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.