Electricity deregulation worth pursuing

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The Arizona Corporation Commission has launched an interesting and important discussion of electricity deregulation. But Robert Robb, a columnist for The Republic in Arizona,  says it started the discussion by asking the wrong question.

The commission opened a docket inviting interested parties to answer a series of questions. The first is: “Will retail electric competition reduce rates for all classes of customers — residential, small business, large business and industrial classes?”

This is the ground on which the debate about electricity deregulation largely takes place. Supporters say it brings about lower rates through competition. Opponents say it leads to price spikes, market havoc and a cost shift from large industrial customers to residential and small-business ones.

But the true benefit of electricity deregulation isn’t that it lowers prices. And the true benefit doesn’t go away if it results in higher prices.

The true benefit of electricity competition is that it results in the right price — the price at which what producers are willing to produce most closely matches what consumers are willing to consume. It is the best mechanism for keeping production and consumption matched over time.

The current system — rate-of-return regulation of monopoly providers — has a decisive bias toward overproduction and overconsumption.

The monopoly utility has an incentive to get as much production capacity into its rate base as possible, increasing what it is permitted to earn its allowed rate of return on. Both the utility and the politicians on the commission have an incentive for excess capacity because the political cost of blackouts are considerably higher than the cost of higher rates.

The politicians on the commission also have an incentive to spare customers the true marginal cost of the electricity they consume. The production cost of electricity varies widely, both during the day and seasonally. The politicians on the commission, however, smooth out this variability considerably in the rates they approve. Even the rate structures that include some variability don’t come close to capturing the true marginal cost of producing peak power. This leads to overconsumption of the most expensive electricity.

In a competitive market, only transmission and distribution would be a monopoly subject to rate-of-return regulation. Generators would be free to come and go. Retailers would make deals for generation and sell it to end users. Ensuring balance on and fair access to the grid are tricky regulatory issues. But it’s doable.

In a competitive market, consumers would no longer be spared the marginal cost of power production. Those willing to expose themselves to price variability would probably get lower prices as a result. Those wanting to contract away exposure to price variability would probably have to pay a premium for it.

So, some customers would probably pay less than they would from a monopoly provider and some would probably pay more. But overall, prices would balance supply and demand in a way that monopoly providers charging prices set by politicians cannot.

Although competitive electricity markets would be a net benefit, I don’t think the commission can just order them into being, as other supporters are urging.

Arizona is unusual in that regulation of utilities is set forth in the state Constitution. And the Constitution clearly contemplates monopoly providers and rate-of-return regulation. The commission is required to set “just and reasonable rates” for public utilities based in meaningful part on the “fair value” of their property.

Deregulation advocates believe the commission can negotiate the interstices of the Constitution to order competitive markets. That’s doubtful. The courts have struck down all previous attempts to do so.

And it’s not right. Those who want competitive electricity markets should propose changing the Constitution, rather than trying to render its provisions essentially meaningless.

That would be a tall order, since a constitutional amendment would require voter approval.

There’s nothing broken about Arizona’s current electricity market and the benefits of deregulation aren’t as obvious as the disruptive effects.

Still, if this discussion is to bear fruit, that’s where it should end up.

View this News Release (external link)

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