Electricity Deregulation Explained

In The United States, Electricity Deregulation is now more than 15 years into an experiment to deregulate and restructure the electric power generation, transmission and distribution industry. Some claim that it has produced national benefits as much as $30 billion per year. Others claim the change has resulted in penalties as high as $30 billion per year. And still others point to major declines in reliability and increased frequency of blackouts.

Why are there such broad disagreement about the impact? How do the results of deregulation and restructuring compare with predictions? Has the change benefited our industrial or commercial users, ordinary consumers and our national economy? To determine the answers to these questions, the key changes that were implemented must be reviewed.

The nature of electric power systems requires significant investments in major facilities, typically costing from tens of millions to billions of dollars. These facilities have long construction lead-times, taking years from start to completion, and often remain in service for as long as 40 years. Regulation provided for the return of the investment (depreciation) and the return on the investment (earnings) over the facilities lifetime.

The systems were interconnected to take advantage of the diversity in times of peak use and in times of equipment failures and emergencies. The industry focus was on long-term cost minimization. Decisions were based on life-cycle cost analyses. In such an environment, a high degree of cooperation developed among those involved in owning, managing, planning and operating electric power systems2. The national savings from this cooperation and interconnection were carefully studied many times and had increased to nearly $20 billion annually3 by the late 1980s. Prices to consumers, controlled by state regulators, were reduced by these savings.

Many supporters of this and the introduction of competition into the electric power business believed it would lead to significant economic benefits and price reductions to consumers. The move to have competition replace government regulation gained many adherents, particularly in large industry, where there were concerns over growing foreign competition; with economists in the nation's universities, who welcomed an opportunity to apply their theories; by investment bankers, who saw the huge fees they would earn to finance numerous buyouts and mergers; by lawyers, accounting organizations and some engineers, who saw increased business; and by entrepreneurs, who saw opportunities for huge profits. Some utility executives believed competition would help increase the return to investors that had, at times, been unfairly limited by regulators.

In general, those favouring Electricity Deregulation and competition as a driver were not aware of its effect on the benefits of coordination. Most lacked knowledge of power systems functioning and costs. The concept that profits would increase for the suppliers while prices would go down for consumers obviously required major cost reductions. But no analyses of the source of these cost reductions were conducted by competent engineers. Rather, it was the common belief they would result from increased competition.

Have such cost reductions occurred? The answer is clearly no. There have been some improvements in generator unit availability and efficiency. On the other hand, there have been huge additional costs and cost increases stemming from the reduced benefits of coordination, the increased complexity of the system, scheduling, and other operating procedures.