Some California utilities are working to turn the clock back to the “good ol’ days” of regulation and guaranteed profits. A bill currently before the Legislature would take hard-won economic power from consumers and return it to monopoly utilities, in the name of increasing investment in the electric power system. This should cause all ratepayers concern.
Eighty-odd years ago a bargain between state legislatures and utilities was struck: provide ample, reliable power to customers, and regulators would guarantee a reasonable profit to the utility. While this guaranteed profit incentive structure funded the industry’s growth it also provided disincentives to innovate. This model has left California – and other states – with a technologically backward energy system, ironically co-existing with the high-tech mecca of Silicon Valley in the age of sophisticated monitoring, switching and control devices.
California can better meet its goal of attracting capital investment by empowering consumers. While utilities have sought rate increases through the regulatory process, entrepreneurs have risked their own capital to create innovative solutions that provide a portfolio of choices to consumers, increasing economic and grid flexibility at the same time. However these innovations remain shackled by regulatory fiat, and blocked by utilities’ control of access.
Regulatory efforts have focused exclusively on the supply side of energy. Noticeably absent from the state’s electricity strategies have been aggressive proposals to empower consumer demand and choice.
Even though the cost of producing and transmitting electricity fluctuates by the hour, and the seasons, almost all consumers pay the same price for electricity every hour, year-round. But electricity used on hot summer days costs much more to generate and transmit. In effect, consumers overpay most of the time – when prices are low – and underpay when prices spike.
By ignoring the basic laws of supply and demand, California’s inefficiencies are perpetuated and consumers lose the ability to benefit from the cost differences – shifting their energy use to less-costly periods, late at night for example, and away from demand peaks. As an end result of the current price structure, off-peak power users unfairly subsidize consumers of costly peak power, creating great strain on the state’s energy supply.
One simple and straightforward improvement that California lawmakers should pursue is incorporating consumer choice and real-time pricing into the regulatory and market institutions that compete to govern California’s electric power network. Providing consumers the ability to react to changes in energy supply creates a dynamic market disciplined by pricing – consumers can shift power usage when prices rise or fall – and provides a platform for product and technology innovation.
Green energy providers can find users willing to pay for environmentally friendly – but more costly – wind, solar and biomass power. Retail energy marketing companies can create contracts with consumers to reduce their consumption when overall demand spikes, in exchange for lower prices. Technology can be installed in homes or businesses to monitor energy prices minute-by-minute and maximize energy use while minimizing cost.
Both the technology and the business know-how exist to implement these changes today, and the technology is cheaper than ever. Allowing entrepreneurs to innovate and reduce peak demand through customer choice may mitigate the need for building new power lines and plants, an enormous cost savings for consumers. Moreover, these changes provide greater security, and a lower impact on the environment.
Customer choice in markets plays a critical role in investment signaling. High peak prices signal a need for investment in more supply or more peak energy conservation, whichever is the cheapest. But the energy regulatory structure prevents the full savings from energy conservation to be enjoyed by consumers.
Without accurate price signals, no amount of regulatory planning can efficiently satisfy consumer demand. The only way to get the right kind of investment signals is to empower consumers with choice, so that customers can communicate their preferences through their choice of providers and service packages.
It is also important that investors risk their own private capital – not taxpayer money or a charge on customers’ energy bills – and that they don’t invest in an environment in which they can recoup cost overruns from their ratepayers. That precise set of perverse incentives has saddled California and other states with unresponsive, technologically stunted energy markets.
Let independent energy companies separate from the wires monopoly, vie for customers like every other industry, and offer competing service packages. Customers should not be required to buy their energy from the same franchised monopoly that rents them the wires. This is a tie-in sale forced on consumers by regulation. When you rent a car no one requires you to buy the gasoline from the car rental agency. But your local utility, which rents you their wires, requires you to buy its energy.
Gov. Arnold Schwarzenegger has a rare opportunity to empower consumers over special utility interests — while at the same time creating a stable and reliable system through a marketplace that invites innovation and investment dictated by need, not the drive for ratepayer-guaranteed profits.
Lynne Kiesling is an adjunct scholar at Reason Foundation and director of applied energy research at the International Foundation for Research in Experimental Economics.
Vernon Smith, a professor of economics and law at George Mason University, won the 2002 Nobel Prize in Economics.