Politics and Power Markets

on October 22, 2012 at 8:30 AM

When it comes to energy and politics, the United States is not what it appears. Deregulation of the power markets is one example. Some regions of the nation have developed robust power markets. Others regions do not and they don’t want it.

The regionalization of the power markets means there is no such thing as a national grid. According to The ISO/RTO Council, the United States has seven formalized power markets and vast regions where no markets exist at all. Approximately two-thirds of US consumers are served by the seven deregulated power markets. The objective of these markets is to provide buyers and sellers price discovery, liquidity, and non-discriminatory access to wholesale power.

When it comes to deregulated power, market-based pricing is something one would normally associate with conservative leaders. With deregulation, the government’s role is reduced and wholesale power prices are set by the free markets.

In contrast, pricing by government agencies rings of central planning. In regulated states, organizations like state-run public utility commissions, engage in central planning for all citizens of the state. In these regions, bureaucrats determine what prices utilities will set and what costs consumers will pay.

Most would expect conservative states would opt for deregulated power markets and liberal states would lean towards government control. It would seem that way, but it is not so.

Not As It Would Seem

Incredibly, most states adopting the free-market model are what many consider the liberal states, while most of the conservative-leaning states love regulation. Surprisingly, most conservative states will not let go of government-controlled pricing.

Free-market states include most of New England, New York, the Mid-Atlantic and the Midwest. Many of these states altered their utilities’ monopoly structures by removing most power plant assets from the states’ rate bases. In these regions, wholesale power is bought and sold in public auctions, which are conducted every few minutes, 24-hours a day, 7-days a week. The seven trading hubs are managed by independent public corporations, called Independent System Operators (ISOs) or Regional Transmission Organizations (RTOs).

On the regulated side, states such as North Carolina, South Carolina, Georgia, Florida, Alabama, Mississippi, Idaho, Montana, Wyoming and Utah maintain state control over power prices. In these regions, the state decides if there is a need for a new power plant, and the utility must agree with the state on the type of power plant to be built.

Red and Blue State Case Studies

Then, there is Texas and California. Texas opted for market-based pricing and created a special power market that is electrically isolated from other states.

California started with market-based power. After the Enron debacle, California restructured their restructured utilities to create a confusing mess. They are deregulated, but not entirely.

With two very different power systems in the country, there are often clear winners and losers. While it may seem counterintuitive, consumers in the regulated states often seem to be winners.

To illustrate the difference, consider two power plants with similar cost structures but one is located in a regulated state and the other in an unregulated state. The levelized cost to operate these hypothetical plants is approximately $30 per megawatt-hour.

Regulated utilities are normally allowed full recovery for all costs plus a modest margin. That recovery represents a blended or average cost of all the utility’s plants, including operations, maintenance, capital, and fuel costs. These blended rates are what their consumers pay for all electricity produced by all utility plants.

The unregulated plant operates in an auction and as such, charges consumers the market-clearing price. That market-clearing price is set by the most expensive plant, which clears the auction. Any difference between the plant’s production cost and the market-clearing price is gross margin and any difference between the plant’s levelized cost and the market-clearing price is profit. Depending on the RTO/ISO, market-clearing prices have been known to exceed $2,000 per megawatt-hour (200 cents a kilowatt-hour) in peak periods. In those cases, average market clearing prices dealt huge bills for retail consumers.

During peak periods, the power from regulated states can provide stable and lower retail rates for residential, commercial and industrial customers of utilities like SCANA, Southern Company, NextEra Energy, TECO Energy, Entergy and others.

At the time of publication, Glenn Williams had no position in any of the stocks mentioned.