From: hal@finney.org
Date: Sat Dec 16 2000 - 10:11:10 MST
Harvey writes:
> What went wrong with deregulation? Why did the deregulated companies
> not produce power cheaper than the regulated government monopoly?
> Because the deregulated industry was not really a free market. The
> state of California was a captive marketplace which had to purchase
> the power by law. There was no customer feedback to reject prices
> when they got too high.
This is true. Only one of the three public utilities, San Diego Gas
and Electric, has been allowed to pass on price increases. And when
they did, customers howled. Prices went up by factors of two or three.
I think they ended up forcing rollbacks of customer prices.
(I think it's kind of ironic: we've been told for years to save energy,
while all the while low prices have caused exactly the opposite behavior.
Now when we are finally given a real incentive to save, it's politically
unacceptable.)
> Instead of high-priced companies losing
> market-share, this deregulated environment ensured market-share to
> all power producers no matter how high their prices got. Naturally,
> prices kept going up and up with no end in sight.
The way the system works, I can't really see how utility companies
can compete. There's one set of lines, the same power producers are
used; the only difference is which company you send your payments to
and who pays the producers to arrange for electricity to be put onto
the wires. The only real places competition can occur would seem to be
in administrative costs and possibly bargaining strength to get producer
prices down. And the latter can't even happen now because of how the
electricity auction market works.
The market is a "first price" auction, where suppliers and utility
companies offer and bid on electricity at a certain price per
megawatt-hour (MWh). With this kind of auction, whatever the highest
price is for the last bit of electricity, that price is used for all
the electricity sold during that time period. So if some providers are
selling for $100/MWh, but that only covers 80% of requirements, and then
others are selling enough for $150 to cover 10% more, and then some are
selling for $200 to cover the last 10%, everyone pays $200/MWh for all
the electricity.
This kind of auction has some advantages in that it reduces "gaming" on
the part of the sellers, which is where they try to guess how much the
others are offering and adjust their offer prices correspondingly. With a
first price auction there is more incentive to just offer an honest price,
because if someone else offers more then you can still get the benefit.
However it does reduce some of the bargaining possibilities, and the
latest proposals get rid of this feature at least for prices above some
cap of $250 or $500/MWh.
> Basically, the new power companies did not try to work more
> efficiently or produce cheaper power than the previous monopoly did.
> Since they are producing a costlier product, the customer is
> switching back to the cheaper brand. The state is not shutting down
> the new companies. It is merely putting them on notice that it will
> no longer purchase high-priced power when it can produce its own
> power cheaper. Only power that is priced at what the state feels is
> reasonable will be purchased by that customer.
During deregulation, the public utility companies (SDGE, PGE, SCE)
were forced to sell off their power plants. These are now owned by a
variety of operators. The utility companies buy power in the markets
and have to buy enough to service their customers.
There is now competition (theoretically) in both areas: power generation,
and providing power to customers. The second is somewhat theoretical,
as I mentioned; you can sign up for another power provider, such as
Green Mountain, but it's largely just a difference in accounting.
The greater hope was for competition among power plant operators.
This seems to be what is breaking down. At the time the California
system was implemented, Californians were paying $100/MWh, twice the
national rate. After deregulation it went down for a while. But starting
this past summer the price has gone unstable and has had some extremely
high peaks. For the past two weeks it has been especially bad and has
reached over $1000/MWh some days.
It's not known whether the power generators are colluding to keep the
price this high. IMO there are enough competitors in the market that
collusion seems unlikely. People say that operators are pulling plants
off line intentionally to cause shortages. But for any given operator, he
can make a bundle if he can manage to get a few more generators operating
given these incredibly high rates. It's hard for me to believe that
some hypothetical cartel has enough discipline to make its members hold
back when there is so much money to be made individually at the expense
of others.
I suspect that the real explanation is simply a matter of supply and
demand. As Harvey says, demand is largely inelastic and doesn't change
with price, since the prices aren't being passed through. And supply has
been hampered due to delays in constructing new plants and environmental
regulations. Any time you have a limited supply and inelastic demand,
you will get price spikes as demand approaches supply.
> In this instance, the state of California seems to be acting like any
> other customer in a free-market environment. They are limiting the
> price they are willing to pay, and they are switching from costly
> producers to more efficient producers. Even when choosing between
> regulated and deregulated industries, the free market chooses the
> most efficient options. Too bad the new companies deliberately chose
> profiteering over efficiency.
Every company chooses that course which maximizes its profits. Using
loaded words like profiteering is pointless. We are all profiteers.
Hal
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