Free market failure: Electricity deregulation

Free markets generally outperform regulated markets — except sometimes.

Deregulation of electricity offered hope of lower electric bills for consumers in the south during the summer, and consumers in the north in the winter. A handful of states pushed through legislation that allows companies to compete in electric rates in a fashion similar to telephone competition: Different services on the same wires.

But electricity deregulation also cut loose the power generating foundation of electrical supply from the customer delivery services. Consequently, customer demand has not played as large a role in the creation of new electrical generation as anyone would have hoped. Many markets in the U.S. today face massive shortages of electrical generating capacity, not because of environmental concerns, but because the finances of deregulation discouraged power plant construction.

David Cay Johnston’s article in the New York Times yesterday details some of the problems:

Some electricity customers are also being saddled with monthly surcharges to cover construction costs for plants that were sold at bargain prices and then resold at huge profits. Some of these surcharges will continue for years.

Analysts cite several reasons that the new system has not been as successful as hoped.

Regulators required some utilities to sell their power plants so that independent electricity producers could compete on equal footing with those plants. But not enough new competitors emerged.

Further compounding the problems was the fluctuation in the prices of natural gas over the past decade or so.

Supporters of deregulation said customers would benefit from healthy competition among a growing number of electricity producers. But such competition has not developed. For one thing, many of the new power plants failed because, unlike many of the old plants, they almost all used natural gas to produce electricity. Demand for natural gas soared, and the price for that fuel tripled, making electricity from these plants too costly to be competitive.

The value of these plants collapsed, and some owners sought refuge in bankruptcy court. That is when investment firms, anticipating a much higher price for the plants’ electricity, bought them for as little as 20 cents for each dollar spent to build them.

And in fact the investment firms calculated doubly right: By paying so little for the plants, they made the construction costs of new plants by competitors seem prohibitively expensive. Over the last five years, few new power plants have been built, although demand for electricity has risen.

In response to shortages of electricity in Texas, where Houston residents now pay about double the national average rate for electricity, Gov. Rick Perry has “fast-tracked” air pollution permits for 16 coal-fired power plants, in the middle of an election campaign, an act that can only compound Texas’ nation-leading air pollution problems.

When we teach free market economics, let’s be certain to note some of the dangers. Especially when we talk about deregulation, it should be “buyer beware.”

Deregulation deserves much more analysis and discussion than we usually give it in introductory economics courses.

And, of course, there is no good example to follow for “deregulation” of education. It’s not been done successfully on any large scale, anywhere, any time.


One Response to Free market failure: Electricity deregulation

  1. […] Texas, electricity is a deregulated industry. To the benefit or detriment (that is another post for another blog) of prices, there has been one large environmental benefit. Green Mountain Energy is an electricty […]


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