Electricity Market FAQ
Q. What is the difference between deregulated, restructured and competitive electricity markets?
A. All three terms are frequently incorrectly used to describe the state of today’s electricity markets. Deregulation is a misnomer. Electricity markets have not been deregulated anywhere. Instead, electricity markets have been restructured to introduce as much competition as possible among generators while maintaining strict regulation over the transmission and distribution wires business. At the wholesale level, the Federal Energy Regulatory Commission (FERC) monitors generators and marketers that charge market based rates to ensure that they do not have market power and requires non-discriminatory access to the transmission grid. In states that have restructured their retail service, the local public service commissions still regulate distribution wires and have structured programs for competitive electricity suppliers, Some state programs require service at regulated rates from incumbent utilities for customers that choose not to shop around. Thus, the term “restructured electricity markets” most closely describes the existing state of electricity markets because the structure has changed but strict government regulation still exists over certain parts of the industry.
Q. What’s the difference between an ISO and an RTO?
A. An RTO is a regional transmission organization and an ISO is an independent system operator. Both are entities formed to operate and manage the interstate electricity grid independently from market participants. An RTO is larger in geographic scope than an ISO and performs more functions. The Federal Energy Regulatory Commission established criteria for RTOs, which include independence from market participants, regional scope, and the establishment of an independent market monitor. RTOs are expected to: independently oversee reservations and use of the transmission system; balance supply and demand on the grid; operate energy markets, including a market-based congestion system; ensure the provision of ancillary services; and provide market monitoring oversight. The important point of both ISOs and RTOs is that they are not affilatiated with any market participants and thus provide the fair access to grid services needed for a level playing field.
Q. Have electricity prices increased more in restructured states?
A. No. Price increases have in no way been limited to restructured states. Since 1999, when restructuring was beginning, electricity prices have generally increased the same (34%) across states with organized markets and across those without such markets. For instance, five states that elected to stay with traditional monopoly regulation (Nevada, Florida, Mississippi, Louisiana, and Oklahoma) have experienced price increases ranging from 39% to 62% during this same period of time [from U.S. Energy Information Administration data].
Q. Is electricity a “value” in terms of what you get for your dollar?
A. When you look at a typical residential electricity bill it’s about $115 per month, or a little less than $4.00 a day. Four dollars equals: a fast food lunch, a box of cereal, 1/3 gallons of gasoline, a bottle of nail polish at the drug store, half a movie ticket. Four dollars of electricity a day provides all of the following: a short shower, a pot of coffee, cooking, cooling your home, drying your hair, ironing a shirt, using the fridge, using the computer, watching TV, using the microwave, running the lights. And electricity’s share of the average household budget has remained about the same over the last ten years (2.8% of budget in 2006 vs. 2.3% in 1997). In fact, Americans spend twice as much of their household budget (5.6%) for recreation as they do for electricity. When you think about it, electricity is actually a great value. [average daily electricity cost from Baltimore Gas and Electric Company data 2006].
Q. Do residential consumers pay more in restructured markets?
A. Many of the states that adopted restructuing were relatively high rate states before restructuring was implemented. The important point is that competition can result in savings at the residential level. In New York, a restructured state, the average resident’s electricity costs fell 16% between 1996 and 2004 [“Staff Report on the State of Competitive Energy Markets,” New York State Department of Public Service, March 2, 2006]. This savings can largely be attributed to the fact that competitive pressures spawned greater efficiency, more innovation and cost discipline. Savings also came from the fact that competitive markets shift the cost of overbuilt capacity from customers to investors [“Beyond the Crossroads, The Future Direction of Power Industry Restructuring,” Cambridge Energy Research Associates Special Report, October 2005].
Q. Weren’t the “good old days” of monopoly regulation better for consumers?
A. No. They were costly, wasteful and detrimental to progress. The old system of government-determined, cost-based regulation brought customers poor performance in terms of too much generation capacity that always cost more than expected, power plants that were not available as much as they should be, declining investment in the electric transmission system that would otherwise have broadened customer access to the lowest-cost resources, and a culture that was resistant to new and innovative technology. Customers paid for this inefficiency in their monthly bills. Between 1970 and 1985, rates for residential customers more than tripled (25% in real terms) and rates for commercial customers quadrupled (86% in real terms). Investors also shared in the pain. Between 1985 and 1992 there were $22 billion in write-offs of nuclear plants. Industrial customers were building their own generators as a way to bypass their local utilities. [Former FERC Commissioners’ letter.]
Q. Hasn’t restructuring been a failure?
A. Actually, experts say it is on the path to success. Restructuring is currently in its early stages. The few states that have begun restructuring haven’t yet matured into fully competitive markets. But even at this early stage, our nation’s top economists agree that competitive electricity markets are the best option for consumers, the economy and the environment. In fact, eight leading economists recently issued an open letter to policymakers saying that “among economists, it is almost universally accepted that well functioning competitive electricity markets yield the greatest benefits to consumers in terms of price, investment and innovation especially when regulated alternatives are no longer warranted.” [The letter was signed by Vernon Smith (Nobel-Laureate, George Mason University), Alfred E. Kahn (Cornell University), Paul L. Joskow (Massachusetts Institute of Technology), William W. Hogan (Harvard University), Peter Crampton (University of Maryland), Howard J. Axelrod (Energy Strategies, Inc.), David W. DeRamus (Bates White, LLC), and Gary Hunt (Global Energy Advisors)]. And just about every study done by economists or independent market monitors in the ISOs and RTOs shows that restructured markets are lowering costs and providing other benefits.
Q. Why have there been substantial rate increases in some of the restructured states?
A. Those rate increases are the result of a confluence of factors. Many states imposed rate freezes at the time restructuring was adopted. Some of those rates had already been in effect for a few years before the freeze. Now some of those rate freezes are coming off. With even ordinary cost inflation, rates would be expected to rise after a multi-year freeze. But fuel costs have soared the past few years, thereby making the “catching up” significant. And competing suppliers have not yet entered the market to lower costs because most of the rate freezes were at levels below the cost of new market entrants, meaning that any new entrants would not have made a profit.
Q. Isn’t the market manipulation that happened in California proof that competitive markets don’t work?
A. No. A Federal Energy Regulatory Commission staff investigation of the California electricity crisis concluded that “significant supply shortfalls and a fatally flawed market design were the root causes of the California market meltdown.” The Commission determined that the underlying supply-demand imbalance and poorly designed market rules made possible the unlawful behavior of Enron and other unscrupulous market participants. Now, California and all of the organized markets in the U.S. have rules and structures in place to prevent such manipulation and are activley monitored by independent experts. In addition, the FERC has adopted anti- manipulation regulations and has been given by Congress the authority to levy substantial penalties for violating them.
Q. What are the environmental and health benefits of competitive electricity markets?
A. Restructured markets result in cleaner generation and provide better opportunities for conservation and efficient usage decisions by consumers. For example, competition drives improved efficiency and operating performance. Since the New England electricity market has been restructured, nuclear power plant availability has increased by 8%, avoiding the construction of up to five new generating facilities. And although electricity generation within the region increased by 25% between 1998 and 2004, associated acid rain-forming emissions decreased by 56%, smog-forming emissions fell by 57% and carbon dioxide emissions were 22% lower [“A Review of Electricity Industry Restructuring in New England” Polestar Communications and Strategic Analysis, September 2006]. Competition also provides consumers with more environmentally sound choices. Over 50 percent of all retail electricity customers in Texas can now can purchase a "green" power alternative from their supplier or utility [“Electricity Pricing in Competitive Retail Markets in Texas,” Public Utility Commission of Texas, February 2006]. Restructured markets also have rules and protocols that better accommodate the variable nature of renewable generation resources. As of 2006, about 73% of installed wind capacity is located in restructured markets, even though only 44% of wind energy potential is in those areas. [American Wind Energy Association] In addition, competitive markets provide the real-time price signals that can facilitate conservation by consumers.
Q. What is “demand response” and how does it work?
A. Demand response gives consumers the option to save money by controlling their electricity usage when supplies are tight or expensive. Basically, energy producers compensate customers for using less energy when demand is high by paying them a portion of the costs avoided by the foregone production. Reducing use during periods of high demand alleviates strain on the system and increases system reliability, helping to lower electricity costs and curb pollution. Because of price signals and fair market rules, competitive markets provide the best opportunity for demand response to flourish.