Academic journal article Chicago Fed Letter

Electricity and the Midwest: A Survey of Conditions and Issues

Academic journal article Chicago Fed Letter

Electricity and the Midwest: A Survey of Conditions and Issues

Article excerpt

Not since the days of the Carter administration have electricity issues and energy markets received such intense national attention. Special energy task forces have sprouted up at all levels of government in response to fears of electricity shortages and high prices. In this Chicago Fed Letter, I take a look at conditions for electricity provision in the Seventh District states. As the survey demonstrates, while the situation in the Midwest is far more secure than in California, the region still faces some significant choices if it is going to provide for its electricity future.

In an age in which globalization is enlarging markets and equalizing prices for goods and services, electricity remains relatively balkanized. The five states that make up the Seventh Federal Reserve District (Illinois, Indiana, Iowa, Michigan, and Wisconsin) are a heterogeneous group in terms of their electricity profile. For example, Illinois and Michigan have relatively high electricity prices1 and have moved fairly aggressively in restructuring their electricity systems to encourage competition in the provision of electricity. Conversely, Indiana, Iowa, and Wisconsin have lower electricity prices and have been cautious in opening their retail electricity markets. Another difference is that while Illinois and Indiana are exporters of electricity, the remaining three states are importers. Perhaps the most common feature that the five states share is their preference for coal for generating electricity, but even here the reliance on coal ranges from 50% in Illinois to 94% in Indiana (see figure 1).

Currently, all five states report that they have sufficient electricity generation capacity to meet most of their own near-term demand. However, studies conducted in each of the five states have identified needs for additional generation to reestablish peak-load generation margins that will protect against unplanned outages. Of even greater concern to all five states is the lack of an adequate transmission system to move electricity across the grid without bottlenecks.

Deregulation and restructuring

Much policy attention has focused on the merits of electricity deregulation and programs designed to introduce market competition, increase the diversity of product offerings, and drive down prices. Roughly 30 states have taken steps toward introducing competition and consumer choice into their systems. Based on experiences gained from other efforts to open network economies (airlines, telecommunications, and natural gas) to competition, electricity restructuring has been seen by its advocates as a logical next step. In the case of electricity, restructuring focuses on dividing the provision of electricity into its three component parts-generation, transmission, and distribution. It is the opening up of electricity generation that is at the heart of the debate.

Traditionally, electricity was generated and delivered to consumers and businesses by regulated monopoly utilities. These utilities were usually vertically integrated in the sense that they provided the generation, transmission, and local distribution of electricity to customers. The utilities had an obligation to serve all customers in a designated service area, and the price was regulated by state public utility commissions to reflect the cost of providing service plus a fair rate of return.

Restructuring "unbundles" these integrated functions. Specific entities become responsible for each aspect of the system. Particularly important is the establishment of independent sources of generation. Rather than being limited to selling generation within a designated area, generators can sell power across the electricity grid. It was widely assumed that by introducing competition into the generation market, prices would be driven down and more efficient generation would occur as electricity would be traded across the grid to move power from generators with excess capacity to utilities experiencing peak-load shortages. …

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