Advertisement

Short circuit

Economics dictated that electrical deregulation would be no panacea

Economics dictated that electrical deregulation would be no panacea

October 15, 2006|by William George

Back in 1999, when the General Assembly passed legislation opening the way for deregulation, the experience with deregulating phone service was fresh in everyone's mind. I doubt there are any critics of phone deregulation, as we have all benefited from these changes. Unfortunately, it appears this experience will not carry over into energy markets, at least in the short run.

The benefits afforded by deregulating phone service were attained due to the cost structures inherent in providing long-distance service. There are steep fixed costs in establishing long distance capacity. These include the initial cost associated in launching satellites and laying cables as well as recurring expenses required to maintain the infrastructure. Variable costs associated with servicing an individual customer are nearly zero in comparison. A provider is therefore encouraged to maximize its customer base. The trick here is to set rates low enough to attract enough customers to maximize revenues.

Advertisement

Deregulation, along with technology advances, led to a significant increase in call-handling capacity. Providers reduced prices in order to generate the volume of calls needed to maximize revenue. As long as capacity exceeds demand, providers will maintain prices at the lowest possible level to gain and hold customers. The situation in the cellular phone market is similar and consumers have experienced similar savings.

Energy markets in comparison have the potential to react in a similar way, but face significant challenges that make it difficult at this point achieve similar results. Providers face high fixed costs in building generating facilities and transmission lines to bring power to customers.

However, unlike the communication industry, the variable cost associated with servicing an individual customer is much higher, as additional power demand requires the use of additional fuel. Therefore, rates are much more dependent upon their underlying fuel cost and providers are less able and willing to cut costs to expand their customer base. Hydro, geothermal, solar, wind and nuclear power have much lower variable costs than traditional coal, oil or natural gas generating plants and would benefit from maximizing their output. However, they are currently operating at maximum capacity and do not need to reduce rates to attract customers and increase revenues.

Unlike phone service, generating capacity does not significantly exceed energy demand. Demand fluctuations are accommodated using higher variable cost coal, oil and natural gas facilities, meaning there is little room for price reductions outside of lower fuel costs. Building more coal, oil or natural gas facilities to expand supply will not lead to significantly lower prices. Neither would a drop in demand, as it would only lead to less output from these higher cost plants.

In order to achieve cost reductions in energy markets similar to those realized in phone deregulation, energy markets must expand capacity in low variable cost generating facilities of the type noted previously.

Once the supply of power from these types of facilities exceeds demand, energy producers will cut prices to attract customers and maximize revenues. By necessity, producers using traditional hydrocarbon fuels to generate electricity would be forced out of the market unless their fuel costs decline sufficiently to compete with these sources. As long as we depend on coal, oil and gas to meet electricity demand, prices will remain at a level necessary to afford these higher cost producers sufficient revenue to operate at a profit.

Obviously, we are a long way from reaching this point, meaning energy deregulation will fail to generate significant cost savings short of a return to the over capacity and price competition in oil and gas markets prevalent in the mid 1990s. There are no short-term fixes on the horizon and consumers will have to absorb higher electric rates. Regulations will still be needed to guard against energy producers taking advantage of the situation. However, capping rates at artificially low levels will only result in shortages during periods of high energy demand as it will discourage investment in needed generating capacity.

Energy deregulation is not to blame for higher electricity rates, though the cap on energy prices coming at a time of rising fuel prices has postponed and magnified the impact on consumers. Efforts are needed to encourage the use of cheaper energy sources that may face higher initial costs, but provide better long-term energy value.

Governments must provide incentives and reduce artificial barriers to expanding nuclear and other lower cost energy sources. Government can also encourage development of new technologies. Development of affordable solar technology allowing most consumers to produce a portion of their home energy needs is a good start. In the meantime, consumers can lower the impact of higher rates through increased energy efficiency and conservation.

If we look at energy deregulation as an opportunity rather than a burden, we have a better chance of reaching our goals of affordable and reliable energy and independence from volatile foreign energy markets.

William George is a resident of Knoxville.

The Herald-Mail Articles
|
|
|