Understanding the Effects of Restructuring Jay Apt Carnegie Mellon University

1. Understanding the Effects of RestructuringJay AptCarnegie Mellon University

2. U.S. Net Electric Generation 70 B kWh / year (10,000 MW/yr) 7¾ % / year

3. Adjusted for inflation

6. 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)

7. EIA Form 826 (monthly) 450 Large utilities and energy service providers Approximately 70% of sales

8. A + B = C ? EIA Form 861 (annual) 3,300 Utilities 1,600 IPPs Schedule A: Vertically Integrated Utilities Schedule B: Power Marketers Schedule C: Distribution Companies

14. Residential Commercial Industrial

15. Residential Commercial Industrial

16. CA NV AZ OR WA

18. RI NH MA CT VT

20. RI ME

25. “The whole electric history of New York points [out] the futility of competition…It 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

26. Gains from USA Restructuring • Labor efficiency: watt-hours per employee up 60% USA 109 watt-hr/employee USA electric services employees

27. Is this a result of restructuring? | Technology Improving? |Nukes? EPA? | Restructuring? |

28. “…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

29. 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."

30. Spot vs. long term 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.

31. Restructuring and natural gas Consumption for Electricity Natural Gas Price

32. Why Prices Have Not Fallen – And Are Unlikely to Fall

33. Restructuring Has Increased Costs of Supplying Electricity to the Customer • Paying market clearing prices • starves peakers • over-compensates base load

36. 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.

37. 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 => investors demand higher ROI – from 10 to 15% ROI => cost up 1-6 cents/KWh to 75-95% of total cost

38. 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

39. 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

40. 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

41. NOx

42. 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 R&D • Problems with RTO: Valuing assets, devising operating rules & pricing • Companies have been reluctant to give up transmission, a strategic asset

43. 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)

44. 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

45. 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

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

47. 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

48. 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.

49. 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

50. 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 • Don’t have full information • Conclusion: Could do better, but regulation is inherently a blunt instrument