The Economics of Pepco

July 13, 2012

A recent storm in the Washington, D.C., area left many households without power for days. Customers served by one company, Pepco, appeared to suffer the worst. Pepco had the slowest rate of power restoration of all the area's electricity suppliers, says Arnold Kling, a member of the Financial Markets Working Group at the Mercatus Center of George Mason University.

That this was allowed to happen is due to two factors that insulate Pepco from facing market discipline concerning reliability. The first is that Pepco is a regulated monopoly.

  • Supposedly, it is inefficient to have multiple service providers in the same area, providing electric utilities with natural monopolistic opportunities.
  • The fact that Pepco is a monopoly means that its incentive to improve its operations is limited: regulators may cajole and threaten, but ultimately Pepco is in a position of power.
  • Thus, there is inevitably a mismatch between the reliability that Pepco offers in its services and the reliability demanded by customers.

This problem is exacerbated by the second factor: there is no mechanism for prices to indicate the benefits of reliability.

  • A perfectly customer-responsive utilities provider would seek to invest the exact right amount of resources into reliability, balancing it against the prices its customers are willing to accept.
  • Under the status quo, there is no means for ascertaining where this balance is, as customers cannot rationally insert the value they place on a given level of reliability.

The solutions to these problems that would make utilities like Pepco more market responsive are twofold: competitive bidding for provider services should be implemented, and utilities should be encouraged to make available reliability insurance.

  • By forcing utilities to undergo a competitive bidding process, perhaps every five years, the monopolistic powers of the position would be undermined while avoiding provider redundancy.
  • Further, customers should be offered reliability insurance, such that they can pay an additional premium in order to purchase a given level of dependability.
  • This would, in essence, price in the value that customers place on consistency.

Through the implementation of these two policies, providers that are unresponsive to the needs of customers (as was highlighted by those still without power in Washington D.C.) would find themselves less able to compete.

Source: Arnold Kling, "The Economics of Pepco," The American, July 6, 2012.

For text:

http://american.com/archive/2012/july/the-economics-of-pepco

 

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