NCPA - National Center for Policy Analysis

Benefits Of Vertical Integration In Electric Power

March 6, 2001

The vertical integration of electricity monopolies may have had advantages that were lost in the forced restructuring and divestiture mandated by California, says Alfred E. Kahn, the Cornell University economist who helped oversee the creation of freer markets in the rail, trucking and airline industries.

Under the previous monopoly regime, electric power utilities were vertically integrated, allowing a single, heavily regulated power company to produce, transmit and distribute electricity. California required utilities, which distribute power, to sell their generating facilities. In addition to this divestiture, they were required to turn over control of long-distance transmission lines to a nonprofit coordinating organization.

"I've always been uncertain about eliminating vertical integration," Kahn is quoted as saying. "It may be one industry in which it works reasonably well."

  • Vertical integration allowed engineers to coordinate power plants and transmission lines in ideal ways, according to Kahn.
  • Planners who saw the need for new plants helped find a place for them to be built. "The players all depended on one another," he said.
  • The electric power markets that have been established so far haven't matched regulators' ability to juggle the complexities of electricity, Kahn said.

On the other hand, in the mid-1970s Kahn headed the New York Public Service Commission. Local utilities, guaranteed a certain return by regulators based on capital investment, overestimated demand to justify new power plants, for which consumers paid through steady rate increases.

In California, restructuring, rather than deregulation, is what consumers have experienced so far: consumer prices were fixed, making it impossible for utilities to pass on higher wholesale costs, and the state required utilities to buy nearly all their power on daily spot markets, rather than arranging long-term contracts that might have allowed them to hedge risk.

Source: Joseph Kahn, "Utility Deregulation: Square Peg, Round Hole?" Economic View, New York Times, March 4, 2001.

 

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