Electric Power Industry Deregulation

Electric Power Industry Deregulation The roots of modern day regulation can be traced all the way back to the late 1800’s and found in the form of antitrust. By the beginning of the 20th century, the U.S. government had formed the interstate Commerce Commission to regulate the railroad industry, and shortly thereafter, many other regulatory commissions were founded in the transportation, communication, and securities fields. The main goal of these regulatory commissions was to create a reasonable rate structure that would be appealing to both producers and consumers. While this system has worked for many years, it has recently come under heavy criticism, with many people pushing for open competition among electric power producers. Although once believed to be an impossible proposal, competition among electric power producers is finally a reality in a few areas. Massachusetts is just one state where legislation implemented to create competition among electric power producers is not only favored by the people of the state, but has also provided significant rate reductions as well.

The attempt at regulating price in the electric industry is a troublesome one. The objective is not only to minimize the cost to consumers, but also to create a rate structure that will entice the electric company to remain in the industry. The regulatory commission wants the electric company to have a reason to innovate so that they will be able to provide cheaper power in the future. However, if the commission captures all gains from innovation in the form of lower prices, then the electric company has no incentive to undertake any type of innovation. Therefore, a compromise must be reached which would provide adequate incentives for firms to undertake cost-reducing actions while at the same time ensuring that the price for consumers is not exorbitant.

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The term regulation refers to government controlled restrictions on firm decisions over price, quantity, and entry and exit. Each factor of an industry must be regulated for producers and consumers to truly benefit. The control of price does not mean setting one fixed price, but rather entails the creation of a price structure for purchasing electricity during peak and non-peak times. The control of quantity refers to the government’s attempt to control the amount produced or in this case the amount of electricity produced. For example, in the electric industry, it does not make sense to have a lot of small power plants produce electricity.

However, at the same time one company can not be allowed to monopolize the industry and set prices at its own discretion. Another factor in this problem is the control of entry and exit in the electric industry. By controlling who can enter the industry, the government can control who produces the electricity and how much of it they produce. However, the effectiveness of regulation has begun to be questioned, and created the evolution of a more competitive market. Ever since the Public Utility Act of 1935, which in turn created the Federal Power Commission, the role of electric utility regulation and its effectiveness has been questioned. Since that act was passed into legislation, the question has always remained: has electric regulation made a difference? Major studies done throughout the 20th century found conflicting results.

A study published in 1962 and conducted by Stigler and Friedland compared the price of electricity in states with regulation to the price in states without regulation. However, at the time all states had electric regulation, so Stigler and Friedland had to go back to the 1920’s and 1930’s to find states without regulation. Their finding was as expected. In 1922, the average price of electricity was 2.44 cents per kilowatt-hour in states with regulation. However, in states without regulation, the average price increased to 3.87 cents per kilowatt-hour. While many would say that prices could vary for reasons other than regulation, Stigler and Friedland controlled the analysis of other variables and found that no significant difference in price existed.

Other critics felt that this study was done in a time when regulation was just getting started, and that regulators in the present day are more effective. Two other studies which found different results were those conducted by Meyer and Leland and another done by Greene and Smiley. In their study, which used data from 1969 and 1974, Meyer and Leland utilized econometric estimates of demand and costs to find hypothetical unregulated prices. Their conclusion was that the regulated prices were significantly lower, but that even lower prices were demanded. In a similar study conducted by Greene and Smiley, they found that unregulated prices were 20-50% higher than actual regulated prices. Although these studies seem to reach conclusions that support regulation, the alternative finding by Leland and Meyer that even lower prices were demanded seems to be an indication towards open competition among electric producers.

Soon thereafter, the trend toward competition between electric producers began to emerge. The passage of the Energy Policy Act in 1992 created the first means of competition among electric companies by giving the government power to order companies to wheel power from one company, over their own lines, to another company. In 1990, there were over 3,000 electric systems in the U.S. alone, and most of them were publicly owned. However, the 267 privately owned utilities accounted for 71% of the sale of electricity. Also, most of these privately owned utilities have been vertically integrated, meaning they own the power plants, the substations, the transmission lines, and the distribution systems. The different utilities are then linked through a national grid, meaning it is possible for the sale of power, or wholesale wheeling, from one utility to the other. The Federal Energy Regulatory Commission is responsible for the regulation of these wholesale transactions, and has done so through market based transactions.

As wholesale wheeling has become more important, large industrial buyers have begun to demand participation. Instead of only being able to buy power through their local utility, they want the choice to purchase it from other companies, thereby creating some type of open market competition. As this has occurred, the trend has trickled down to the individual consumer level, thereby creating legislation such as the Massachusetts Electric Utility Industry Restructuring Act that was signed into law on November 25, 1997, and upheld with the passage of Issue 4 in the general election on November 4, 1998. This piece of legislation has allowed consumers to choose their power supplier, and has led to decreased prices without regulation. The Massachusetts Electricity Law, passed by legislature and signed into law on November 25, 1997, was developed over three years …