Deregulation of Electricity Markets - Essay Example

 Deregulation of Electricity Markets Introduction The markets are regulated to remove the influence of an externality or to balance an overbearing equation in market control and power. Usually natural monopolies or monopolistic markets like electricity generation and distribution are subject to control as there are very few suppliers for such a product as the investment outlay required for electricity generation and distribution is abnormally high and beyond the reach of normal investor. However, in US jurisdictions large sized electricity generation and distribution set-ups have been working under private ownership for long. The regional markets for electricity generation and distribution typically resemble monopolistic markets with few suppliers. However, they have been under variety of controls imposed by the concerned state in which they operated. These controls had more of social objectives than the commercial objectives. Such social objectives included ensuring uninterrupted power supply at affordable price for the general consumer. Take for instance the case of California. In the state of California he three monopolistic power suppliers were regulated by the State commission.Kunnapallil(Centre) describes this scenario as follows, “California’s electricity industry was vertically integrated and organized around three regulated private monopolies or investor owned Utilities (IOUs): Pacific Gas & Electric Company (PG&E),Southern California Edison Company (SCE), and San Diego Gas & Electric Company (SDG&E).These companies owned and operated everything from generation, transmission, and distribution and catered to the electricity needs of consumers in their exclusive franchise areas. California Public Utilities Commission (CPUC), an independent state regulatory agency, heavily regulated the prices, costs, and service obligations of these. These three companies together supplied three-fourths of the total consumption”. The Deregulation In the early 1990s Californian polity came to the realization that its electricity markets were so heavily regulated that the productions process had become inefficient and the producers were passing on merrily the high cost of production to the customers .California cost of electricity was one of the highest in the US at the time. As Beder (2001) states, “Before deregulation the Californian government set electricity rates and guaranteed the private utilities a set return on their investment. But it was argued that this provided no incentive for the utilities to cut costs. Prices were high compared to some other states, mainly because of cost overruns of billions of dollars on two nuclear power plants. Industry groups threatened to move interstate”. The deregulation was intended at cutting the cost based inefficiency and the main objective was efficient costing and pricing.However,California committed a tactical mistake in selling utilities ‘ large electricity generation facilities to private brokers that were, often ,not located within California. As Beder (2001) explains, “The final plan, approved in September 1996, involved the utilities selling off their generating plant to ensure there was plenty of competition between electricity suppliers. More competition was supposed to mean lower prices. The generating plant was bought by private companies, often based in other states. The plan also included a rate freeze until March 2002 or until the utilities had paid off their past debts, whichever came first. However the owners of the generating plant, the suppliers, had no constraints on what prices they could charge utilities, the retailers, for the power generated”. The control of production facilities and the removal of rate freeze in 2002 almost left the entire electricity market in the hands of such a monopolistic lobby which now manipulated supplies in high demand months of summers and jacked up the prices. These suppliers were ostensibly operating much above the P=MC level; however, interestingly it was not very clear if they had been actually able to gain a grip of MC to an efficient level. There were blackouts in peak summer months and prices rose sharply over any previous levels. As Badham & Han (2007) state in respect of deregulation blues and the subsequent correctives by the US administration, “The Californian Energy Crisis resulted in blackouts, price spikes, bankruptcy and the reintervention of the State in a privatized, deregulated market. The Clinton administration exercised its emergency power in December 2000 to compel sales of electricity and gas to the IOUs. President George W. Bush ordered relevant Federal agencies to speed up review and licensing of new power plants in California in February 2001. Recently introduced legislation authorized the Californian Department of Water Resources to enter into long-term contracts to purchase electricity and to then sell electricity to consumers. Forty such contracts were signed in early March 2001”. Important Lessons The main pitfalls experienced in the Californian deregulation centered on only couple of factors. One was the fact that the State had not planned its deregulation along with true privatization and dispersal of production capacities. Instead it had sold the state controlled production facilities to the brokers who acquired control over these facilities through backdoors. A move to deregulate markets towards free competition can occur only f the market does have monopolistic imperfections; in the case of California such monopolistic imperfections deepened as a result of sell out of the utilities’ production facilities. Secondly the State had not reckoned or planned any pricing and distribution strategy for the peak months of summer when the weather in California forces the demand for Electricity to shoot up abnormally. In fact, deregulation meant that rate payers would be left to the mercy of suppliers who would charge much above their MCs.The final US solution to the above crisis was based on broad basing electricity licensing so that monopolistic control is weakened. In jurisdictions like Australia such a crisis have remote possibilities of happening as most of the factors present in California example are absent in Australian realities. As Badham & Han (2007) state in this respect, “It may be that such a crisis will not happen in Australia. Generators and retailers here are not restricted from entering into arrangements to protect them from wholesale price fluctuations. Australia does not have the same stringent environmental laws and we have the Californian example to 'flag' potential problems with our electricity market. However, the Californian energy crisis was not caused by one or two 'fixable' causes but many factors (including the weather). Even if the Australian electricity industry can protect itself against these factors, a combination of different circumstances (such as widespread industrial disputes) could conceivably lead to an electricity crisis. The best safeguard against such a scenario is to ensure there is enough generating capacity in Australia to meet demand (and sufficient infrastructure to distribute electricity between states with varying levels of demand). The Australian market and Australian regulators must give the right signals and incentives to promote this level of investment.” References Kunnapalli, Piyush. (). Centre for Civil Society. California Electricity Experience. Beder Sharon. (2001).Deregulation disaster in California. Engineers Australia. February 2001, p. 38. Badham Alex & Han Edwards.(2007). Electricity deregulation California v Australia.Retrieved on June 8, 2007 from www.Freehills.com. Read More