Turning On The Lights: Deregulating The Market for Electricity

Policy Reports | Regulations

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

A Model for Deregulation

Figure III - The Restructured Electric Power Industry

The public policy goal of deregulation is to allow competitive markets to evolve so consumers can reap the benefits of increased efficiency in the production and delivery of goods or services. With respect to electric power, this means substituting competition for regulation in the generation and, potentially, the delivery of electricity. As previously noted, the wholesale market for electric power has been deregulated to the extent that utilities and nonutility generators can buy and sell power in some markets, and large industrial consumers can buy power directly from nonutility generators. However, the prices and conditions under which electricity is transmitted, and the prices and conditions under which residential consumers and businesses purchase distributed power, are controlled by federal, state and municipal regulators.

"In a restructured industry, 'supply' companies would generate power and 'wires' companies would transmit and distribute it."

Most states are moving toward retail competition, which will allow consumers to purchase electricity from competing generators. However, retail competition is not deregulation unless there is competition in the prices offered to consumers. Price competition is impeded if all consumers are required to pay arbitrary fees to reimburse utilities for their so-called stranded costs. Nor is there much consumer choice if there are price controls on power transmission or if local distributors are able to exercise monopoly power.

Thus, proposals to bring retail competition to the electric industry must address two major issues:

  • What should be the relationship between generation and transmission? (Many utilities generate and deliver electricity through their own transmission networks.)
  • What should be done about stranded assets - utility investments such as nuclear power plants whose value under competition is discovered to be substantially less than their cost?

A solution to these difficulties is divestiture. This would allow the successful deregulation of the electric power industry.

Today's electric utilities should divest themselves of power generation facilities and restructure the industry. Divestiture would create two discrete kinds of businesses [see Figure III]:

  • "Supply" companies involved in power generation.
  • "Wires" companies involved in transmission and distribution.

Technique presents no important difficulties. The breakups could be accomplished through asset sales or spin-offs. Let us examine how an industry so structured would function.

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