markets are efficient. When we want stuff that’s in short supply, prices rise, and before you know it, factories are pumping out the things we want. And then something fascinating happens: As all these things flood the market, prices level off, then decline, and factories stop producing so much. If demand surges again (or supplies dwindle), prices rise, factories call back the third shift, more stuff gets produced, and on and on it goes.

Notice the role that prices play. Funny to think about them this way, but at their core prices are high-quality information, signals that tell businesses when to step up production, add more assembly lines, build new factories ... or cut production, close assembly lines and shutter plants. (In communist countries, governments tried substituting plans for prices, but it didn’t work because five-year plans don’t deliver information as quickly or decisively as prices.)

So what does this have to do with deregulation? For prices to work their magic, they need a reasonable response time, a time during which signals (we want more!) result in action (call in the third shift and start building a new factory!). It turns out that airlines and trucking companies can respond to those signals in a reasonable amount of time, but electric-generation companies can’t.

Why? Because it takes so much time and money to build a plant. In the years it takes to site, build and power up a generation plant (given the engineering and environmental restrictions, not to mention objections from neighborhood groups), prices can go up, down or sideways numerous times. And not just at the consumer level. Most of the power plants built in recent years burn natural gas, which was cheap, available and more environmentally friendly than coal until ... oops, Hurricane Katrina knocked out much of Louisiana’s natural-gas production last year and gas prices went through the roof.

Well, if it’s so hard to predict a decade out how much electricity we’ll need, how have power companies managed it in the past? Through a system of shared responsibility. The electric companies made their guesses, state public service commissions verified the reasonableness of the estimates, then committed the state’s consumers to paying for those plants, regardless of how things actually turned out.

Compared to the mess caused by deregulation, that looks like a reasonable way of providing such a vital but difficult-to-create commodity. Not convinced? Ask consumers in Houston, where, according to the New York Times, a botched state deregulation plan has produced electric rates nearly double the national average.

Footnote: There are other reasons electric deregulation hasn’t worked as planned. In some cases, the deregulation schemes were deeply flawed (deregulating, for instance, the prices utilities paid their suppliers but continuing regulation of consumer rates). In others, the free market wasn’t really free; that is, not enough companies jumped into the electric generation business to create a free market. And, of course, deregulation opened the door to all kinds of financial shenanigans and outright market manipulation. One word describes how heedlessly state legislatures deregulated electric power: Enron.

Posted October 27, 2006


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