Impact of Macro Shocks and Utility Restructuring on Energy Markets. (Focus on Industries and Markets)
Cuomo, Robert J., Business Economics
Over the past two years external shocks have had a significant impact on electricity markets. Electric utility restructuring was proceeding at a very rapid pace in the late 1990s, and there was every expectation that this pace would accelerate in the early 2000s. The process of utility restructuring was moving toward complete restructuring of power generation and significant regulatory reform of transmission and distribution. However, a series of external shocks have taken their toll, largely thwarting existing trends. Utility restructuring was already under intense scrutiny and generating considerable debate, with many stakeholders questioning the benefits of restructuring. Today, there is considerable rethinking about how--even if--electricity markets should be structured.
Status of Utility Restructuring
What is the current state of restructuring? In the power industry, power generation is competitive in many states while transmission and distribution activities remain regulated in all states, albeit under revised rules. Table 1 depicts the current status of utility restructuring in the United States.
Utility restructuring legislation was first passed in Rhode Island, Massachusetts, and California. Thus far, some form of electric utility restructuring has been implemented in eighteen states. Future restructuring dates have also been established in four states.
However, utility reform implementation has been delayed in two states that had established dates, and the shocks of recent years have retarded the spread of restructuring to the remaining states.
There are a number of external shocks that have recently had a substantial effect on utility restructuring and ultimately on energy markets. Within the last two years, one can identify at least five such shocks. These are:
* Terrorist Attacks of September 11, 2001
* Recession in 2001
* Erosion of Stock Market Wealth
* California 2000-2001 Experience
* Collapse of Confidence in Key Electricity Market Players
Terrorist Attacks of September 11
The events of September 11 had a very significant impact on expenditure patterns. Consumer spending fell precipitously on travel and tourism, and this led to significant reductions in airline and hotel employment. It is likely that families are spending more time at home, tending to increase growth rates of demand for electricity-using appliances and residential electricity. However, because of increased business uncertainty, business spending has languished, causing a decline in the growth rate of commercial and industrial electricity demand. Moreover, concerns with security and terrorism in the wake of September 11 has pre-empted electricity restructuring as a priority issue.
Recession in 2001
The nine-month recession in 2001 resulted in a slowdown in the rate of growth of electricity demand in the short-run. The slump in industrial output and the derived demand for electricity was one factor. Moreover, as the economy faltered, the financial ability of competitive suppliers to enter markets decreased. This has contributed to utility restructuring being delayed in some states and tabled in others.
Erosion of Stock Market Wealth
It has been estimated that approximately $7 trillion in stock market wealth has been lost since the stock market peaked in March of 2000. In addition, corporate misreporting and malfeasance have seriously eroded investor confidence in corporate reporting and have heightened the sense of market risk. Together these dynamics have made it more difficult for electricity companies--particularly independent power producers--to raise funds in capital markets. As capitalization becomes more difficult, there is increasing concern as to whether competitive markets will produce profits for investors and lower prices for consumers.
California 2000-2001 Experience
The California electricity experience in the summer of 2000 and winter of 2000-2001 had a profound effect on the utility restructuring movement in the United States. Prior to the disruptions and price spikes that occurred, the general public and most market participants believed that restructuring would lead to increased competition in the marketplace and ultimately lower prices.
While the failure of California's power restructuring was made more likely by the design of its program, extenuating circumstances and market manipulation hastened the onset of failure and exacerbated the disruption caused by that failure. The upshot was that because of the fear that the California debacle was inherent in utility restructuring, the pace of restructuring in the United States has slowed appreciably.
Collapse of Confidence in Key Electricity Market Players
The collapse of Enron sent shock waves through the energy community. As a prominent energy trader, Enron was viewed as a symbol of free market economics and the benefits it could bring. Moreover, Enron was a major driving force for deregulation of wholesale power markets and a major provider of the trading liquidity that a deregulated wholesale power market needs in order to function. Since Enron's disappearance from the market, many other traders have also withdrawn (or been shut down). Enron's collapse and the related collapse in market liquidity have led many regulators and stakeholders to question whether this type of market can provide uninterrupted service of this critical commodity. Further, the revelations of market manipulation have led many to conclude that more regulation of electricity markets is needed. There is no doubt that these events are retarding the restructuring movement in the United States
Electricity Landscape Before and After Recent External Shocks
Two of the external shocks described above have had a definite impact on the electricity supply landscape. The terrorist attacks of September 11, 2001, and the collapse of confidence in key energy market players will have a long-run impact on electricity supplies.
Because of the terrorist attacks, there is much greater concern over the security of generation resources. In order to address the security issue and to assure a reliable electricity supply, many commercial and industrial electricity customers are seeking their own dedicated electricity supply. One such source is distributed generation. A brief discussion of distributed generation is presented below.
The collapse of confidence in key energy market players will also serve to limit future electricity supplies. In addition to the Enron bankruptcy, accusations of market manipulation have triggered expensive litigation, which has greatly limited the ability of energy firms to raise the capital necessary to enter electricity markets--particularly impacting competitive generation. The long-run impact may be to reduce future electricity supplies and lead to higher prices.
Regulatory reform in the electricity sector has been greatly shaped by the external shocks we have discussed above. The following are some of the key implications for regulatory reform.
* Based upon the California experience, there is the realization that both retail and wholesale markets must be price sensitive.
* In order to respond to regional electricity deficiencies caused by the external shocks discussed, it is important to have a national energy policy that will facilitate the flow of electricity across regions.
* The establishment of Regional Transmission Organizations should reduce the high-voltage transmission bottlenecks that might result from external shocks.
* Electricity company reporting will be standardized and expanded.
* States will delay restructuring until they become confident that electricity markets are ripe for competition.
The external shocks that have occurred over the past few years have had a pronounced impact on the electricity market restructuring process. External shocks and restructuring are highly interactive forces. The California and Enron experiences have led to significant impacts interms of employment, income, and output losses. In turn, the momentum of electricity sector restructuring has slowed appreciably because of these external shocks. However, in the long run, regulatory reform should be driven by long-run considerations and not by the external shocks that will inevitably occur.
Corollary to Lessons Learned: Reducing Risk through Distributed Generation
An outgrowth of the above external shocks has been an increased interest in distributed generation. Distributed generation refers to small-scale power generation facilities at or near a customer site that are directly tied into the electricity distribution system. Distributed generation systems have emerged as a response to higher electricity prices and reduced distribution system reliability. The external shocks described above as well as the growing concern over the long-term security of supply in deregulated wholesale markets have added to consumer concerns over both prices and reliability. Although many distributed generation systems provide emergency or backup power, there is a trend toward their becoming a primary power source. Global Insight estimates that in the year 2000, distributed generation represented approximately fifty-six gigawatts (gW) of generation capacity. This is approximately seven percent of the U.S. installed generating capacity. Going forward, the expansion of distributed generation will depend upon the volatility of electricity prices and the perceived reliability of electricity supplies. Global Insight now projects distributed generation to reach approximately 155 gW in 2025.
TABLE 1 PROCESS OF UTILITY RESTRUCTURING State Date State Date Rhode Island January 1998 Michigan January 2002 California March 1998 Texas January 2002 Massachusetts March 1998 Oregon March 2002 New Jersey November 1999 Illinois May 2002 Maine March 2000 Nevada June 2002 Connecticut July 2000 Maryland July 2002 Arizona January 2001 Virginia January 2004 District of Columbia January 2001 Montana July 2004 Ohio January 2001 Arkansas October 2005 Delaware April 2001 New Mexico July 2008 New Hampshire May 2001 Oklahoma Delayed New York July 2001 West Virginia Delayed
Robert Cuomo is a principal in the Advisory Services Group with Global Insight in Lexington, MA.…
Questia, a part of Gale, Cengage Learning. www.questia.com
Publication information: Article title: Impact of Macro Shocks and Utility Restructuring on Energy Markets. (Focus on Industries and Markets). Contributors: Cuomo, Robert J. - Author. Journal title: Business Economics. Volume: 38. Issue: 1 Publication date: January 2003. Page number: 55+. © 1999 The National Association of Business Economists. COPYRIGHT 2003 Gale Group.
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