August 25, 2008
Like everything else in Texas, energy prices are getting big. But is it the cause of deregulation or other factors such as the price of underlying fuels?
This is the question that the Governor's Competiveness Council took up. It concluded that energy demand in Texas is expected to rise by 2 percent a year for the foreseeable future and that the state would need to remain competitive so as to attract the necessary investment to build a variety of power plants. It acknowledges that prices have risen there the last few years but it says that this has been a function of shedding the last remnants of regulation along with high energy demand and rising natural gas prices.
"Our retail market is the most successful retail market in the world," says Barry Smitherman, chairman of the state's Public Utility Commission, whose comments appeared in the council's report. "We have 25 retail electric providers fighting against each other every day for your business. Natural gas prices have increased 400 percent while electricity costs have risen just 30 percent."
Texas began restructuring its wholesale electricity business in 1995. In the last decade, at least $20 billion has been invested in dozens of new power plants. There's another $25 billion expected to go into power generation in the coming years -- investments that the governor's council say should be diversified among wind, solar and nuclear and away from natural gas. That fuel now makes up half the state's portfolio mix and is responsible for most of the price volatility.
Deregulation allows retail consumers in Texas to choose their so-called retail electric provider (REP), which purchases its power from competing generators. Transmission and distribution is still provided by the local utility. To help customers shop, the REPs are required to provide standardized information related to pricing, contract terms and emission levels.
The transition was never expected to be easy. And while there are certain unwelcome events that should have been anticipated, the choice movement says that none of them obviate the need -- and the potential benefits -- associated with free markets. They say that a marketplace that operates without subsidies for electrical suppliers is also one that would afford residential, commercial and industrial users better services and a well-rounded portfolio of new products.
While imperfect, the system is working. In 2006, Texas consumers in areas subject to competition could choose from 17 providers that offered as many as 36 different rate plans. Now, those customers can pick from roughly 28 suppliers that provide nearly 100 rate options. The new opportunities have meant that roughly 70 percent of commercial and industrial customers have switched providers since 2000 while about 40 percent of residential customers have shopped around.
"You can't grab consumers by the throat and force them to shop; you also can't allow their inertia to stifle the development of decentralized market processes that benefit so many other consumers as well as innovative producers," says Lynne Kiesling, economics professor at Northwestern University. "So the institutional design challenge is to reduce the information costs and switching costs that create the inertia."
Choosing a Course
Critics question, however, whether there can ever truly be a free market in electricity trading. They argue that the transmission system is simply too constrained, which provides opportunities for market manipulation. When supplies are short, producers can exert too much influence and drive up prices -- like they did in California in 2000-2001. They reason that the jury is still out as to whether electricity is truly a tradable commodity, or a natural monopoly.
By extension, they say that Texas has fallen prey to deregulation's pitfalls. While some surveys show that Texas ranks about the same nationally now as it did prior to the implementation of deregulation in 2002, the state nonetheless is feeling squeezed by rising natural gas prices and increasing power demand. Natural gas prices have jumped nearly five-fold since the inception of deregulation while the state's transmission system is overburdened.
Summers there are especially brutal. In Houston, electric bills are said to run $220 a month for average households compared to about $160 before deregulation. "Deregulation advocates urge regulators to stay the course, but consumer experience with deregulation suggests it is time to change course," says Tyson Slocum, director of energy for Public Citizen.
Looking back, deregulation was oversold. Consumers were essentially told it would bring down prices by rooting out inefficiencies and introducing competition. But policymakers underestimated the power of market forces and the willingness of consumers to endure price gyrations. In the intervening years, regulators have been battling with the proper balance between free markets and government controls.
At the heart of the discussion is whether consumers are better off participating in an open electricity market or whether such markets ought to be tightly regulated. The Brattle Group found that average electricity rates have increased 31 percent in both restructured and non-restructured states over the last decade. It adds that average rates in restructured states are higher than rates in non-restructured states but that had been the case in the mid 1990s before any state had begun tinkering with its electricity market.
Texas has been at the forefront of the choice movement and its experience is therefore under the microscope. The goal of keeping markets steady while inspiring innovation has been challenged. But the state says that it remains committed to deregulation and that over time free markets will flourish and bring increasing benefits to citizens there.
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