Electricity Restructuring Term Paper

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Electricity Restructuring

Restructuring of the electricity industry has been approached with a top-down approach that has failed to result in benefits to consumers. Economic theory states guidance on conditions that are essential for well-functioning markets to exist in which the consumer benefits and the firms utilize innovation to control costs. There is currently a debate surrounding the importance of each 'condition' as well as the resulting harm when conditions are unmet. It has been learned that without the essential pieces in place that restructuring of the electricity industry may result in results that are highly negative in nature. These essential pieces include new transmission capacity, real-timing pricing, the absence of excessive market power in generation, fair competition between utility incumbents and other market players, effective regulatory oversight, a level playing field between private entities on the one hand and electric cooperatives and public power suppliers on the other, well0infomed small retail consumers and the opportunities and the correct incentives for risk-management activities by regulated utilities. Questions that are addressed in this research initiative include the question of why the difficulties of restructuring were so greatly underestimated. Secondly, the research in this work intends to examine why restructuring has been successful in some jurisdictions but has not been successful in other jurisdictions. This work also intends to address the question of since governmental agencies would play an important role in any restructuring can we be assured that they will do their job? Experiential knowledge informs this study that greater pressure exists at the local and state levels than at the federal level insofar as accountability and toward exploitation of regulation as a means of distribution. Finally, the primary and most fundamental question addressed in this study is whether the electric utility industry should proceed with restructuring without all of the essential pieces in place? It just may be that constraints that are political in nature will be far too binding to attain the necessary conditions vital for successful restructuring of the electric utility industry. It is clear from the material reviewed in this study that at this point there is no feasibility to turning back from restructuring but instead it is critical that the electricity industry move forward because the underlying premise for restructuring is just as if not more valid that it was when first conceived. Restructuring that has been successful has been characterized by a bottom-up rather than top-down approach and has concerned itself with the benefits that consumers receive for the services for which they pay. The forces which move in the electricity industry against a more competitive market are strong indeed however, historically deregulation has been effective and efficient as well as beneficial for the consumers and society at-large. This study concludes that deregulation and industry restructuring should continue although at a slower pace and in a bottom-up approach.

ELECTRICITY RESTRUCTURING

STATEMENT OF PROBLEM

Restructuring of the electricity industry has been approached with a top-down approach that has failed to result in benefits to consumers. Economic theory states guidance on conditions that are essential for well-functioning markets to exist in which the consumer benefits and the firms utilize innovation to control costs. There is currently a debate surrounding the importance of each 'condition' as well as the resulting harm when conditions are unmet. It has been learned that without the essential pieces in place that restructuring of the electricity industry may result in results that are highly negative in nature. These essential pieces include new transmission capacity, real-timing pricing, the absence of excessive market power in generation, fair competition between utility incumbents and other market players, effective regulatory oversight, a level playing field between private entities on the one hand and electric cooperatives and public power suppliers on the other, well0infomed small retail consumers and the opportunities and the correct incentives for risk-management activities by regulated utilities.

INTRODUCTION

This thesis will conduct a review of the major federal initiatives that have driven the restructuring of the Electric Utility industry and will evaluate the success or failure as well as considering the roles the states have played in supporting or preventing Federal action in this area. The seminal events that will be reviewed in this study include: (1) FERC Order 888 which opened access to transmission systems to any market participant. This was a revolutionary idea that radically transformed the traditional utility industry. It was a necessary component of any further restructuring of the traditional vertically integrated utilities; (2) FERC followed this successful initiative with the Single Market Design (SMD) Order 2000.

FERC proposed to require all utilities to join a Regional Transmission Organization, turn over assets to a third party transmission operator and participates in regional power markets. While this model was embraced in the North East, many Midwestern and southern companies rejected it and the SMD failed to be adopted as a model for regional transmission operation or markets; and Title XII, Electricity, Section 1211-Electricity Reliability Standards, called for the creation of a national Electric Reliability Organization to oversee the development of and enforcement to standards of operation and design for all Bulk Power System users, owners and operators. Bulk Power Systems typically are defined as 100kV and above and are used for transmission, including interstate commerce. They are regulated by FERC, not the states.

RESEARCH QUESTIONS

Questions that are addressed in this research initiative include the question of why the difficulties of restructuring were so greatly underestimated. Secondly, the research in this work intends to examine why restructuring has been successful in some jurisdictions but has not been successful in other jurisdictions. This work also intends to address the question of since governmental agencies would play an important role in any restructuring can we be assured that they will do their job? Experiential knowledge informs this study that greater pressure exists at the local and state levels than at the federal level insofar as accountability and toward exploitation of regulation as a means of distribution. Finally, the primary and most fundamental question addressed in this study is whether the electric utility industry should proceed with restructuring without all of the essential pieces in place? It just may be that constraints that are political in nature will be far too binding to attain the necessary conditions vital for successful restructuring of the electric utility industry.

IMPORTANCE OF STUDY

The importance of this study is the information that it will add to the knowledge already existing in this area of study, discussion and debate. Additionally, this work conducts a synthesis review of recent literature on electricity industry restructuring and the status of this restructuring which is ongoing in the electricity industry.

BACKGROUND

Regulation of the electricity industry began "with the use of franchise licenses by municipalities to control rates and right-of-way as early as 1885." (King, 1912; in Knittle, 2006) There was little done by the local regulatory authorities to control rates but instead the focus of the municipalities was on "controlling the number of franchises offered, and thus the level of competition." (Knittle, 2006) State regulation migration began in 1907 according to Knittel (2006) who states that once Wisconsin, New York and Georgia had passed legislation that expanded the "scope of their railroad commissions to include gas and electric companies...[that] more state quickly followed suit." (Knittle, 2006) Prior to 1920 there was very little electricity transmission across state boundaries thereby little need for federal regulation existed. However, in 1920, the Federal Power Commission was created and began to regulate a part of the electricity industry. Knittle (2006) states that Peltzman's (1976) interest group theory of the capture group theory holds that "as economic agents, regulators will respond to the lobbying efforts of both the firms they regulate and other interested parties, such as consumer groups. Thus, just as electric utilities may gain if they are able to capture state regulators, specific consumer groups may gain from state regulation at the expense of the regulated firm, other consumer groups, or, in this case, municipal regulators." (Knittle, 2006) The work of Priest (1993) is stated by Knittel to advocate "a theory of regulation based on contracting costs; changes in regulation occur when the existing regulatory framework has contracting inefficiencies. There were two primary sources of contracting inefficiencies in municipal regulation and the first of these is the introduction of alternating current (AC) by George Westinghouse in 1893 allowed electricity to travel long distances more efficiently...increasing the minimum efficient scale of the industry. The result was it being easier to service a number of municipalities by a single firm. Knittel notably states that the increase in the "...geographical breadth of electricity firms and the ability for ex-post opportunism by corrupt municipal regulators likely led electricity firms to curb large sunk cost investments, resulting in inefficient levels of generation. If state regulators were less corrupt, or potentially less corrupt, then state regulators and interested parties would have seen state regulation as a means of relieving the contracting inefficiencies, thereby spurring investment in generation capacity. Furthermore, even absent corruption, an efficiency…[continue]

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