Blackout Blame Started as Soon as Lights Went Out

Time to revise obsolete regulatory structure

The blaming and finger pointing began almost as quickly as the lights went out. First it was the U.S. and Canada blaming each other for causing this particular blackout, but inevitably the blame conversation turned to larger issues of policy, and how something like this could happen in such a heavily regulated industry.

Some of the finger pointing in the national press has been at deregulation – if it weren’t for deregulation, we would be better able to control and manage the grid. This misguided contention is incorrect in a number of ways.

First, the “deregulation” that has occurred in electricity has primarily been in opening up wholesale markets for power generators and their customers (i.e., utilities), enabling people in Manhattan to continue consuming power (and clamoring now for more regulation) without Con Edison having to build more power plants on the island itself. The existence and growing vitality of wholesale electricity markets has created substantial value in the past decade, through encouraging generation where it is cheapest and sales of power to where it is most needed.

But this limited amount of market liberalization has left the industry in an awkward place. Generation is largely governed by market processes, but transmission and retail distribution remain heavily regulated. The investment decisions of transmission owners and the retail rates that they can charge to their end customers all hinge on rate cases that are decided by state-level regulators. The rates that regulators allow take into account changes in costs, required investments, and the payment to the utility of a rate of return on the assets they own. For much of the past decade this rate of return has been substantially lower than what utilities could earn from doing other things with their money, so they did not invest in building much new transmission capacity or in upgrading existing lines. Nor did a regulatory environment that is a relic from the 1930s, constructed to govern and control local, vertically integrated utilities, either have the incentive or the wherewithal to force the utilities to invest in transmission assets that would carry power to customers in other states.

This lack of investment in the infrastructure that carries the product exchanged in growing, vibrant wholesale electricity markets has become a problem – not an overnight problem, as those who follow the industry have been concerned about transmission capacity for at least five years. The numbers offered this weekend suggest that electricity volume has increased 30 percent while transmission carrying capacity has increased only 15 percent. This fact illustrates the mismatch between the dynamic markets for wholesale power and the rigid, maladaptive set of state-level regulations and incentives that govern transmission investment decisions.

Markets adapt to changing conditions. The existing electricity regulations do not, and because of that, the transmission infrastructure has not adapted to the increased demand on it from the increasing vibrancy of wholesale electricity markets.

So how do we proceed to ensure that a blackout of this magnitude does not happen again? There are four things that can relieve the strain on the grid. The knee-jerk reaction of many people is “build more wires!” More wires will increase the carrying capacity of the system, and in some cases transmission owners can add lines to existing paths. But this approach faces some serious obstacles – such construction is expensive and time-consuming. Most importantly, though, getting new lines and towers sited is increasingly difficult, as people and communities object to having such large structures near them or strung overhead.

A second option is to use new technologies, such as high-temperature superconductors and sophisticated computer switching, to upgrade the capacity of the existing power lines. While also expensive, this option gets around the NIMBY issues that accompany the siting of new lines.

A third option is to build more generation nearer to customer demand – having more generators near Manhattan would reduce the need to transmit power from Niagra. Again, though, NIMBY concerns have been a strong constraint on large-scale generation construction near population centers. One way to increase generation, though, is distributed generation, which involves installation of small-scale generators on-site. DG is particularly economical for high-rise buildings (indeed, as we saw last Thursday and Friday, many buildings have DG for backup power already), and can reduce or eliminate a building’s need to be connected to the grid. DG does increase the complexity of managing a grid, though, because the grid has to be configured to accommodate DG if they are going to be hooked into it.

A fourth option is usually not discussed, because of the tendency to think of the grid as a supply issue. We can, and should, use market-based retail pricing to communicate customer demand into the grid. Under the decades-old regulatory rules controlling the retail sale of power, customer rates are set as averages over the entire year. Averaged rates do not take into account the fact that the cost of supplying power to customers can vary hourly. Averaged rates also give customers no incentive to conserve when the cost of providing them with power is high, such as during the late afternoon on a warm summer day like last Thursday. Grid operators saw power flow anomalies as early as three hours before the blackout that spread in nine seconds, and in those three hours, if we had market-based retail pricing, even the shifting of a few large customers could have lowered the peak demand and prevented the power surge.

Both reality and laboratory experiments show that electricity customers do respond to price changes, and that both suppliers and customers are better off from doing so. This option does not currently exist for most customers in most places – large or small, we cannot choose how to buy and consume power. Imagine if the telephone industry still operated this way; if it did, we would not have the vibrant, competitive, thriving cellular phone alternatives that we do now. One major lesson of this blackout should be the need to revise our obsolete electricity regulatory model, and the ability of market-based retail choice to lessen the strain on the transmission grid.

Lynne Kiesling is director of economic policy at Reason Foundation and senior lecturer in economics at Northwestern University.