“Totally forgotten in this transformation [to mandatory open access] was a simple removal of the regulatory covenant to allow a real free market and genuine entrepreneurial discovery process…. Instead, we were told the ISO/RTO model worked: the planners knew how to price for volume and for reliability with Texas as the national model.”
Classical liberal theory explains market coordination and governmental discoordination, even “planned chaos.” The same intellectual tradition notes the propensity of government intervention to expand from its own shortcomings. Electricity is no exception. The rise and fall of the Texas grid is a case study–just the opposite of what some claiming to be classical liberal thought (see yesterday’s post).
The history of electricity in the U.S. is supportive of an undesigned order, beginning with inventor Thomas Edison and his business protégé Samuel Insull in the 1880s. In its first decades, electricity largely overcame the problems of local regulation on the one side and municipalization on the other. Still, the threat of both led industry leaders to embrace statewide public-utility regulation to protect investment against takings via rate ordinances or socialization.
The state-level ‘regulatory covenant’ gave utilities franchise protection in return for cost-plus rate maximums. But for Insull and other industry leaders, rate ceilings were all but superfluous as economies of scale allowed a virtuous cycle of rate reductions and load growth. It began in the cities and reached the suburbs and then the countryside, a story told elsewhere. [1]
There was no market failure to justify the regulatory covenant–only political failure. There were industry complaints that ruinous competition would lead to natural monopolization and exploitation, but that theory never seemed to find traction in the real world. Besides, regulation introduced its own set of shortcomings that would evolve to where we are today.
Public utility regulation worked reasonably well in the era of coal-fired generation and hydropower. Natural gas later emerged to steam the turbines only to encounter shortages from federal price regulation in the 1970s. The bust of cost-plus regulation came with nuclear power, both before and after the Three Mile Island partial meltdown in 1979. [2]
Utility owners were entitled to a reasonable rate of return on regulatory-approved capital projects–and nuclear was the most capital-intensive generating source of all. More capital, more profit. Economists correctly fingered ratebase (mal)incentives under public-utility regulation for the cost inflation.
The ratebase problem of franchised utilities gave rise to a new model of electricity, mandatory open access, where both wholesale interstate transmission (federal) and last-mile transmission (state) were ‘socialized’ by government intervention. The owners of the transmission could no longer buy and sell their own power on the grid; they had to provide transmission services at cost and let outside parties buy and sell the electrons.
Totally forgotten in this transformation was a simple removal of the regulatory covenant to allow a real free market and genuine entrepreneurial discovery process between firms, independents and integrated majors alike. Instead, we were told, the ISO/RTO model worked: the planners knew how to price for volume and for reliability. Texas was the premiere example, as explained in a book edited by Lynne Kiesling and Andrew Kleit, Electricity Restructuring: The Texas Story (American Enterprise Institute, 2009). [3]
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This background sets up a list of questions for any alleged classical liberal supporting infrastructure socialism and multi-service-area government-directed wholesale power planning. The Independent System Operator/Regional Transmission Organization (ISO/RTO) model for wholesale electricity sets up outsider “competition” to buy and sell power versus the traditional franchise utility model where integrated operations fulfill the ‘obligation to serve.’ But at what cost? And opportunity cost?
Questions for Lynne Kiesling
MasterResource will be happy to publish the answers to these questions–and entertain follow-up questions for continuing debate.
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[1] Bradley, Edison to Enron: Energy Markets and Political Strategies (Salem, MA: Scrivener Publishing; and Hoboken, NJ: John Wiley & Sons, 2011), Part I.
[2] “A survey of plants begun after 1970 shows an average overnight cost overrun of 241%.)
[3] Kiesling and Kleit wrote: “Electricity Restructuring: The Texas Story tells how Texas, alone among U.S. states, moved forward into a truly restructured and competitive electricity era.” (p. 2)