Report Claims U.S. Electric Restructuring Costs Too Much

Unlike their neighbors in regulated states, consumers are paying higher prices and receiving less service in electricity-restructured states, according to a report released Thursday by the Consumer Federation of America (CFA). The non-profit CFA, composed of 285 pro-consumer groups, reported that "policymakers now face the prospect that the costs of ensuring retail competition in electricity markets will greatly exceed any efficiency gains, so electricity prices will rise, not decline."

To offset the higher prices associated with electric restructuring, the CFA report suggests, among other things, that deregulation be either stopped or at least slowed down in states that have not yet implemented it, and also calls on regulators to restore public confidence in their ability to investigate market manipulation.

"Policymakers are slowly learning a tough lesson: the fundamental conditions of supply and demand in the electricity industry are so unique and severe that it is difficult to make this market work properly," according to the report. "Electricity markets can only perform well if all generators are equal in size and if total demand for electricity is significantly less than the amount that these generators can produce."

Retail competition has higher costs because of the additional reserve requirements to prevent market power abuse, higher capital costs to attract investment, "large windfalls" for existing plants and transaction cost increases to run the competitive network, according to the report.

"Consumers have been subjected to rate hikes and lack of competition not just in California but also in New York, Pennsylvania and other states that have restructured," said Mark Cooper, CFA's director of research and the report's author. "Only a dramatic change in approach by federal and state policymakers can offer consumers the possibility of lower prices and better service.

CFA cited these "structural" reasons for the "failure" of electricity restructuring:

  • Highly concentrated generation markets that "bred price gouging and hoarding;
  • Increasing cost of capital for new plants and "windfall profits" transferred to old plants;
  • Transmission grids "not designed" and with "inadequate capacity to support competitive markets" as well as ownership by utilities that "often refused to let their part of the grid be operated in an open, nondiscriminatory manner that allowed competition;" and
  • Loss of efficiency resulting from "deintegration of an industry that requires high levels of coordination and cooperation among suppliers, traders and government regulators."

Said Cooper, "California policymakers made some bad decisions, but they were not entirely responsible for the state's energy crisis. Exploitive energy suppliers and irresponsible federal regulators also played major roles."

To make it work, CFA recommended in its report that electricity markets have "at least twice as many competitors as currently deemed sufficient to support competition." It said that the Federal Energy Regulatory Commission has been defining markets as "workably competitive when there are five equal-size competitors in a broadly defined market. The empirical literature shows that there must be at least 10 equal-size competitors in narrowly defined markets."

CFA also recommends that reserve margins be "much larger" than previously thought. "In addition to operating reserves that have traditionally been set at 15-20%, competitive markets need an economic reserve to discipline price abuses of an additional 10-20%. Thus, most competitive markets need at least a 30% reserve margin."

The transmission system also has to be "independent of all generator interests and operated by an entity whose sole purpose is to promote the public interest," noted the report. "Because the transmission wires are natural monopolies, companies owning the wires must be closely regulated to prevent them from earning windfall profits."

Said CFA, "An obligation to serve customers without an obligation to build energy facilities is a prescription for disaster. It is too easy for spot market traders to exploit utilities that are desperate for power."

Cooper said CFA does not think policymakers will address the "underlying problems" it found in electricity markets in the near term, and said the organization is pushing for legislators and regulators to take the lead. CFA advocates the following:

  • Any state that has not restructured should not;
  • States that can slow down or stop should;
  • States that do move ahead should "re-orient their approach to competitive bidding for long-term supply and avoid spot markets";
  • Federal policymakers "should ensure competitive interstate wholesale markets and an open interstate transmission system, with adequate capacity for electrons;" and
  • Federal regulators have to restore public confidence in their ability to "identify, investigate and ameliorate market manipulation."

The entire 35-page report, "Electricity Deregulation and Consumers: Lessons from a Hot Spring and a Cool Summer," is found on CFA's web site at www.consumerfed.org/erspring.pdf.

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