Turning On The Lights: Deregulating The Market for Electricity

Studies | Regulations

No. 228
Friday, October 01, 1999
by Vernon L. Smith and Stephen Rassenti


Introduction

All over the world, governments are deregulating their economies to increase competition, lower costs and promote innovation. In the United States, beginning in the 1970s controls were relaxed or largely eliminated on five major industries: natural gas, trucking, long-distance phone service, railroads and air travel. The savings to consumers, manufacturers and businesses have been enormous. Competition has spurred the introduction of new technologies, with resulting productivity gains. Meanwhile, safety records have steadily improved and the environment has benefited from fewer emissions.

However, in other industries such as local telecommunications services deregulation and decontrol have proceeded fitfully over the past 20 years, and reforms have even been reversed. For example, cable television rates were decontrolled, recontrolled, then decontrolled again; and federal regulators say that so far there is no effective competition in local telephone service. Thus consumers have yet to realize the full benefits of improved service, quality and competitive pricing in these industries.

In the past few years, state legislatures and the U.S. Congress have begun debating deregulation of the largest, most highly regulated monopolistic industry: electric power. Whether, how and to what extent this industry is deregulated will determine the benefits residential consumers and businesses receive.

"The annual cost of electricity for a typical family can vary by as much as $950 from one section of the country to another."

Regulation of electric power is complex and fragmented because local, state and federal legislators and regulatory bodies all claim a role. It is extensive because electric power has been treated for nearly a century as a natural monopoly, allegedly requiring government oversight to protect consumers. Indeed, progressives and socialists were so concerned about the monopoly power and political clout of the electric power industry that for many decades they advocated total government ownership of electric power utilities, and today some 25 percent of electrical power in the United States is produced by generators owned by local and federal agencies.

Commercial and residential customers spend more than $200 billion a year for electricity. Of that amount $20 billion to $50 billion is unnecessary spending caused by regulatory inefficiencies.1 Regulation also causes electricity prices to vary widely from state to state. Thus:

  • The annual cost of electricity for a typical family can vary by as much as $950 from one section of the country to another.2
  • The average cost of electricity is 10 cents per kilowatt hour (kwh) in New York and almost 10 cents in California, but is only 5 to 7 cents per kwh through much of the country's midsection.3
  • In Chicago electricity costs 13 cents per kwh, compared to 6 cents in neighboring cities in Indiana.4

Changes in federal law and regulations have allowed some customers to reap the benefits of competitive electric power. Wholesale electric power markets now allow utilities and independent producers to buy and sell electricity at competitive market rates. Also, technology enables many large industrial customers to produce electricity on-site for a price below that of the local utility or to bargain with utilities for a price nearer the wholesale competitive price.

However, small businesses and residential customers who purchase electricity at the retail level have not had the option of buying competitive power or producing their own power at competitive rates. Thus it is low-volume, high-cost customers who are being left to pay monopolistic electric power prices.

In the past few years, some states have passed legislation to restructure the industry and allow consumer choice. The limited competition implemented so far bears comparison with the "managed competition" health care proposal of the Clinton administration: it is so highly regulated and burdened with mandates that consumers have few alternatives. Deregulation in other states has been bogged down by demands to subsidize some ratepayers at the expense of others and to favor so-called green energy sources. It has also been held up by utilities' attempts to recoup the estimated cost of uneconomical investments made under prior regulatory regimes.

"There is a danger that the industry will be reregulated rather than deregulated."

Today, the danger is that instead of being deregulated, the industry will be reregulated. An industry restructured to conform to yet another regulatory framework will not provide the potential benefits of market competition. If deregulation is not effective, customers will not enjoy the potential reductions in price and improvements in service. Worse, market failure will probably be blamed for the inadequacy of reforms.


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