Understanding the Effects of Restructuring Jay Apt Carnegie Mellon University

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Understanding the Effects of RestructuringJay
AptCarnegie Mellon University
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U.S. Net Electric Generation
70 B kWh / year (10,000 MW/yr)
7¾ / year
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Adjusted for inflation
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Net Result to Date

• Industrial prices have not declined, except when
  ordered by regulators
• Investment dead in the water capacity additions
  needed in some places Regulated Southeastern US
  has many fewer problems
• Exercise of market power (California)

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EIA Form 826 (monthly)
450 Large utilities and energy service
providers Approximately 70 of sales
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EIA Form 861 (annual)
3,300 Utilities 1,600 IPPs Schedule A Vertically
Integrated Utilities Schedule B Power
Marketers Schedule C Distribution Companies
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Residential
Commercial
Industrial
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Residential
Commercial
Industrial
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CA
NV
AZ
OR
WA
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RI
NH
MA
CT
VT
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RI
ME
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• The whole electric history of New York points
  out the futility of competitionIt is coming to
  be generally recognized that monopoly control of
  electric light, heat and power may be very
  beneficial to the public if one company or the
  few non-competing companies can be placed under
  such public regulation and control as will secure
  for the public a fair share in the many benefits
  arising from unified management. That competition
  cannot be depended upon to protect the consumer
  from high prices and poor service has been fully
  demonstrated.
• - New York Public Service Commission, 1908

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Gains from USA Restructuring

• Labor efficiency watt-hours per employee up 60

USA electric services employees
USA 109 watt-hr/employee
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Is this a result of restructuring?
? Technology Improving? ??Nukes?
EPA? ?? Restructuring? ?
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• quite frankly, the electricity blackout last
  August, the Enron scandal and the problems in
  California have thrown some cold water on the
  move toward deregulation. At this point it could
  go either way
• U.S. Rep. Zach Wamp, R-TN as quoted in
  Chattanooga Times/Free Press, Jan. 15, 2004

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September 3, 2006 - Chicago Tribune - By Robert
Manor

• "This whole system is set up to create the
  illusion of competition when there is no
  competition," said David Kolata, executive
  director of the Citizens Utility Board. "No
  matter who you are, in some way you are going to
  have to be buying your power from Exelon."
• "The electricity auction will not save money for
  consumers it will generate windfall profits for
  Exelon, ComEd's parent company," Illinois Atty.
  Gen. Lisa Madigan said Friday. "That's not fair,
  and it is not what the General Assembly intended
  when it authorized deregulation in 1997."

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Large customers were thought to be the
beneficiaries of restructuring

• They have the option to purchase power in
  bilateral contracts through RFP / direct
  negotiation for block purchases they can become
  their own load-serving entity and buy in the
  wholesale market. They are getting killed.

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Restructuring and natural gas
Consumption for Electricity
Natural Gas Price
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Why Prices Have Not Fallen And Are Unlikely
to Fall
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Restructuring Has Increased Costs of Supplying
Electricity to the Customer

• Paying market clearing prices
• starves peakers
• over-compensates base load

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Restructuring Has Increased Costs of Supplying
Electricity to the Customer

• Industry interest rates are considerably higher
  Median investor-owned utility rated A in 1999,
  BBB in 2005.
• Median public power still rated A.

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Effects on a capital-intensive industry

• For new coal plant, capital is 67-92 of total
  costs (number of operating hours/yr)
• Deregulation increases uncertainty gt investors
  demand higher ROI from 10 to 15 ROI gt cost up
  1-6 cents/KWh to 75-95 of total cost

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Restructuring Has Increased Costs of Supplying
Electricity to the Customer

• RTO / ISO costs are considerable
• The California ISO cost 1 billion to set up and
  its budget is nearly 200 million per year
• The budget for PJM is nearly 250 million per year

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Restructuring Has Increased Costs of Supplying
Electricity to the Customer

• Unleashed tigers invested in foreign companies,
  built IPP, started new ventures with almost
  uniformly bad results
• A few companies have prospered

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Future Environmental Challenges

• Mercury stricter NOx PM 2.5 regulations
  challenge beleaguered companies.
• Uncertainty over when CO2 regulation will begin
  and how stringent it will be.
• Uncertainty over application of NSPS to old
  plants.
• Rate of return regulation handled environmental
  uncertainties better

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NOx
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Restructuring Effects

• Threat of competition has (probably) reduced work
  force and eliminated some bad projects
• Cost of capital has increased
• Natural gas generation construction boom
• Companies have slashed RD
• Problems with RTO Valuing assets, devising
  operating rules pricing
• Companies have been reluctant to give up
  transmission, a strategic asset

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Net Result to Date

• Prices have not declined, except when ordered by
  regulators
• Investment dead in the water capacity additions
  needed in some places Regulated Southeastern US
  has many fewer problems
• Exercise of market power (California)

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Eliminating Market Power

• Have price caps force generators to offer power
  at variable cost when demand is high
• Build more generation
• Build more transmission
• Break up firms to keep them small
• Change structure Eliminate hourly auctions

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Price Caps

• Current FERC regulations
• Price caps to keep price in control
• Require pivotal firms to offer electricity at
  variable cost when demand is high
• Firms could never cover their fixed costs and so
  no future investment

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Build more generation

• Building enough generation to prevent pivotal
  duopoly adds considerable costs
• Doubtful that deregulation would lower
  costs/prices if extra capacity built

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Build More Transmission

• New transmission expensive hard to site
• Works only if there is surplus power to control
  market power in home market.
• Throughout the East, peak demands are highly
  correlated.
• In the West, some sharing possible between NW and
  CA

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Break up firms to limit size

• Are there economies of scale in management?
  Would a firm as small as one generator be
  efficient? Safe? Reliable?
• Some data on nuclear reactors indicate that when
  Excelon and Duke operated large number of nuclear
  plants availability went way up.

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Necessary Conditions for Deregulation to Work

• Competitive markets (not a synonym for free
  markets!)
• Build much more transmission
• Allow long-term (life of plant) contracts
• Need real-time pricing for large customers
• Rationalize capacity markets
• Complete markets (regulation, reactive power)
• Lower investor uncertainty
• Deregulation is unlikely to lower prices anytime
  soon

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• Why not reform Regulation?
• Can PUC monitor investments and operations to
  ensure efficiency?
• PUC members are generally not industry experts
• Few have business/electricity expertise
• Focus on equity, not efficiency
• Dont have full information
• Conclusion Could do better, but regulation is
  inherently a blunt instrument

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Deregulation Hurdles

• Immediate effect of deregulation is higher costs
  higher prices due to
• Dereg increases uncertainty in a capital
  intensive industry - Investors want higher ROI
• Auctions pay market price, not AC of each unit
• Utility management is challenged - and fails
• Utility restructuring costs mergers, etc.
• New Regulatory costs ISO, RTO, etc.
• Long term dynamics may bring down prices but
  short-term effects are higher prices

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For more information
http//aem.cornell.edu/research/researchpdf/wp0514
. pdfsearch2222WP202005-142220Mount22
The Electricity Journal, 2005. 18(2) 52-61
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Thank You!

• Jay Apt
• apt_at_cmu.edu
• www.cmu.edu/electricity