Electricity Industry Center Carnegie Mellon University Understanding the Effects of Restructuring...

Electricity Industry Center

Carnegie Mellon University

Understanding the Effects of Restructuring

Jay AptCarnegie Mellon University



1960 1970 1980 1990 2000

1000

2000

3000

4000

5000

6000

7000

no

il

li

Bh

Wk

1960 1970 1980 1990 2000

1000

2000

3000

4000

5000

6000

7000

no

il

li

Bh

Wk

U.S. Net Electric Generation

7¾ % / year 70 B kWh / year(10,000 MW/yr)



Adjusted for inflation



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)



EIA Form 826 (monthly)

450 Large utilities and energy service providers

Approximately 70% of sales



EIA Form 861 (annual)

3,300 Utilities

1,600 IPPs

Schedule A: Vertically Integrated Utilities

Schedule B: Power Marketers

Schedule C: Distribution Companies

A + B

= C ?



Frequencies Present in Maryland Industrial Price Data

0

1

2

3

4

5

0 0.05 0.1 0.15 0.2 0.25 0.3 0.35 0.4 0.45 0.5

Frequency (cycles per month)

Po

wer

12 months 6 months 4 months 3 months 2.4 months



1990 91 92 93 94 95 96 97 98 99 2000 01 02 03 04

3.5

4

4.5

5

5.5

6

6.5

stne

Cre

ph

WkMaryland Industrial



Residential

Commercial

Industrial



1990 91 92 93 94 95 96 97 98 99 2000 01 02 03 04

4

6

8

10

12

stne

Cre

ph

WkWestern Industrial

WA

OR

NV

AZ

CA

CA

NV

AZ

WA

OR



1990 91 92 93 94 95 96 97 98 99 2000 01 02 03 04

4

6

8

10

12

stne

Cre

ph

Wk

Southern Industrial

SCAL

MS

GAFL



1990 91 92 93 94 95 96 97 98 99 2000 01 02 03 04

4

6

8

10

12

stne

Cre

ph

WkNew England Industrial

VT

NH

CTMA

RI

RI

MACT

NH

VT



1990 91 92 93 94 95 96 97 98 99 2000 01 02 03 04

4

6

8

10

12

stne

Cre

ph

Wk

Gas Generation States Industrial

OK36%TX51%LA50%MA38%RI89%



1990 91 92 93 94 95 96 97 98 99 2000 01 02 03 04

4

6

8

10

12

stne

Cre

ph

Wk

Rhode Island and Maine Industrial

ME60%RI89%RI

ME



-25%

-20%

-15%

-10%

-5%

0%

5%

10%A

nn

ua

l In

du

str

ial

Pri

ce

Ch

an

ge

Before

After



0.0%

-0.6%

-1.3%

-0.7%

0.8%

-1.3%

-0.7%

1.0%1.3%

-1.8%

2.5%

-0.8% -0.8%

0.3%

-5%

0%

5%

An

nu

al

Ind

us

tria

l P

ric

e C

ha

ng

e

Before

After



0.4%

0.0%

0.9% 0.8%

0.4% 0.3%

1.8%2.1%

-1.7%

2.0%

0.5%

1.7%

-5%

0%

5%

An

nu

al

Ind

us

tria

l P

ric

e C

ha

ng

e

Before

After



Correlation of Restructuring with Industrial Price Changes

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

Regulated Restructured

An

nu

al R

ate

of

Ch

ang

e A

fter

- B

efo

re



“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



Gains from USA Restructuring• Labor efficiency: watt-hours per employee up 60%

350,000

375,000

400,000

425,000

450,000

475,000

1985 1987 1989 1991 1993 1995 1997 1999 2001

USA electric services employeesUSA 109 watt-hr/employee

5

6

7

8

9

10

11

1985 1987 1989 1991 1993 1995 1997 1999 2001



BWh per employee

0

2

4

6

8

10

12

1950 1960 1970 1980 1990 2000

Electric Services Employees (thousands)

0

50

100

150

200

250

300

350

400

450

500

1950 1960 1970 1980 1990 2000

Is this a result of restructuring?

| Technology Improving? |Nukes? EPA? | Restructuring? |



• “…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



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."



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.

0

2

4

6

8

10

12

0 6 12 18 24

Hour of the Day

cent

s pe

r kW

h

5/18/2005

5/19/2005

Spot vs. long term



Restructuring and natural gasMonthly Natural Gas Citygate Price

and consumption of natural gas for electric power generation

-

2

4

6

8

10

12

14

16

1990 1992 1994 1996 1998 2000 2002 2004 2006

$ p

er

mc

f

-

1

2

3

4

5

6

7

TC

F u

sed

fo

r e

lec

tric

ity

Consumption for Electricity

Natural Gas Price



Why Prices Have Not Fallen – And Are Unlikely to Fall



Restructuring Has Increased Costs of Supplying Electricity to the Customer

• Paying market clearing prices

– starves peakers

– over-compensates base load




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

• Median public power still rated A.



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




• 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




• ‘Unleashed tigers’ invested in foreign companies, built IPP, started new ventures – with almost uniformly bad results

• A few companies have prospered



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



NOx



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



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)



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



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



Build more generation

• Building enough generation to prevent pivotal duopoly adds considerable costs

• Doubtful that deregulation would lower costs/prices if extra capacity built



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



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.



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



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



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



For more information

http://aem.cornell.edu/research/researchpdf/wp0514.pdf#search=%22%22WP%202005-14%22%20Mount%22

The Electricity Journal, 2005. 18(2): 52-61



Thank You!

Jay Apt

[email protected]

www.cmu.edu/electricity

Electricity Industry Center Carnegie Mellon University Understanding the Effects of Restructuring...

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