Academic journal article Economic Perspectives

The Electricity System at the Crossroads-Policy Choices and Pitfalls

Academic journal article Economic Perspectives

The Electricity System at the Crossroads-Policy Choices and Pitfalls

Article excerpt

Introduction and summary

In the mid-1980s, electricity policy in the United States began a new chapter when wholesale electricity markets were opened to competition. While the immediate goal was to increase the diversity of supply for electricity generation, proponents of restructuring also cited other dimensions of success arising from the restructuring of other network industries (such as telecommunications, airlines, and natural gas) as justification for introducing competition to the electric utility industry. Wholesale competition for producing electricity would improve generation efficiency, diversify supply, promote innovation, and even lower prices. Success in opening the wholesale market, proponents argued, would eventually be extended to the retail market, and all consumers would have the opportunity to choose their supplier and pick an electricity service that best fit their individual needs.

The initial enthusiasm for restructuring was particularly noticeable in states with high electricity prices. In theory, splitting the traditionally integrated functions of a utility--power generation, transmission, and distribution--into separate functions would expose cross-subsidies and inefficiencies, and competition among power generators would lead to lower prices for all classes of customers. Restructuring was designed to introduce open market competition only in electricity generation. Transmission and distribution services would still be subject to varying levels of regulation. By 2000, almost half of the states were pursuing some form of restructuring. However, several recent events have cooled the enthusiasm for abandoning the traditional heavily regulated and integrated utility system. Foremost among these was the California electricity crisis. The state garnered daily headlines as a series of events, including a flawed restructuring plan, left California facing skyrocketing prices, potential blac kouts, and bankrupt utilities. California's high-profile bad experience clearly demonstrated that the costs of a flawed electricity restructuring policy could be very high. In addition, states that had demonstrated early success in restructuring, such as Pennsylvania, Connecticut, and Massachusetts, were beginning to find that sustaining competition and promoting new market entrants was harder than they had anticipated.

This apparent conflict between theory and outcome has left restructuring at a crossroads. States are examining what elements and structures need to be in place to realize the promise and benefits of opening electricity markets to competition. The questions policymakers need to answer include the following:

* Is the physical infrastructure (particularly, adequate supplies of generation and transmission) in place to support new market entrants and a competitive market?

* Are the incentives for investing in new electricity facilities adequate? What can be done to improve these incentives if they are lacking?

* Do new institutions need to be developed to facilitate this new structure for delivering electricity? Should these be federal, regional, state, or quasi-public institutions? What is the role for existing regulatory institutions?

* Should restructuring expose consumers to changes in electricity prices, even when those prices can be volatile?

* What is the relationship between meeting environmental goals and generating greater power supply? Can the two successfully coexist?

In this article, I examine what restructuring means in the electricity field. I discuss the legacy of the existing electricity system, which favored local electricity provision by integrated and highly regulated monopoly utilities, and describe the issues involved in moving to a more market-based system. Then, I use the five states of the Seventh Federal Reserve District as a case study for examining how restructuring issues are being addressed at the state level. …

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