Thoughts on Electricity

Faithful reader Spoonie Luv, in response to my post about electricity in California, New York, and Iraq, asks how a free market in electricity can be made to work. (Actually he asks for an example, but I'll enlarge the query to provide a better discussion of the issues.)

A Very Brief History

Back in the late 19th and early 20th centuries electric companies had to compete in a free market. Anyone who wanted to generate power and sell it to consumers could. Anyone who wanted to run power lines could. Consumers often had many different electric companies they could go to, some companies offered better service, others offered cheaper rates, some were more reliable in certain areas, some offered AC power, others offered DC power. There was a tremendous diversity in product offerings.

There were perceived problems, city streets were becoming tangled in power lines. It was an eyesore and hastily built utility poles could fall over breaking competitors power lines during a storm. Another "problem" was that the competition was fierce and margins for power companies were quickly dropping.

Power company executives went to the politicians and went into great depth on how much of a problem there was and how a politically enforced monopoly would be so much better for everyone. The argument was that it would be more efficient if there were only one company in a geographic area providing power. The various local and state governments went along with this and enacted legislation merging electric companies into single monopoly providers.

In recent years, several states have attempted to "de-regulate" the electricity market in an attempt at getting some benefit from free markets. The way most of the legislation has been passed the only benefit is to the politicians who say "see the free market didn't work, you need government to regulate this." The reality of the "deregulation" in California is that there was no deregulation. Instead of a direct decree of monopoly status for the electric companies, California now has an "open" market that allows anyone to provide electricity to consumers, once they pay billions of dollars to the existing utility companies. In other words, instead of coming right out and saying there is no free market, they guarantee a monopoly through restrictions while saying there is a free market.

Effects of Utility Monopoly

The first and primary effect of the utility monopoly was making the consumer and the utility political enemies. The utility companies no longer need to satisfy customers (they can use the company or go without), they only need to satisfy politicians. Politicians are easy to satisfy, a couple of junkets, cash in the campaign chest, and some plausible "reasons" for enacting or not enacting a piece of legislation and the politicians are happy to comply. For a single power company a piece of legislation can be worth millions of dollars, for the individual consumer it is worth at most a few dollars.

Without competition, service quality goes down. There is no need to reduce spikes and surges in the lines. There is no loss of customer base if the power company does not generate enough electricity to meet demand and rolling blackouts are required. There is no incentive to better protect power lines from the whims of nature.

What Would an Electricity Free Market Look Like?

I do not know. I cannot know. Noone can know. We do not know what innovations will occur, what novel technique someone will come up with to be even more efficient. We only know that when individuals are free to try, something better will be offered.

One likely thing would be that there would be several power lines in each neighborhood with some companies sharing lines, and others on their own. Each building would have a line out to the street and the various power companies would move your line to the box you entered into contract for, or maybe you have a box "on the pole" with a switch and each of the power companies has a line to your box.
We might have also had several different power grids not connected to each other, such that even though an entire grid was brought down, few people would have been affected. With multiple service providers we might even have automated "selectors" that monitor what lines have power and switch to the active power feed, ensuring no blackout period even in the worst storms. If prices are allowed to fluctuate in the electricity market it may be in our interests to have computer monitored systems to adjust our electricity use when dangerously high demand occurs. Do we really need to run the home A/C at 2:00 in the afternoon while we are at work? Maybe we want to do that to keep the house cool, but if the electricity price is going way up at that moment, we could let the computer adjust the A/C by a couple degrees to save money. Or maybe the Honda generator will automatically come on and help provide additional electricity when the computer sees electricity spot prices going way up.

We can never know if anything I listed above might make any sense as long as the market for electricity remains restricted.

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When somebody develops a

When somebody develops a super-efficient solar panel or cold fusion generator the size of a refridgerator, each individual home would become self-sufficient in a sense, and the free market would allow multiple vendors of power generation technologies to compete, similar to HVAC and appliances.

Until then, I think the government will have to play a large role in electricity regulation.

What benefit does

What benefit does electricity regulation provide?

Typically I'm not a

Typically I'm not a proponent of regulation, but in this case we do not want a repeat of the perceived problems described before.

The basic problem as I see it is that there is only one way to get electricity from the power plant to my home, via power lines. Even if multiple power plants existed on the grid which were owned by different companies, the government would have to control the infrastructure of delivering the power. This is only true because it is not reasonable to have multiple companies wire each house separately.

I am hoping a future technology will address the delivery problem and we can a free market in power generation.

This is only true because it

This is only true because it is not reasonable to have multiple companies wire each house separately.

Why not?

Why not? The key word here

Why not? The key word here is "reasonable". All political philosophies are non-functional in their extreme form.

As pointed out by David before, the tangling of power lines and utility poles falling over, etc., are the problems we would face.

Not to mention the cost prohibitive investment required. The US still supports analog cell phones because our land mass is so large. Re-wiring the power lines in this country is an exponentially more difficult task.

I have not actually seen

I have not actually seen power lines on poles in a couple of years now (with the exception of long haul high tension lines). Most power lines are run underground.

The "problems" were perceived problems not real problems. Even in the case of shoddy poles, if the owners of the shoddy poles are held liable for damage they do, there won't be shoddy poles for long. The regulation of electrical markets as a solution for "tangled" power lines is throwing the baby out with the bath water.

Also, what do we care about

Also, what do we care about the cost of running more lines? If it is a free market, and someone wants to set up the infrastructure, then that person (or company) should be free to do so. Just like some cable or telco company just ran additional fiber down my street a few months ago.

All political philosophies are non-functional in their extreme form.

All violent philosophies are non-functional in their extreme form.
Hmmm...you know, I think you have something there.

Catallarchy is apolitical. ;-)

Why not? The key word here

Why not? The key word here is "reasonable". All political philosophies are non-functional in their extreme form.

What does political philosophy have to do with why it is 'unreasonable' to have multiple companies fighting for your business, constantly making improvements, and trying to satisfy you?

It seems more like you are the one being 'unreasonable.' You think a certain way of doing things is 'unreasonable' so you are willing to prevent competing companies from taking part in the free enterprise system. Some might even call that selfish.

Taking a slightly different

Taking a slightly different approach here, I wonder if having redundant lines serving the same neighborhood might actually be a good thing.

Hasn't the media been talking a lot lately about the need for redundancy and decentralized distribution systems as a defense against terrorist attacks? If one service fails, consumers that use alternate circuits would still have power. Those consumers, such as supermarkets, that suffer significant costs from power failures, might wish to purchase power from multiple providers, as a backup source to go along with their generators.

From a neo-classical economic standpoint, this kind of redundancy might be inefficient. But perhaps "inefficiency" is exactly what we need.

I knew that comment would

I knew that comment would rustle up some hokie feathers

Anyway, by "reasonable" I mean, that it is not practical for anyone to dig in new power lines for every home in a neighborhood, both for the residents and the company. I believe the answer lies in a future technology to provide an alternate delivery mechanism.

Just like satellite dishes provided a new way to watch high-fidelity television or cell phones offered a new way to dial your friends, a new technology is needed for power. I hope in the near future either solar panels become more efficient or some form of hydrogen cells are affordable. Until then, I think we are screwed much like we were before DirectTV and SprintPCS arrived. The wiring for homes for cable and phone lines was single sourced (a bad thing) and the consumer suffered.

I like to think about the realistic solutions to real-world problems. I think often it is easy to get into an academic mindset that doesn't offer any plausible solutions. Basically what I'm looking for here is an answer to my original question. How can we accomplish a free market for electricity starting today given our current situation?

How about repealing the laws

How about repealing the laws and regulations and see what happens? That is how one "implements" a free market.

Do you think post-Enron,

Do you think post-Enron, that the people would trust energy companies and more de-regulation?

Unfortunately, companies

Unfortunately, companies like Enron tarnish the reputation of deregulation and decentralization.

I find it strange that when a private business is caught in a scandal, people use that as an argument against the free market and call on the government to enforce greater control. But when a politician or government agency is caught in a scandal, what happens? Exactly the same thing. People call on the government to enforce greater control.

Meet the new boss, same as the old boss.

I seem to have not made my

I seem to have not made my point very well. The regulation of electricity benefits the providers at the expense of the consumer. The providers went to government to get a guaranteed market at guaranteed prices.

Do you think post-Enron, that the people would trust energy companies and more de-regulation?

What's this "more" de-regulation??? The exchange of one set of regulations for another set of regulations is not de-regulation.

I am still wondering why people trust an organization with accounting practices worse than Enron's.

The reality of the

The reality of the "deregulation" in California is that there was no deregulation. Instead of a direct decree of monopoly status for the electric companies, California now has an "open" market that allows anyone to provide electricity to consumers, once they pay billions of dollars to the existing utility companies. In other words, instead of coming right out and saying there is no free market, they guarantee a monopoly through restrictions while saying there is a free market.

Exactly what billions? For the power plants they bought? Surely you are not suggesting that they be given the plants for free?

One reason for regulating the lines and wires is that they are considered natural monopolies. Further, there is the strategic nature of the lines and wires. Suppose you want to provide electricity to a customer on the otherside of my service territory. Your options are build your own lines and wires or using the existing lines and wires. The first one might not be an option if I want to keep you from serving that customer. The second might be prohibitively expensive unless you get enough customers.

Lets consider an example:

Suppose we have a community with 100 people in it. Now, if we both build grids there we might each be able to serve 50 people. Now since I have my grid in place and you have your grid in place, is there any way a person in my area can switch to yours? Only if you duplicate my grid as well. No you have doubled your costs and gained very little. Since your costs are now higher I'll be able to under cut your price (granted most of the costs are fixed costs). If you don't build the additional lines and wires we'll each be monopolists.

Basically I see two outcomes:

1. We duplicate each others system and spend twice the fixed costs, but get little additional benefit.

2. We don't duplicate each others system and we each can act like monopolists (or have some price setting power at least).

Spoonie asserts:
This is only true because it is not reasonable to have multiple companies wire each house separately.

Jonathan asks:
Why not?

For the same reason you don't drive around towing 2 or 3 other cars. The cost of electrical service can be broken into three components:

1. Transmission
2. Distribution
3. Generation

If you have 4 distribution companies connecting to your house your electrical costs will be 4x, i.e., you'll quadruple it, but you'll only get service from one at a time.

Also, what do we care about the cost of running more lines? If it is a free market, and someone wants to set up the infrastructure, then that person (or company) should be free to do so. Just like some cable or telco company just ran additional fiber down my street a few months ago.

Sure, but lets go back to our example of the 100 person community. I'm already in there charging my monopoly prices. You see this and say, "Ha!, I'll jump in and undercut him." What do you think I'm going to do? Be stupid and keep charging monopoly prices? No, I'll drop my prices to the competitive level. Now, why keep adding lines and so forth knowing that customers wont have any incentive to switch to your service? The only thing you can hope for is that my monopoly prices excluded some customers so you could pick those up.

However, electricity distribution systems are not set up so that they go just to the customers. Typically there'll be facilities on each street that has just one customer. So I'll have an initial advantage signing up customers at the new competitive rates in that I wont have to lay as much wire as you.

You need to think strategically with this industry. It isn't like hot dogs where anybody can come up to your hot dog stand.

Taking a slightly different approach here, I wonder if having redundant lines serving the same neighborhood might actually be a good thing.

No. These systems are not complicated like cars. They only tend to have problems when there is too much load or things like trees touch the lines. Too much load only happens rarely, and tree branches can be averted by proper maintenance. Having multiple systems is, once again, like driving one car while towing one or more cars as a "back up".

Don't like that analogy, it is like walking into a car dealership and buying X cars. The other X-1 cars are in case the first one you drive breaks down. Kind of silly when cars are fairly reliable, expensive, and simple maintance can solve the problem much more cheaply.

For the record, the rate of return utilities tend to get isn't all that hot. This is one reason why there hasn't been that much investment in new lines and wires.

On a final note: Enron, is not a utility company. They weren't even much of a generator either. Their big thing was trading energy contracts.

Exactly what

Exactly what billions?
Enough to guarantee no one will be competing with PG&E or SoCal Ed. This is the power retail and distribution side. The generators have a whole different set of regulations (must sell through a state mandated market for example).
For the power plants they bought? Surely you are not suggesting that they be given the plants for free?
Given to who? In order to enter the retail electricity market, the startup must pay to a state mandated fund a ridiculous amount of money "to recoup for existing retailers the loss of power generation facilities". This fund is then distributed to existing retailers.

One reason for regulating the lines and wires is that they are considered natural monopolies.
"Natural monopolies" do not exist. On top of that, the late 19th century and early 20th century showed that electricity can not be a monopoly without government intervention.

Suppose we have a community with 100 people in it. Now, if we both build grids there we might each be able to serve 50 people.

Again, the history of electric power in the U.S. suggests that your analysis is wrong.

The analogy to buying multiple cars (to use one as a spare) is forcing a single consumer type decision on multiple producers. If we both lived in the same area, and our schedules were such that we could both use the same car, would we? Would it be a good idea for the state to force us to do so?

If I wish to compete in the electric market, and there is a free market, then I'd probably run my own lines. There may be multiple lines to any given house, but the consumer does not pay for that, the producer does.

If you think you can get away with monopoly prices for any period of time and then drop them when a competitior shows up, you better think again. The competitor will take advantage of your pricing antics in his marketing campaigns, and you will lose customers when they see how you deal with them.

For the record, the rate of return utilities tend to get isn't all that hot.

No, but it is pretty much guaranteed.

This is one reason why there hasn't been that much investment in new lines and wires.

Nor is there any incentive to invest in new lines.

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