The Structuring of Deregulation!

Wednesday, January 28, 2009

The current economic crisis has given "deregulation" a bad score and the government is now working hard to "regulate." The banking industry is being partially nationalized to avoid the suspected collapse of our financial system. Amazingly, this is happening just over 10 years after major parts of the US introduced deregulation and restructuring in electricity markets on a large scale. This experience in the power industry had major ups, downs and setbacks, but thanks to cool heads and the availability of good options the clock was not rolled back to the full regulation days.

At the time of the California electricity crisis in 2000-2001 whereby a flawed market design coincided with rather predictable, but ignored, factors, led to the equivalent of "nationalizing" of the power generation sector. At the time, the State of California took upon itself the burden of securing adequate electric generation at highly-priced long-term contracts. No wonder, the State of California is in dire straits today. In fact, the volume of its current budget deficit is almost the same as the cost of the 2000-2001 crisis, about 40 Billion dollars! Soon afterwards, we would see the collapse of ENRON, and the various bankruptcies of some giants like Mirant, Williams Co. and others. Everyone was talking about "greedy" people from the CEO’s, down to the energy traders, a reminder about the greedy folks on Wall street in recent days.

But thanks to the fact that more than one market design was introduced in 1998, and notable among these was the PJM Independent System Operator (now PJM RTO). What was notable about the PJM experiment in deregulation is that it had built-in "conservative" safeguards, but yet brought about what the economists where recommending: competition. These safeguards included: (a) An Installed Capacity Market (ICAP) that guaranteed the reliable availability of generation resources, (b) Strict rules about the exercise of so-called, "market power," by any generation company, (c) Financial hedging instruments against congestion charges via the Financial Transmission Rights (FTR) system, (d) Full transparency in providing information to the market, (e) Elaborate training programs and customer relations to insure that all users of the PJM system are well informed and treated on a level-playing field, (f) Effective software tools in the PJM control center to allow for the complex computations of Locational Marginal Prices (LMP’s) to be done accurately and reliably, (g) Built-in capability to respond to the stakeholders and to make needed changes to the market rules as more experience is gained, to name the major safeguards.

Of course we have now several major well-run electricity market areas, including California! This has been done in what I call, "Structured Deregulation." It is deregulation in the sense of allowing competition, and hence, greed, to be part of the "design," but structured, in the sense, of avoiding artificial regulation that only causes economic inefficiency. Perhaps our government would listen to what the power industry has done in this country, and hopefully avoid the pitfalls of the looming danger of economic inefficiency at these critical times.

Stay tuned. In the meantime, I appreciate your direct feedback – adebs@dsipower.com