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Electricity Deregulation: A Failure

by DoDo Fri Sep 16th, 2005 at 03:06:42 AM EST

this is kind of a supplement to Jérôme's post against power sector privatisation - promoted from the diaries ~ site gnomes

Claim: electricity market deregulation will drive down electricity prices, it'll be good for us all.

Theory: free competition between producers with grid access means the cheapest offer wins, which means unfair overpricing by monopolists will be eliminated.

Counter-theory: Prices will go down first, but that at a cost: producers will spare by drawing down investments, which will lead to long-term problems and a price rise. But even before, large producers will use their financial reserves to drive prices down so much that upstarts go bankrupt, and then cooperate in raising the prices again, while blaming everything and everyone else. On an even shorter term, the general instability of markets will mean large price oscillations. Meanwhile, all this focus on lowering prices forgets about sustainability and global warming.

Practice: No need to talk about the California Energy Crisis again. My counter-theory exactly describes what happened after price liberalisation and market opening in Germany. The up-starts, except those defended by the feed-in law for regenerative energies, went bust in a few years, and indeed prices began to climb and oscillate. Evidence in graphs below the fold.

I created the above graph (the 2005 data is for the first quartal, it must have risen since another 5-10%) using the numbers calculated every year by the German Association of the Electricity Industry (VDEW), which represents the traditional producers and grid-owners - and pushes their agenda. Their reports since 2001 claim that prices rise due to the state, which added environmental tax and the feed-in law as price pushers. But, the netto price also increased significantly (even more since Q1) - and was calculated dishonestly.

The trick is with the feed-in law. The extra price for the consumer would be their share of the money paid out to regenerative energy producers at fixed prices minus the average production cost of the traditional industry for the same amount of electricity. But the VDEW tricksters simply calculate with the money paid out, without substracting the cost of the replaced traditionally produced electricity. (Correcting this would move up the right side of the Netto lines by about € 0.50.)

To get a bit closer to the truth, let's look at how the pre-tax price of electricity sold to medium-size industrial customers (who can connect directly to the intermediate-voltage network) developed since deregulation:

I created the above graph combining the VIK electricity price index (pdf!) and its predecessor, the Dow Jones/VIK price tracker (Excel!), using January 2002 as junction.

Update [2005-9-15 12:51:49 by DoDo]: I forgot to add this final note:

Another 'effect', which can be seen to some extent on the first graph: the large locally monopolistic private companies that ruled the regulated market before the March 1998 deregulation significantly raised the prices leading up to that date. That is, the initial decrease in prices was to a significant part the elimination of windfall profit margins.

Update [2005-9-16 5:22:25 by DoDo]: Some more tidbits and another graph (I also quantified two effects above, emphasized by italics):

First a note on the VIK price index for electricity to the industry. It is based on wholesale prices at an electricity stock market (a combination of baseload and peakload averaged over a month), but the pricing for many customers is determined by long-term contracts - hence lower; it's new customers who are f***ed with. On the other hand, the March 1998 starting point, as argued above, is at the top of a spike previously created by the regional monopolists for windfall profits.

I created another graph for the typical private home (the metric used is 3500 kWh/year with the usage patterns of a three-person home throughout), this time extending back to 1980 (yearly to 1990). But I will note some other strong effects that shroud what I want to show.

You will first note the giant jump in 1991, which is the effect of German reunification: in the former East, production was less efficient, and upgrading them to Western standards or replacing them costed time and money. However, that process was essentially over by 1998. Second you'll note that in 1996, brutto prices moved down while netto prices moved up: then the regional monopolists used the elimination of a tax as cover, hence the bumpy rather than straight three-year rise for extra profits before deregulation.

Finally, note that that 1998 peak is actually the average of a late 1997-early 1998 spike and subsequent steep fall - so when you look again at the graph of VIK monthly data, the starting point is even more skewed than you'd guess from the above. (I also emphasize again that since the first quartal 2005, prices rose another 5-10%.)

The last issue is gas prices. While most of the German production is not gas, it is significant in the short-term peakload production - and as Jérôme explained us, producers use marginals to determine the prices. So much so that at the above mentioned electricity stock market, baseload prices moved in lockstep with peakload ones (being lower by a constant ratio).

However, unlike in Britain or the USA, in Germany there is no apparent supply-side justification for the gas price hikes in the last year. Indeed a consumer group sued one of the main suppliers, E.ON, for the release of its price calculations - and yesterday a court gave them right. But E.ON still refuses to comply. I think that is proof enough that the big private suppliers are hitching a ride on top of the global oil and other regions' gas price rises.

The ironic thing about all this is that Europe has misunderstood how America works, and is trying (at least some are trying) to move to a point that America will never get to.

There is this "cowboy" image of America that is totally wrong. Sure, there are cowboys here. I saw a horse tied up outside a bar a few weeks ago, ten miles from my inner city house. And obviously there are companies that go beserk once in a while--usually as a result of failed deregulation. But the country is not such a hotbed of unrestrained capitalism that some Europeans seem to think.

In my current city, the following are publicly owned: Water, sewer, electricity, gas, buses, all roads, parks, many museums. The following are private: Telephone, cable TV, railroads, health care for most people. There is no proposal whatsoever to change this setup, with the exceptin of health care.

I think what is going on is that Europe has this view of the U.S. as a horrible dog-eat-dog kind of place, and then sees our reasonably successful economy, and makes an invalid connection between the two. It's not a dog-eat-dog world, and our economy is successful mostly because of its size and our homogeneous population.

Deregulation of electricity is not going to solve Europe's problems. You need an EU federation, but that's not politically correct for an American to say, as I know so well...

by asdf on Thu Sep 15th, 2005 at 10:16:56 AM EST
I disagree about the US economy (in its current form, as opposed to say 40 years ago) being reasonably successful, I agree about a distorted view of the USA, tough with the qualification that potentially confusing-rhetoric-with-thruth negative views from the left are not exactly the same as our elites' view/propaganda about what should be copied.

But I don't get how the 'EU federation' comes into the picture here, and why it would be non-PC in any way. I do think the EU should become more federal (because that's more democratic than the current version), but a lot of people especially in Britain don't like that idea, so I have to wait longer; but I don't see its relevance to the energy question.

This post of mine BTW was not at all about US-EU comparisons - I even only mentioned California because I thought many would expect me to write about that when they see the title I put up. Moreover, though it may well be, I don't remember the particular policy of electricity marget deregulation being promoted with a US example - just the usual market-is-more-effective mantra.

*Lunatic*, n.
One whose delusions are out of fashion.

by DoDo on Thu Sep 15th, 2005 at 01:04:46 PM EST
[ Parent ]

In my current city, the following are publicly owned: Water, sewer, electricity, gas, buses, all roads, parks, many museums.

Out of pure interest, could you tell us more about the electricity part? Do you mean the grid, or production too? If the latter, what is its structure (i.e. coal/gas/etc.)? Since when is it as it is, were there any changes?

*Lunatic*, n.
One whose delusions are out of fashion.

by DoDo on Thu Sep 15th, 2005 at 01:08:07 PM EST
[ Parent ]
Ok, I can actually give several different examples. In the town in Massachusetts where I used to live, the town provided the electricity. In the old days it had its own generating plant, but at some point it converted over to just buying power from the (privately owned) grid. So as a homeowner or business, you get an advantage because the town buys the electricity in bulk. Homeowner rates are considerably lower than surrounding communities that don't have their own system.

In Colorado Springs, the city owns its own power plants. They're coal fired plants and they're pretty big, around 600 MW altogether. There's also a couple of small hydro plants.

The city offers all sorts of special deals. There's an experimental load balancing system for A/C systems. You can also buy wind power from the city for a $3 surcharge per 100 KWH. You can get automatic set-back thermostats at a discount. Also, Nikola Tesla, inventor of many of the features of AC power distribution, lived in Colorado Springs for a while and did lots of interesting experiments here..

Historically in the west, each town had its own power plant because things are so spread out. Rural electrification proceeded pretty slowly until the second world war; about 25% of rural homes had electricity by 1940. The Rural Electrification Administration was part of Roosevelt's New Deal, and it set up a bunch of rural electric cooperatives. Most city systems, independent operators, and rural cooperatives were gradually consolidated into the Public Service Company of Colorado, which was recently taken over by Xcel energy which covers several states. There are still about a dozen different electricity suppliers in Colorado. I don't know why Colorado Springs remained independent.

All of this is regulated by a state agency.

Here's an example of another Colorado city, Fort Collins, that decided in 1935 to stop buying power from the Public Service Company and run its own system. I remember my mother complaining about how stupid it was for the city to be in the electricity business, but the conservative farmers who live there think it's better than being under the thumb of a nasty corporation. They probably were happy when the Public Service Company was bought by Xcel, which is even more anonymous.

by asdf on Thu Sep 15th, 2005 at 03:27:41 PM EST
[ Parent ]
This link answers your questions, I think, about my utility.

Austin Energy Power Plants.

Although Texas authorized utilities to deregulate, Austin has chosen not to go that route (Whew! Thank God!) As a result, our rates are much lower than comparable privately-owned electric utilities. This newsletter (pdf, scroll down) shows the rate comparisons - note that the deregulated utilities are the ones with the highest rates.

As a bonus, check out Plug in Austin and some of the other links on the side of the page.

by Janet Strange (jstrange1925 - that symbol - hotmail, etc.) on Fri Sep 16th, 2005 at 12:39:31 AM EST
[ Parent ]
Coming from California...it was, is, and as long as they stay deregulated...will be a horrible failure. LA just had a blackout too. (I hope Arnold gets blamed for it too).

I'm not sure which Europeans are looking hopefully at the US as some kind of model, but if they are, helloooo...wake up!!

"Once in awhile we get shown the light, in the strangest of places, if we look at it right" - Hunter/Garcia

by whataboutbob on Thu Sep 15th, 2005 at 10:25:06 AM EST
Of course it will be a failure as it is in Northern Ireland .Where we pay yhe highest cost of any country for electricity .
However there is  an answer . Live off grid and supply your own power. There are many many inexpensive ways off doing this so why ar we not getting on with it . Are we so used to instant power that we cannot provide with a little work and forthought our own  needs .
Innovative technologies exist for the home brewer to use wastes to generate power . Why do we not do it ?
by BIGKEV on Thu Sep 15th, 2005 at 05:50:09 PM EST
The reason electricity deregulation will be a fialure is that electricity is a good with little tolerance for the business cycle.

The business cycle goes as follows:

  • there is a need for something, and little supply, so prices increases;
  • companies invest to provide the good/service to capture these prices;
  • as more invest, supply increases, and prices go down
  • typically, there will be too much investment, supply becomes plentiful and prices collapse
  • some of the supplies collapse, investment dries up, the survivors regroup, slash costs, and wait for demand to grow again
  • supply declines until we get back to the first point of the cycle.

Now, demand for electricity is fairly predictable, it grows in line with activity, in a pretty linear fashion. Supply, however, comes in fits and starts - and in discrete blocks that need a lot of time to be built and that require to be amortised over a long life.
Electricity cannot be stored in any meaningful way, and people have very little tolerance for missing supply. Thus a need for a decent volume of spare capacity, which is something hard to give value to (it needs to be paid for, but it's used only very rarely) - either you get very high price peaks that makes it worthwhile to build peak capacity (used only very rarely), or you have regulations imposing that each producer have x% of spare capacity at all times.

If you start having such intrusive regulation, you might as well have the capacity yourself, and plan it in a macro-economically sound way.

The alternative is explaining to people why, once in a while, their electricity will cost 10 or 50 times more than usual - or have blackouts.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Fri Sep 16th, 2005 at 04:17:09 AM EST

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