. "Appendix E Paying for Reliability in Deregulated Markets." Alternatives to the Indian Point Energy Center for Meeting New York Electric Power Needs. Washington, DC: The National Academies Press, 2006.
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Alternatives to the Indian Point Energy Center for Meeting New York Electric Power Needs
value of installed generating capacity, it was still large enough to send a message of dissatisfaction to investors. Since only a fraction of the total cost of building excess generating capacity was charged to stockholders, ratepayers were also adversely affected by paying higher rates; the primary cause of the problem was a failure by the industry and regulators to predict future levels of demand accurately.
The memory of excess generating capacity and unrealistic demand forecasts was part of the rationale for utility restructuring, based on the perception that the investment decisions made by regulated utilities were often economically inefficient (Rebellon, 2002). Regulated monopolies were thought by many people to imply high rates for customers owing to “overbuilding.” It was also thought that more competition would lower costs, encourage innovation, and attract new investment (Rebellon, 2002; Anderson, 2004; Higley, 2000; Potts, 2002).5,6 In addition, investment decisions in deregulated markets would be decentralized, and as a result, the responsibilities of regulators for selecting a particular forecast of demand and authorizing an expansion plan would be substantially reduced.7 Supporters of deregulation argued that market forces could be relied on to ensure that there would be enough installed generating capacity to meet the growth of demand.
Although it was not recognized at the time, the changing economic circumstances in the 1980s had already led most utilities to reduce their level of capital investment. Some analysts attributed the cause of this reduced investment to the “hammer” of the prudency reviews and the resulting regulatory disallowances (Geddes, 1992).8 Other analysts, however, concluded that the primary cause was the existence of excess generating capacity and the economic incentives to shift away from expensive nuclear power plants to less expensive natural gas turbines (Lyon and Mayo, 2000).
In the latter half of the 1970s, high oil prices, restrictions on the use of natural gas by utilities, and increasing environmental concerns about the adverse effects of air pollution were among the major reasons that utilities in New York State embraced nuclear power as an alternative to fossil-fuel sources of electricity. When high oil prices and cost overruns for constructing nuclear power plants drove electric rates steadily higher, the New York legislature responded by enacting a law in 1980 that required utilities to buy power from independent power producers (IPPs) for 6¢/kWh. Unfortunately, this law was enacted just before the price of oil dropped, and after additional supplies of natural gas became available after the oil industry was deregulated. Consequently, the actual cost of generating electricity from natural gas turbines, including the capital cost, was well below 6¢/kWh. Nevertheless, forecasters did not anticipate these changes in 1980, and therefore they expected higher prices for oil and natural gas in the 1980s.
The assumption underlying the “six-cent law” was that rising oil prices and the high construction costs of nuclear power plants would soon make 6¢/kWh a bargain for the buyers. In fact the opposite happened. Falling fuel prices, technological advances, and successful energy-efficiency investments created a surplus of generation that kept the cost of electricity well below 6¢/kWh, and the six-cent law created a substantial subsidy for IPPs and became a source of controversy for the public. The six-cent law was reinterpreted in 1987 to require an IPP to accept 6¢/kWh until such time as the front-end subsidy was paid back to customers, but projections indicated that wholesale prices of electricity would be so low that repayment would never occur. The overall outcome of the six-cent law was that thousands of megawatts of new contracts were made to buy electricity from IPPs at above-market prices. Most of this new capacity was built upstate, because construction costs were lower there than they were in the New York City region. The high cost of these contracts resulted in higher rates for customers. In the 1990s, regulators decided that the best strategy was to allow utilities to buy out the IPP contracts and treat the cost of doing this as a lump-sum loss.
Combining the effects of the high construction costs of the new nuclear power plants, the impact of the six-cent law, and the high property taxes in Long Island and New York City, electricity prices in New York State remained among the highest in the country, even though the amount of generation from oil-fired sources diminished to relative insignificance. Large customers in New York State—as in Cali-fornia and other high-cost states—became interested in self-generation and retail access as ways to “bypass” paying the high rates for electricity and, in some cases, as ways to shift production and jobs to regions with lower electricity prices. In 1994, California became the first state to announce the intention of permitting retail customers to choose their power suppliers. New York State announced its own plan for retail access one year later. This plan started by persuad-
“The primary rationale for electricity restructuring in most countries has been to reap welfare gains by supplanting regulation with competition where it is viable” (Anderson, 2004).
“Calls by large industries for utility deregulation found a ready chorus in academics, analysts, and politicians who believed that competition could produce lower prices, better service, and more innovation than government regulation. The free-marketeers pointed at other industries that had been deregulated during the 1980s, such as airlines and telecommunications, claiming that deregulation helped lower the cost of airplane tickets and long-distance telephone rates (Public Citizen disputes many of these claims; deregulation helped lower prices for some, but others have seen price increases and reduced service). The free-market proponents argued that since deregulation worked for the airlines and telecommunications (which Public Citizen disputes), why not the electric power industry?” (Higley, 2000).
“Recent history has created a tremendous disincentive to risk the economic future of the industry on forecasting the right energy production technology and building the correct amount of it to serve future demand” (Zadlo et al., 1996).
“The lesson of that experience was not lost on electric utility managers. They now fear that the cost of large (and efficient) new generating capacity might not be recovered through the regulatory process. New capacity might be disallowed from the rate base although its costs were justified and prudently incurred” (Geddes, 1992).