University of Georgia study is disconnected from grid economics
R Street Institute's Devin Hartman says a new study fails to accurately weigh the contrasts between wholesale markets and monopoly utility regulation
A February 2018 report by the Carl Vinson Institute of Government at the University of Georgia grossly mischaracterizes the experience with competitive electricity markets and monopoly utility regulation. Although the report makes a few fair points, it’s a deeply biased and intellectually unsound research document overall. The paper misunderstands economic concepts, fails to examine the core value components of electric competition and cherry-picks the economic literature and contemporary developments. Each of the report’s key points (below in bold) are swiftly refuted and, in many cases, the evidence points to the opposite conclusion:
1.“Price volatility and immediate rate increases have been an all-too-frequent outcome when restructuring has occurred.” The data do not support claims that restructuring has increased retail price volatility. Regardless, price volatility alone is not a concern unless it exceeds the risk tolerance of market participants. When it does, retail choice allows customers to choose their electricity plan based on the premium they’re willing to pay for rate stability. Monopoly utilities provide few retail options to customers, which tend to be less reflective of wholesale level conditions.
Prices in wholesale electricity markets are often very volatile because they accurately reflect the highly dynamic nature of real-time supply and demand (i.e., fluctuations in marginal cost). This provides a basis for efficient investment behavior from suppliers and for price-responsive demand. By comparison, the practices of monopoly utilities do not efficiently anticipate or respond to real-time supply and demand.
2.“Market restructuring has highlighted that the electricity industry’s unique technical requirements should take precedence over political or economic theories.” Electricity has unique technical characteristics, such as network externalities and the “common good” of resource adequacy, which require efficient policy interventions consistent with economic theories and empirical evidence. As such, a laissez-faire model does not work, but the “visible hand” of market design has proven superior for letting the “invisible hand” drive resource investment decisions. More on this later.
3.“While numerous factors such as geography and fuel mix inform the average price of retail electricity, the region with the highest retail prices is New England, where five of the six states have restructured markets. The lowest rates are in regions where none of the states have restructured markets: the East South Central, West North Central, and Mountain regions.” This is factually accurate but alone provides no information on the effect of restructuring on retail electricity prices. Many variables affect retail prices that are very statistically difficult to control for. The report’s implied point comparing across regions is misleading. Consider that New England has higher fuel costs, land values, taxes, environmental compliance costs and labor costs, just to name some factors, than the monopoly regions mentioned. There’s actually evidence that New England’s retail prices would be higher – and thus the gap with other regions wider – if it wasn’t mostly restructured.
Comparing within a region offers a perspective with less noise in these variables. The Midwest is the best regional mix of monopoly and restructured states. Illinois, Michigan and Ohio had the highest retail rates in the Midwest prior to restructuring. Now, Illinois and Ohio – the only two restructured Midwest states – have the lowest rates. Michigan remained higher than average.
It's important to remember states that restructured had higher rates in the first place, so it’s better to compare retail price trends than absolute levels. The weighted-average retail price in monopoly states increased 15% from 2008 to 2016, while it decreased 8% in restructured states.
4. “Significant policy discussions at the federal level are currently focusing on what the future “mix” of baseload power should look like to maintain a reliable electric system. One critical question is how consumers will be protected from unanticipated price increases and variability that may arise out of a changing baseload portfolio.” In making this point, the Georgia report cites a study with such profound flaws that the technical lead on the Energy Department’s grid reliability study said it has “so many factual, logical and methodological flaws that it is wholly unsuitable to inform serious public policy.”
The baseload debate ended in 2017, with the conclusion that baseload retirements are generally a sign of healthy markets. First, baseload is a type of operational mode, not a reliability service. An R Street Institute report separates the political connotation of “baseload” from the industry definition of the term (e.g., many coal plants no longer operate in a baseload role but retain the political label). Stressing the promotion or retention of baseload is not a relevant policy focus. This perspective is shared by the independent auditors of all competitive wholesale power markets, which view subsidies that prevent so-called “baseload” retirements as their primary concern.
The baseload retirement scare has been a false narrative promoted by rent-seeking interests seeking subsidies for unprofitable power plants. The Department of Energy’s 2017 grid reliability study that, if anything, held a bias toward concern over baseload retirements did not find reliability problems. The technical lead on the study said “as a root cause of retirements, wholesale competition worked as intended, driving inefficient, high-cost generation out of the market.”
5.“Electricity, as an “essential service,” must continue to be provided in an affordable and reliable way that promotes public safety and bolsters resilience to natural disasters.” The report goes on to claim that monopolies are better situated for resiliency and that restructuring could disrupt resiliency efforts by regulatory bodies and monopoly utilities. There’s simply no evidence to back this up (more below). As the Federal Energy Regulatory Commission noted in January, there is no uniform definition for resilience, and the Energy Department highlighted in 2017 that grid operators define criteria for resilience and examine resilience impacts. In short, the concept, let alone metrics, for resiliency are so immature that no definitive conclusion can be reached about the resilient performance of any electric system. As far as reliability goes, competitive power markets have actually demonstrated increasing reliability metrics while lowering costs. The bottom line is the literature shows that competitive markets are capable of attracting sufficient investment for grid reliability, and that the relevant policy question is therefore about the relative economic efficiency of different investment paradigms.
The report also provides a “closer look at state-specific experiences.” This cherry-picks four state developments, while ignoring the broader performance indicators of state electricity markets.
- In Connecticut, the report notes recent penalties levied on an electricity retailer by state authorities for charging excessive rates. As with any market, predatory or fraudulent tactics can be a concern if consumers are uniformed. A far more robust report on electric retail choice found that smaller customers at the onset of restructuring were vulnerable to fraudulent business behavior because they lacked familiarity with electricity providers and contract terms, but this diminishes as customers become more alert to the possibilities of fraud. That’s a decidedly different take then one cherry-picked example in the Georgia report. Plus, the digital age has unleashed platforms enabling customers to easily evaluate the validity, prices, and quality of services offered by electricity suppliers. Point being, electricity customers are more savvy than ever, which increases the value proposition of competitive markets.
- The report cites a decision in 2013 by Maryland regulators to reject a grid resilience charge as evidence that restructured states lack mechanisms to address grid resiliency. This is ridiculous, as restructuring doesn’t inhibit planning and funding mechanisms for transmission and distribution systems, which is where the bulk of resiliency risks exist. At the generation level, where restructuring created competitive markets, nothing prevents the administrators or regulators of these regional markets from pursuing resiliency initiatives. In fact, several are considering them now and have far more potential to achieve resiliency targets at lower cost than monopolies planning in a fragmented, uncoordinated fashion.
- The report cites an Illinois law passed in 2016 to subsidize two nuclear power plants as necessary to avoid Illinois importing power from outside the state, to avoid exposure to market volatility and to avoid job losses at the power plants. Importing power is sensible if it’s more affordable – it’s why economists love free trade – while job losses are sometimes a necessary part of market evolution (labor transition is outside the scope of energy policy). Most importantly, numerous economists, including the independent auditor of the market these plants participate in, firmly noted that these plants were not needed for grid reliability and that new, lower-cost power plants were driving them out of the market. The subsidies contradicted the premise of restructuring to let markets signal resource entry and exit, while resulting in unnecessarily increasing costs to Illinoisans by over $200 million per year.
- The report states that Ohio’s “[c]ompetitive wholesale markets have not developed as anticipated” with studies showing rate increases resulting from restructuring and one of Ohio’s utilities on the brink of bankruptcy. This is misleading and completely misses the mark on the problem. The problem in Ohio has not been underdeveloped wholesale markets but rather retail market intervention that has inhibited the formation of a robust retail market. As recent testimony from the R Street Institute and Ohio consumer groups note, Ohio has been the worst-performing restructured state precisely because they haven’t let markets work. Most problematically, Ohio’s Consumer Counsel has estimated subsidies exceeding $14 billion paid through mandatory charges on customer bills.
Fascinatingly, the report poorly interpreted the results of a study by concluding that restructuring caused rate increases in Ohio. The study indeed found increased rates in most of Ohio after restructuring, but the authors believe this resulted from a “perverse system by which commission intervention distorted true market-basis pricing. Rather than moving to a fully market-based pricing system, the restructuring design allowed all investor-owned utilities to retain protections through a hybridized tariff system… by which substantial regulated costs are passed through to ratepayers.”
In a presentation on related empirical analysis, the authors found savings from competitive wholesale markets that should have benefited customers, but instead Ohio implemented a cross-subsidization program that more than cancelled out the benefit of restructuring. They note that this problem could have been averted had restructuring been implemented as recommended by longstanding academic literature. Despite these flaws, another academic study found $15 billion in Ohio consumer savings from restructuring since 2011, but was conveniently excluded from mention in the Georgia paper.
Lastly, bankruptcy is a natural occurrence in competitive markets, but very rare in the regulated monopoly construct. In Ohio’s case, the entity on the brink of bankruptcy put itself in that position by acquiring assets that couldn’t compete in the age of inexpensive gas. Their folly will fall on shareholders, whereas monopolies that have made comparable decisions will pass the costs along to captive customers. That’s the difference between socializing risk versus placing it on private investors.
Speaking of socialized risk, it’s important to note the report excluded an examination of the central value components of restructuring in the literature. As noted by Paul Joskow, an economist that pioneered restructuring concepts, the “most important opportunities for cost savings are associated with long-run investments in generating capacity.” The economic discipline imposed by restructuring drove investors to make more prudent decisions in response to shifts in natural gas prices, fluctuations in demand, environmental compliance, consumer preferences and new technological advances. This has saved tens of billions of dollars, at least, in generating capacity cost savings.
Meanwhile, monopoly utilities have continued the poor investment decisions of decades prior – the worst being the atrocious “mega-project” decisions in the region the study emphasizes – the Southeast. Just three monopoly power plants in the Southeast will cost consumers tens of billions in excess. For a study authored by Georgians, it’s incredible that the billions in cost overruns at the Vogtle nuclear power plant – a direct result of the perverse incentive structure of the Georgia monopoly paradigm – received no mention in a paper on the regulated monopoly paradigm.
The report repeats the theme of the regulated monopoly model serving consumer’s interests. In that case, surely sophisticated consumer groups would flock to the regulated monopoly model! But that’s not the case. Customers are spearheading the rejuvenation of the electric competition movement, led by retailers, big tech companies and reinvigorated industrials. For example, Wal-Mart backed the Florida restructuring initiative because it estimated $15 million per year in savings at its Florida stores. Overall, the company has seen its costs decline in states with electric competition, which lowers costs to its retail consumers.
Altogether, the report’s detachment from the economic literature and practitioners’ experiences renders the key points and conclusions of the study highly suspect. The literature cited is very selective, and the report’s interpretation of that literature is consistently one-sided and sometimes dead wrong. The report rehashes monopoly utilities’ talking points that have been empirically debunked, calling into question why this reads like more of a PR document than academic piece. It should not form a basis for informing policy discussions. An accurate assessment of the issues raised in the report reaches the opposite conclusion – the value of competition has clearly exceeded the value of regulated monopolies.