Recently, in a story on industrial prices, the New York Times described EPSA’s rationale: “John Shelk, president of the supply association, said that but for efforts to create competitive markets, government would not have ordered lower prices during a transition from regulation to market pricing. Therefore, he reasoned, government-mandated savings should be included in calculating the benefits of market pricing.”

This is curious logic, indeed: Legislated price caps are a benefit of market prices because they are constraining what would be higher market prices in the absence of the price caps, but these market prices are not yet in place and may never be.

Readers can ponder this brain twister for themselves, but even EPSA’s selection of states does not compare well with the rest of the states.

I had categorized as “deregulated,” for purposes of industrial electricity prices, the states of California, Connecticut, District of Columbia, Delaware, Maryland, Massachusetts, Maine, Michigan, Montana, New Hampshire, New Jersey, New York, Rhode Island & Texas. I reported that the gap in industrial prices between regulated and these deregulated states tripled since 1999. I also reported that the cumulative value of this gap from 2000 through 2007 is $55 billion in 2006 dollars if invested at a real return of 5%.

However, adding in the five states EPSA wants included, the gap doubles and the cumulative value of the gap from 2000 through 2007 rises to $70 billion. Not much to crow about, there. (The rise in value is due to the large size and relatively high prices of the five states added into the “deregulated” groups and subtracted from the regulated group.)

Perhaps readers would like to make their own categories. Here are the incremental price increases since 1999 for all 50 states, ranked by size of increase. Go ahead! Color-code it for yourself! Of the top ten states, how many are deregulated, in your view?

Power in the Public Interest Says Consumers “Deeply Disappointed” in Electricity Restructuring and Price Deregulation

FERC Urged to Compare Prices in RTO Regions with Traditional Cost-Based Systems

Olympia, WA—Emphasizing the Federal Energy Regulatory Commission’s obligation under the Federal Power Act to produce “just and reasonable” rates, Power in the Public Interest (PPI) urged FERC to compare consumer prices in Regional Transmission Organization (RTO) areas with prices in traditional cost-based systems and bilateral markets.

In its response to FERC’s Advance Notice of Proposed Rulemaking on Wholesale Competition in Regions with Organized Electric Markets, PPI said it supported the commission’s efforts to determine how RTO operations might be improved because consumers so far have been “deeply disappointed” in electricity restructuring and price deregulation.

“RTOs are corporations with no stockholders, no citizen voters, and no end-use ratepayers to hold them accountable for costs in the usual way that these groups exercise cost and profit pressures on traditional utilities, whether investor-owned, municipal or cooperative,” said PPI.

At issue is whether RTOs produce net consumer value over the long term, PPI said. Using Energy Department data, PPI noted in its comments that, on average, consumers in price-deregulated states pay 4 cents/kwh more for electricity today than do consumers in states with regulated prices, including price caps—up from a 2 cents/kwh differential in 2000.

“This is not to say that deregulation/restructuring is responsible for the whole gap, or that the gap can be closed. The gap does, however, reveal the significant economic disadvantage suffered by customers in the price-deregulated states, and the imperative for the Commission and the regions—whatever their resource mix—to ensure they are pursuing the most effective form of economic regulation of electricity,” PPI told FERC.

In addition, PPI said, the widening gap is “strongly consistent with the proposition—which should be more thoroughly considered—that RTO marginal pricing policies, market power, and open-access markets are driving up prices for ultimate consumers on a sustained basis. The Commission should pursue this question rigorously.” PPI noted that all states that have deregulated retail prices for a significant portion of their electricity customers are also participating in RTOs. Retail prices are thus a combination of the effects of wholesale and retail pricing policies.

For more on how this graph was constructed go to http://www.ppinet.org/graph_construction.php

Excerpts from Power in the Public Interest Sept 13 filing with FERC

“These comments focus on some of the fundamental elements at issue:

• The neither-fish-nor-foul nature of RTOs. The lines of public accountability in RTOs are inherently weak, placing an extra-heavy burden on the Commission to regulate them in the public interest.

• The Commission’s obligation under the Federal Power Act to ensure that RTOs produce just and reasonable rates. As part of this obligation, the Commission should engage in an on-going and rigorous review of prices in RTO regions, and their effect on end-use consumer prices—compared to more traditional cost-based systems and bilateral markets.

• The consequences of marginal pricing and single-clearing-price auctions. This central feature of RTO day-ahead markets guarantees that all plants needed in a given time period are paid the highest price bid by any participating plant. Many plant owners are paid amounts far above their incremental costs to supply power into these day-ahead (and hourly) markets. Not surprisingly, the owners of these plants find that supplying power through long-term, fixed-priced contracts is a comparatively less attractive business opportunity. Consumers, of course, pay the consequences. The best way to encourage long-term contracting, a goal with which PPI agrees, is to constrict or remove opportunities for unwarranted profits in the day-ahead market.”

“Some advocates claim we haven’t waited long enough for the inevitable cycling of marginal prices to below average price, at which time consumers in competitive markets will make up for what they lost, and consumers in cost-based systems will suffer. This crystal ball is unreliable, given the growing demand for resources worldwide and renewable energy requirements legislated by many states. On September 12, 2007, world oil prices topped $80 per barrel for the first time. Absent a collapse in the economy (that drops demand for electricity), the marginal bid—whether based on natural gas, renewable resources, or collective market behavior—is likely to stay above average system costs for some time come. Nor is it clear that lower organized wholesale prices, should they occur, would flow through to end-use consumers. Moreover, time is no friend to consumers and businesses paying high prices now. It is unfair to expect them to foot the bill for a promised benefit they may not survive to see, if it ever comes at all.”

David DeRamus, PhD, on behalf of EPSA, has criticized my blog post, “A Billion Here. A Billion There. Price Matters,” calling it “nonsense.”

For the most part, EPSA is beating a horse that never stepped out of the barn. EPSA implies that I have attributed to deregulation the entire gap between prices in deregulated states and prices in regulated states. But as I said in the fourth paragraph of a seven-paragraph article:

This is not to say that deregulation is responsible for the whole gap, or that the gap can be closed. It is to emphasize the significant economic value of lower-cost electricity systems, and the importance to any region—whatever its resource base—of pursuing the most effective form of economic regulation of electricity.

Of the states that deregulated, I also said:

Of course, most of these states began with higher prices, motivating them to experiment with deregulation. (Two exceptions, Maryland and Texas, began with modest rates, and have experienced immodest increases.)

Thus, I never claimed that the difference in prices was wholly due to regulatory policy, but I did point out the very significant disadvantage in purchasing power that consumers in high-cost states suffer. Those states are also, overwhelmingly, the states that participate in organized wholesale markets and that do not have regulated, cost-based retail rates. And the gap has increased.

A more substantive disagreement rests in the choice of states to compare as “deregulated” or “regulated.” EPSA faults me for not including Illinois, Ohio, Pennsylvania, and Virginia as deregulated, because they have been “restructured.” All of these states, however, had prices caps in place for all or nearly all times periods for which prices were shown. (A small part of Pennsylvania and few months of Illinois prices were not capped.) Prices in these four states reflect legislated price caps, not market prices, and would mask price trends in the states that actually do allow markets to set prices. This masking effect is one reason some of the studies purporting to show benefits in “restructured” states are misleading.

To show how misleading, here are the prices for Illinois, Ohio, Pennsylvania and Virginia, compared to prices for the states that have deregulated prices:

Obviously, merging the two lines would dampen the appearance of the price increases in the deregulated states and obscure the actual dynamics in both sets of states. For further explanation of the choice of states, which does involve some judgment, please go here. (Note: New York has always been included in my calculations of prices in “deregulated” states. The inadvertent omission of “NY” in a label in the original article has been corrected.)

Meanwhile, EPSA doesn’t want us to watch the horse that’s running away—all the way to the bank. The “dark spread” is no longer a dark horse so I’ll call her Margie, and she is making billions. Misapplied marginal pricing theory is forcing consumers to fund huge profits for companies with low-cost plants or plants in fortuitous locations. This is not a matter of a time-lag, in which the regulated states will “catch up” to prices in the deregulated states. It is a matter of structure.

In an organized market, as long as the clearing (marginal) price—whether set by a natural gas plant, an even pricier renewable plant, or market-player behavior—is above the average cost-based price, consumers will be paying more for their power than they would under a regulated, cost-based system. While it is difficult to quantify this effect with precision, because of the problem of “proving the counter-factual,” it is not difficult to see, qualitatively, that high marginal prices will drive prices up for all participating resources. Price trends in the deregulated states are consistent with this dynamic. And absent an imploding economy, there is reason to think that high marginal prices will persist for some time.

Finally, EPSA does not challenge the actual prices reflected in my graphs—nor could it, since they are drawn from EIA data. The dispute is over how to aggregate, compare, and interpret the price-trends. EPSA has both overstated my position and understated real differences in price-trends in regulated versus deregulated states.

To see a broad array of price-trends, go to PPI’s website and click on the map.

The gap in retail electricity prices between the deregulated and regulated states continues to widen. As the accompanying graph shows, the difference has roughly doubled, from around 2 cents/kwh in 2000 to about 4 cents/kwh in 2007. (All figures reflect rolling 12-month averages—currently, through May 2007—for total delivered electricity to all customers in a state.)

The comparative economic disadvantage to consumers in the deregulated states is enormous. Of course, most of these states began with higher prices, motivating them to experiment with deregulation. (Two exceptions, Maryland and Texas, began with modest rates, and have experienced immodest increases.) Collectively, in 2000, consumers in the now-deregulated states paid $26 billion more (in 2006 dollars) for their power than they would have, had they purchased their power at the average rate of the states that have remained regulated.

Today, consumers in the deregulated states pay $48 billion more for their power (in 2006 dollars) than they would pay if they were able to enjoy the average rate of the regulated states. The 7-year cumulative value of the gap, compounded at 5%, is $294 billion.

This is not to say that deregulation is responsible for the whole gap, or that the gap can be closed. It is to emphasize the significant economic value of lower-cost electricity systems, and the importance to any region—whatever its resource base—of pursuing the most effective form of economic regulation of electricity.

If, since 2000, the average price in the deregulated states had simply risen at the same rate of increase as the average price in the regulated states (roughly paralleling historical trends prior to 2000), consumers in the deregulated states today would have $60 billion more ($66 billion if compounded at 5%) to spend on other things—on their families, their businesses, or the coming costs of addressing global warming.

Some studies purport to show that prices in the deregulated states would have been even higher had they not deregulated. These studies have been discredited. Moreover, the wholesale market designs that drive retail prices in the deregulated states fairly explain the high prices. By design, the most expensive needed resource, often natural gas, sets the price for all needed resources, regardless of their underlying cost. So if the price of natural gas increases, as it has, or if an even more expensive renewable resource becomes the marginal resource, prices for all resources will increase as a result.

By contrast, in regulated cost-based systems, a higher-cost resource will not affect the amount consumers must pay for a lower-cost resource. In any event, as a group, electricity consumers in the regulated states have lot more buying power—buying power that is becoming more and more precious as pressures mount on the electric industry to meet new environmental requirements.

To see more price-trend graphs, and how they were created, go here.

Feel free to comment. Name and address are optional.

Feel free to comment. Name and email address are optional.

Ignoring the point that these are rate-increase requests, not decisions of a regulatory body, EPSA’s spins percentage increases in low-cost states as somehow comparable to increases in restructured states. Take, for example, Idaho, whose rates have recently decreased and which now has the lowest rates in the country. Citing Idaho for an anticipated increase is like faulting a marathon winner for adding a few seconds to her new time, and implying it is “equal” to the couch potato’s addition of several minutes to an already sluggish performance.

Here are Idaho’s rates, compared to rates in the deregulated states:

And here are Georgia’s:

And Virginia’s:

In for a penny; in for a pound? As a consumer, I’d rather pay the penny.

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Retail competition in the electric and gas markets is ipso facto the acknowledged driver behind wide-scale utility attention to customers, customer service, and improvement of service delivery.

Well, ipso facto (“by the fact itself”), consumer satisfaction has “fallen off substantially,” according to the most recent J.D. Power survey of residential users (July 2006). Customer satisfaction ranks highest, however, in the Southern and Western regions, which largely have not deregulated. Moreover, two public-power utilities, Salt River Project and Sacramento Municipal Utility District, enjoy the very highest customer satisfaction in the country.

Ipso facto, exceptis excipiendis (“excepting what is to be excepted”).

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You can, however, put the statutory toothpaste back in the statutory tube. Legislatures can and have restored utilities’ obligation to serve, in a prudent manner, with self-build and contract options, all as overseen by a regulator to be “fair, just and reasonable” and “in the public interest” (or similar phrases). As a matter of legislative drafting, cost-based economic regulation of utilities is relatively simple and simple to restore. (The politics and related vested interests are a different story.)

If a fully restructured state were to put the statutory toothpaste back in the tube—i.e., re-regulate as a legal matter—utilities would have to secure the most prudent mix of resources (including conservation and environmental requirements) to serve their customers, and the regulators would set rates based on the prudent conduct of the utilities.

In practice, this might mean a mix of power contracts in the short run, and the gradual acquisition of more owned assets or long-term contracts in the longer run—if that were forecasted to be the lowest-reasonable-cost way to meet load. Alternatively, a utility could try to demonstrate to its regulator that passing on the wholesale rates of an organized market would produce the best balance of price and risk for its customers. As with traditional regulation, these choices would be laid out in an integrated resource plan, reviewed by the regulator, and implemented by the utility. Unlike utilities that have always been regulated, however, the re-regulated utilities and their customers would be building their portfolio from scratch. The cost of acquiring resources might be high, but would have to be compared to the price of not acquiring resources and relying instead on the wholesale market.

As an economist might say, actions in the past are “sunk costs.” The question is what to do going forward. The toothpaste tube and the toothpaste are still on the counter.

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Holding up two Shields as I picked my way through this screed, I pondered a couple of sentences:

Centralized command economics is a discredited concept that deserves to be consigned to the dustbin of history, along with the other vestiges of socialism.

The authors mean to indict regulated utilities in favor of regional markets, but what is an RTO if not “centralized command economics”? These organizations are highly centralized, employing complex designs comprising rules (computer programs, really) that are meant to comport with prescriptions written by five people in Washington and that often have disregarded the (even unanimous) advice of state officials.

If these highly centralized structures can deliver real net value that demonstrably flows through to end users, perhaps their structure should be overlooked. That case has not been made, however, and there are reasons to think that the lack of accountability that attends them may be part of the reason.

The second sentence is a quote from Pat Wood, former FERC and Texas PUC chair, who said in March 2002:

I’d give the regulated market about a ‘C’ or a ‘C+’ on its best day.

Using the state Pat Wood regulated, if the best that the regulated market of pre-1999 produced was a C+, what’s the grade of restructured Texas today?