Electricity and Markets – Have Customers Benefited?

1. Electricity and Markets – Have Customers Benefited? Presentation by John Kelly MMEA Fall Conference September 20, 2007

2. Five Questions • Why did we move to choice (price deregulation)? • Why have rates gone up? • Why has choice/LMP lead to (a) high prices & (b) not induced new investment? • Have consumers benefited? • Going forward, what will happen?

3. APPA Electricity Market Reform Initiative (EMRI) • APPA Supported Original Vision of RTOs/ISOs: • Non-discriminatory transmission access; • Elimination of transmission-rate pancaking; • Coordination of regional transmission planning

4. APPA Electricity Market Reform Initiative (EMRI) • APPA Anticipated: • Continuance of Bilateral Markets/Contracts • Small Short-term Balancing Market • Instead: • Expansion of RTOs/ISOs from grid operators and police to “market makers” • FERC is allowing market-based rates subject to price cap and selective market power mitigation.

5. APPA Electricity Market Reform Initiative (EMRI) – Sponsored Studies 1. Evaluate Evidence of Consumer Benefits (Restructuring the U.S. Power Sector: A Review of Recent Studies, John Kwoka) 2. Causes of High Rates (Increasing Electricity Prices: Are Fuel Costs the Only Explanation, Ken Rose) 3. Utility Profits (The Electric Honeypot: The Profitability of Deregulated Electric Generation Companies, Ed Bodmer) 4. Lack of Investment/Reliability (Investment Performance in Deregulated Markets, Timothy Mount)

6. APPA Electricity Market Reform Initiative (EMRI) – Sponsored Studies 5. Locational Marginal Pricing (LMP) and Short-Run Marginal Costs (Comparative Analysis of Actual Locational Marginal Prices and Short-Run Marginal Costs, London Economics International) 6. LMP and Bidding (LMP Electricity Markets: Market Operations, Market Power, and Value for Customers, Synapse Energy Economics) 7. RTO/ISO Costs (Analysis of RTO Operational and Administrative Costs, GDS Associates.

7. 1. Why did we move to choice (price deregulation)? • Belief that wholesale power markets can be competitive; • Markets – imperfect or not – are always better than price regulation; • Monopoly Firms/Power Eventually Destroyed – just wait; • Markets do better job allocating investment than regulators or central planers;

8. 1. Why did we move to choice (price deregulation)? (cont.) • Inherent Inefficiencies of Price Regulation (construction, operation, innovation); • Inefficiency in utility rate designs • Worked in other industries (airlines, etc.) • Lower prices (But being questioned now)

9. 2. Why have rates gone up? • First, not largely because of fuel costs • Rose study – movement of fuel prices and rates • In PJM – MD & DE versus Carolinas & GA, w/ essentially the same fuel mix (Hogan Comment) Rather: (1)Relaxed price deregulation and (2) Absence of competitive entry in base-load capacity markets – too few players

10. 2. Why have rates gone up? (cont.) Evidence from EMRI Studies: • LMPs well above relevant costs (LEI) • Reg. v. Dereg. States (Rose, Lave) • Profits of companies & implication of (values of companies, profits=p-c) (Bodmer) • Profits in capacity markets, e.g., New York (Mount)

11. 3. Why has choice lead to high prices and failed to induce investment • Simple answer is that that’s what happens in monopoly (oligopoly) markets; • Two basic requirements for competitive prices are: • Allowing prices to vary • Low barriers to entry

12. 3. Why has choice lead to high prices and failed to induce investment (cont.) • The economic characteristics of electricity markets are very different from other markets – significant barriers to entry for base load; • Not an excuse for continued regulation; rather, an economic reality that can’t be ignored • Plus, of course, it is an essential service.

13. Importance of industry characteristics for competitiveness Somewhat Very Not Very Capital intensiveness Financial capital requirements Scale economies Lumpiness of investments Location of facilities Technology Product durability Sunk costs Substitutes Seasonality Product differentiation Vertical integration Number of sellers and buyers Mobility of resources/ Asset specificity Foreign competition Network industry

14. 3. Why has choice lead to high prices and failed to induce investment (cont.) • Warren Buffet: • Investing in electric utilities is “not a way to get rich, it’s a way to stay rich.” • “Most of deregulation was a mistake” because, in a deregulated market, “generators have a clear incentive to reduce power reserves.” • Owners of generating assets want the market to be tight • “The last thing in the world an unregulated operator wants is excess capacity.”

15. Graphic Description (A): Initial Case

16. Graphic Description (B): Strict Price Regulation

17. Graphic Description (C): Relaxed Price Regulation

18. Evidence: Company Profits

19. Evidence: Company Profits

20. Evidence: Prospective Profits

21. 4. Have Consumers Benefited? According to some prominent economists – Yes “There is growing evidence and convincing studies that show that consumers have saved billions of dollars in energy costs as a result of competitive markets.” “Open Letter to Policymakers,” Compete Coalition, Washington, D.C., June 26, 2006

22. 4. Have Consumers Benefited? (cont.) According to Prof. John Kwoka: • Methodologies used in the studies that showed benefits “consistently [fell] short of the standards for good economic research.” • “In particular, despite much advocacy there is no reliable and convincing evidence that consumers are better off as a result of restructuring of the U.S. electric power industry.”

23. 4. Have Consumers Benefited? (cont.) Specifically in regard to the “Open Letter …”: • “… Existing studies do not support that proposition.” • “Indeed, … there is no credible and convincing economic evidence that consumers have been made better off by electricity restructuring.”

24. 4. Have Consumers Benefited? (cont.) Further … • Unsupported conclusions should not serve as the basis for further ill-defined deregulation

25. 4. Have Consumers Benefited? (cont.) • Items cited above in 2 and 3 demonstrate that consumers haven’t, on average, benefited.

26. Final Thoughts • Threshold question is not about markets v. regulation, as such; rather it’s about competition v. monopoly. • “Imperfect information, imperfect capital markets, imperfect competition: These are the realities of market economics – aspects that must be taken into account.”

27. Final Thoughts • “The advocates of deregulation say it was not done perfectly. • They would have us compare an imperfect regulated economy with an idealized free market • … Rather than an imperfect regulated economy with an even more imperfect unregulated one.” Joseph Stiglitz

28. Final Thoughts • Economic Analysis v. Value Judgments (what is an acceptable degree of competition/monopoly, how long to wait, etc.) • As much about economic ideas as about vested interests • Important to understand economic ideas and question assumptions that underlie them, “So,” as one prominent economist warned, “not be duped by economists.”