Vertical disintegration for electric utilities: A half-serious proposal

At Utility Dive Ari Peskoe tries answering the question, “Can FERC convince utilities to build modern transmission systems?” Peskoe directs Harvard Law School’s Electricity Law Initiative. The summary up front succinctly states the problem.

For FERC’s rules to be successful, they must overcome utility incentives to overlook cost-saving technologies, prioritize local projects over regional investments, and thwart development of projects that might threaten their generation interests.

Notice that the incentive problem is inherent to the nature of vertically-integrated electric utilities. If a company owns transmission assets and generation assets in the same region, then decisions about transmission assets affect payoffs expected by generation assets. Similarly, decisions about generation assets affect payoffs expected from transmission.

A company board and management cannot be made to be ignorant of the interactions. The board and management of vertically integrated utilities have inherent incentives to invest in transmission assets in ways that do not detract from the value of their generation assets. No code of conduct erases the incentives. Executives may be prohibited from stating the obvious, but they cannot be prohibited from thinking the obvious.

Peskoe said, “Rather than expanding transmission to increase interconnectedness, utilities have recently been mired in small-scale projects that often simply rebuild last century’s grid.”

Not too surprising, right?

The grid built up last century primarily served to connect a monopolist’s generation to the monopolist’s locked-in customer base. That grid and the companies generation fleet were developed together in ways that made sense to utility shareholders last century. That grid enhances the value of old generation assets to utility shareholders even while it may reduce the overall value of the grid to society.

One possible fix is an old idea that was mostly ignored in the US: the transco.

The federal government should prohibit ownership ties between transmission and generation. (Ownership ties between transmission/distribution and retailing are also suspect, but that is less of a federal issue.) Spin off all transmission in an RTO to a single transmission owner with no financial ties to generation or retailing companies. That transco would remain a FERC-regulated public utility. Competition among generation is heightened when the bias created by vertical integration is removed.

So, half seriously, I’m proposing a ban on vertical integration in the electric power industry.

Only half seriously because it would be a fairly heavy handed regulation. Vertical integration often provides economies that dis-integration would eliminate. But here it seems that vertical integration of transmission and generation assets is driving anti-competitive behavior that itself has high costs. Two decades ago FERC and most utilities involved in the formation dismissed the transco idea. Might have been a mistake, as two decades of FERC frustration around transmission investment suggests.

Virtical disintegration. It’s a half serious proposal that requires serious consideration.

I admit it, I was wrong (about a federal government price gouging investigation)

Recently a handful of politicians called upon the Federal Trade Commission to investigate oil companies for potential price gouging. I was reminded of an episode from a few years back in which politicians called upon the US Department of Transportation to investigate potential price gouging by airlines.

An Amtrak train derailed in Philadelphia in May 2015, interrupting passenger service in the area for several days. Air travel rates jumped along some affected travel routes. In response Senators and Members of the House called upon the DOT to investigate.

I blogged about the calls for investigation in a July 2015 post at Knowledge Problem. There I made the following prediction:

After a month or two the DOT will report finding that airline prices did jump suddenly after the derailment as demand for air travel jumped up. They will observe that initial price spikes resulted from airlines’ computerized pricing mechanisms and did not reflect an intent to “take advantage of stranded passengers in the wake of such a tragic event.” They will note that airlines responded by adding flights and pressing larger aircraft into service. The report will conclude temporary price spikes reflected the ordinary workings of supply and demand under short-lived extraordinary circumstances. No finding of unfair practices will result, and no trade practices will be condemned.

I did not recall whether the investigation led to any particular conclusion, so I Googled it. To my surprise, my prediction was wrong in a key part.

I wrote “after a month or two the DOT will report…” but it was actually 18 months before DOT concluded its investigation. There was no report. Rather, as the Associated Press described it, the “department quietly sent letters to the airlines” stating the investigation had concluded. The DOT said it found “no evidence of unfair manipulation of airfares or capacity, nor evidence of unconscionable increases in fares beyond normal pricing levels.”

I was wrong on the timing of DOT action, but right about what it would find.

One wildcard this time around. The new chair of the FTC is a strong critic of existing competition policy practice. Last September the FTC announced several efforts to boost scrutiny of gasoline markets. Perhaps under new management FTC lawyers and economists will come up with some new theory of price gouging to justify doing something.

More likely, sometime after the November 2022 elections, the FTC will conclude they found no widespread market manipulation or price gouging. It won’t make much news when they conclude the report.

Inflation and the origins of anti-price gouging regulation

Inflation and price gouging are both in the news. You likely don’t need reminding about inflation, currently running at an 8.5% annual rate. Not surprisingly, the story on inflation was accompanied by a picture of a gas pump. The New Jersey government reports receiving more gasoline price gouging complaints in March than it saw in the previous two years.

Inflation, oil prices, and price gouging laws have a surprising historical connection. At least this is my claim: had inflation not been a problem in 1970 and 1971, we would not have price gouging laws in 37 states in 2022.

The links in my chain of reasoning are as follows:

  1. In 1970 and 1971 inflation had become a public policy problem. President Nixon, looking forward to his 1972 reelection campaign, imposed broad-based wage and price controls in August of 1971.
  2. While most price controls disappeared quickly (consumers hated shortages even more than price increases), oil price controls remained politically popular and continued through the 1970s.
  3. In 1979 President Carter began slowly lifting the price controls, with the predictable short run consequence of higher and more volatile prices.
  4. Higher heating oil prices and cold weather in New York prompted an outcry by voters, and the state legislature responded with the nation’s first anti-price gouging law.
  5. New York’s law was followed by three more states in the 1980s, eleven more in the 1990s, another sixteen in the 2000s, and six in the 2010s.

I rely on a bit of speculative consumer psychology: my view is that during the 1970s consumers became used to (a) relatively stable home heating oil prices, and (b) oil prices as an intensely political matter. Maybe (b) is true even if (a) is not, but it seems notable that it was home heating oil price increases that motivated legislative action.

It is possible, of course, that other states would have pursued price gouging laws even had New York not done so in 1979. In fact, New York might have acted anyway sometime later, in response to some other price jump. The three states that followed in the 1980s were Connecticut, Alabama, and Hawaii. I don’t know the circumstances of the legislative actions in those three states, so don’t know if New York’s action was important. Research on these three histories would be suggestive, either for or against my view.

But plausibly without New York’s action in 1979, other states would have responded to the politics surrounding emergency price increases in other manners and price gouging laws would be fewer than 37 in number in 2022.

[I blogged copiously on price gouging related topics at Knowledge Problem. See also my “The Problem with Price Gouging Laws” in the Spring 2011 issue of Regulation magazine.]

Will Wall Street discipline delay US oil industry response to higher prices?

For the last several years a common media story has been that Wall Street investors are tired of pouring money into oil and gas wells for paltry returns. When prices rise, the story goes, Wall Streeters will hold drillers back. Wall Streeters want to first recover past losses before unleashing a new wave of drilling. Wall Street discipline will mean a delayed response to higher world oil prices.

Versions of the story have been around for a while. In 2019 a CNN story was headlined, “Wall Street taught oil drillers restraint. That could lift oil prices.” “There’s a renewed discipline,” said one oil company CEO. The article explained, “Pioneer and other oil drillers are instead focused on returning cash to shareholders in the form of dividends and buybacks. The shift is a reflection of Wall Street’s disappointment with the industry’s shoddy returns.”

Just a few days ago–March 2022–a CNN story, “Gas prices are high. Oil CEOs reveal why they’re not drilling more,” explains that Wall Street is to blame. The article said, “Today, oil companies are under enormous pressure from Wall Street to return cash to shareholders through dividends and buybacks, instead of investing in badly needed supply.” The article quoted an oilfield services executive as telling the Dallas Fed, “Discipline continues to dominate the industry.” It is not just CNN. The discipline story has been just about everywhere: Forbes in 2019; NPR , CNBC, and WSJ in 2021; CBS News and Investor’s Business Daily in 2022.

My view throughout has been that it is nigh impossible to impose cartel-like discipline on competitive industries. Both investing and upstream oil and gas development are pretty competitive businesses. Individual investors may hold back and drillers may find their traditional funding partners reluctant, but when a profit opportunity is out there someone will chase it.

In other words, while the discipline story may be true of many investors and for many drillers, it will not substantially delay a supply response to higher prices. Recent stories appearing in the WSJ (here, here, and here) and in the Financial Times make the case. Private equity, privately-owned drillers with some cash on hand, and other independents and minor players are out there chasing the higher prices.

The Benefits of a Competitive Market as Swing Producer

There is a feature of fracked oil wells often presented as a detriment but one which comes with some advantage. Fracked wells produce a lot quickly, but then production falls off quickly as well. A traditional vertical into a large reservoir may take a decade or more to produce half of its reserves. For fracked horizontal wells half of the production may come in the first one or two years. Fracked wells are exposed to much smaller market and political uncertainties.

Look at the growing electric vehicle market, consider carbon-connected innovation, examine climate regulations now and future policy options being debated. How confident can anyone be that they know what oil markets will look like in 2035?

One side benefit: macroeconomic swings should be moderated by having the competitive American oil industry as the markets primary swing producers. Adjustments are more incremental and market-focused relative to a world in which the Saudis acted as the swing producer. Saudi decisions are made by a few powerful men who have to balance Saudi national politics and interests along with international political and economic factors. Their decisions then swing output choices of the worlds biggest oil exporter.

In the competitive US oil business, each company is a tiny sliver of overall world production. The range of interests and outlooks are more varied and each personality affects just a little bit of the action. Yes, boom and busts, but economic theory suggests we’ll see much more moderated boom and bust cycles (probably more frequent but also lower highs and higher lows).

Retail power rates before and after retail restructuring

How have retail power prices changed due to reforms enabling customer choice of electric power suppliers? Here is a chart summarizing average changes before and after 1997, the year the first state began to reform.

Source: Presentation by Brattle Group economist Johannes Pfeifenberger to the National Council of State Legislators Energy Policy Forum, Dec. 6, 2016).

Prior posts have discussed the effects of allowing electric power customers to choose their own electric suppliers (here and here). Many states initiated reforms to allow customer choice explicitly to bring retail power prices down, so many assessments of reform have been concentrated on the price effects.

It seems like an easy task to compare prices before reform and prices after, but easy comparisons can be misleading because they ignore other influences on power prices not directly related to allowing customer choice. For example, natural gas prices have seen dramatic ups and downs over the last 20 years and those fuel price changes will affect retail power prices. We would only want to credit retail price reforms for the benefits of low natural gas prices (or blame them for the burden of high natural gas prices) if the reforms themselves caused those price changes.

Wholesale market reforms may have enabled growth in natural gas generation capacity, but it does not seem that retail customer choice independently has increased demand or otherwise directly affected natural gas markets. Instead, the fracking-driven boom in supply and, more recently, increasing exports of LNG seem to have driven natural gas price trends over the past two decades.

So I’ll repeat the warning from one of the previous blog posts which also applies here:
“[T]he chart above isn’t a sophisticated analysis of the causes of electricity rate changes. It would take a lot more advanced analysis to solidly back the claim that competition produced lower rates.”

Some economists and data analysts have sought to produce the necessary analysis. I’ll discuss some of these works in future posts.

Surprised to see NFIB promoting electric monopolies in Arizona, especially as competition is bringing rates down for small businesses elsewhere

“Over the period [2001-2020], Arizona’s electric rates for commercial customers have increased 2.74¢/kWh (a 37% increase over 2001 rates) whereas similar rates in New York, Illinois, and Ohio have increased by only 1 to 1.5¢ and rates in Texas and Pennsylvania have fallen.”

Last week the Arizona Senate discussed SB1631, a bill that would repeal the state’s stated policy of promoting competition in electric power service. It’s the companion of HB2101 that I discussed in a post two weeks ago: “Electric monopolies in Arizona fear their customers would leave if given the chance.”

I was listening to the Senate’s Natural Resources, Energy, and Water committee discussion of the bill and was surprised to see the AZ representative of the National Federation of Independent Business stand up in support of this bill, which is to say for monopoly and opposed to competition. (Video of the committee’s discussion is here. The link takes you to the start of the discussion at the 0:49 mark, NFIB’s Chad Heinrich appears just after the 1:19 mark.)

Now Mr. Heinrich reports that the position is the result of a vote by his members, and that is a perfectly respectable way for a group to choose positions. But the organization should also help its members understand the context of the vote. Arizona’s commercial ratepayers may be paying a little extra because consumers are locked into monopoly providers.

The following chart shows the change in average commercial electric rates since 2001 for several states. I’ve shown the U.S. average (blue) and Arizona (light green) along with the five largest states to allow commercial customers to choose electric suppliers: Texas, New York, Pennsylvania, Illinois, and Ohio. (You can look at the data yourself. Click the link to see this data via the EIA’s Electricity Data Browser. Go explore.)

Now the chart above isn’t a sophisticated analysis of the causes of electricity rate changes. It would take a lot more advanced analysis to solidly back the claim that competition produced lower rates. (Some relevant advanced analysis was discussed in my HB2021 post.)

Still, at first glance, over the period available in EIA’s Electricity Data Browser, Arizona’s rates for commercial customers have increased 2.74¢/kWh (a 37% increase over 2001 rates) whereas similar rates in New York, Illinois, and Ohio have increased by only 1 to 1.5¢ and rates in Texas and Pennsylvania have fallen. Again, the chart is not conclusive evidence, but if a monopoly lobbyist wants to reject the suggestive picture above or dispute the data collected by the U.S. Energy Information Administration, ask them to show their work.

NFIB members in Arizona may want to hear from NFIB members in New York, Pennsylvania, Illinois, Ohio and Texas about the advantages and disadvantages of competitive power markets.

Electric monopolies in Arizona fear their customers would leave if given the chance

Recently Arizona electric utilities convinced a few state lawmakers they should repeal a 20-year-old law and fast! That law, which was never implemented, said Arizonans should be allowed to choose their own electric power suppliers. The anti-customer freedom bill is HB2101.

Last year Green Mountain Energy requested permission to sell 100 percent renewable power directly to Arizona consumers, citing that 20-year-old law as the basis for its request. The state regulator might not grant permission, but the power monopolies fear even the possibility of customer freedom. The monopolists are lobbying fast and hard against it.

The claims monopolists make about customer choice are predictable and largely groundless. They claim reliability will suffer and that rates will go up. They’ll point to California, which stumbled on its early attempt to create competition, and Texas because of its energy failures in February 2021.

Arizonans need not fear the California or Texas scare stories. Here’s why:

California’s early attempt at creating competition did fail 21 years ago. That failure has been well studied and is well understood. California regulators invented a new market, it was badly designed, and it fell apart under stress. Everyone now knows better. None of the fourteen states now allowing customer choice copied California regulations, and none have seen similar failures. None.

Arizonans should only fear the California example if Arizona regulators were considering implementing old California policies. There is no chance of that kind of mistake, so Arizonans should ignore this bit of fearmongering.

What about the Texas disaster in February 2021? It was catastrophic, but it was not caused by allowing customer to choose their own power suppliers.

Many power plants failed in Texas as components iced up or fuel supplies froze. As a result many homes were without power for hours and sometimes for days during the storm. It was some of the deepest, longest lasting cold to hit Texas in past 100 years.

Here’s the thing: these were power plant and natural gas supply failures, not failures caused by retail customers.

It is easy to see that customer choice was not to blame. Parts of Texas remain served by electric power monopolies, for example Austin and San Antonio. These monopoly areas saw power system failures like those in Houston and Dallas where customers choose their suppliers.

It’s worth noting, too, that electric reliability remains regulated. Federal regulations dictate reliability standards that apply nationwide, even in Texas. That’s why federal regulators led a major investigation of the failures, issuing a massive report last November. Nothing in the regulator’s report hints customers caused power plant failures.

Under state law Texas regulators have responsibility for overseeing the state’s power grid. That’s why every Texas public utility regulator at the time of the failures resigned or was fired by the Governor. Regulations were inadequate, as the massive failures revealed, but they were regulatory failures.

All this talk about regulation should make clear customer choice is not “deregulation.” Policymakers in fourteen states have chosen regulated markets for their electric power industry instead of regulated monopoly.

What about rates?

A detailed academic study by Rice University economists published in 2019 compared the parts of Texas allowing customer choice to those parts of the state still using monopoly. Power customers with choice saw their prices decline on average while customers locked into monopoly saw their rates remain about flat.

A 2018 analysis by the late Phil O’Connor, a former Illinois state regulator, compared prices in the fourteen states allowing customer choice to rates in the states locking customers into monopolies. customer choice states saw prices drop by 7 percent while rates in monopoly states rose over 18 percent.

A recent survey of rates by the Pacific Research Institute found similar patterns in rates and higher reliability performance and better environmental outcomes in the fourteen states allowing customer choice.

Opponents of customer choice will point to a story in the Wall Street Journal claiming customer choice led to billions in excessive power bills. The WSJ calculation assumes, without explaining or justifying the assumption, that rates should be the same everywhere. This baseline assumption is obviously false and the conclusions are useless.

Note again the more careful study done by Rice University economists that found competition pushed prices down overall in Texas. Some still unpublished academic research finds lower prices in some states with customer choice and higher prices in others, so a full understanding of power prices would require thoughtful digging around.

Arizona’s monopoly utilities are not encouraging thoughtful digging around in the evidence. They want to stop everything without time for any thinking through the evidence.

Monopoly utilities are telling Arizonans scary stories about customer choice because monopolies are afraid of one thing: A customer with a choice might not choose them.

More about Michael Giberson here. While I’ve linked to supporting information above, obviously there is more that can be said on the topic. I’ll continue to build on and explore the issues discussed in this blog.

Comment here or email me at

February 2022 #texasfreeze offers ERCOT a practice run

Many Texans faced forecasts of the early February 2022 winter storm with a degree of anxiety. Last year’s energy system failures had horrendous consequences including lost lives and damaged property. The energy system failures in the biggest energy producing state resulted in billions in damages.

The forecasts were clear this year that nothing like last year’s long, deep freeze was expected. Still, many worried.

As it turned out the forecasts were true enough. There was a two-day period with temperatures stuck below freezing, but nothing like last year. In February 2021 the Dallas-Fort Worth area stayed below freezing for about 130 consecutive hours, but the February 2-5 winter storm remained below freezing just 44 hours.

All in all, the early February freeze made for a practice run for Texas energy suppliers, but not a severe test of the ERCOT-managed power grid. Natural gas supply remains a concern, both because its state regulator appeared relatively unconcerned about last year’s failures and because productions has dipped with freezing temperatures this winter.

The chart below shows temperatures at Dallas Love Field, starting with the hour before temperatures dropped below freezing and ending when temperatures rose above freezing. The early February 2022 event is shown in blue and the solid black is a January 2018 cold snap it resembles. The January 2018 did not produce any serious problems for ERCOT, so there would be few reasons to expect this similar freeze to be a challenge either.

Three other winter weather events are shown for comparison, including last year’s freeze and the February 2011 winter storm. Data described below.

February 2022 is not over yet and we may yet get another winter blast in Texas. No one should declare “mission accomplished.” But the cold did let ERCOT practice it’s “all hands on deck” winter response. They’ll also get a chance to review how things went and be better ready next time.

Chart data: Data above for 2011-2021 collected from the NOAA’s National Centers for Environmental Information. The NCEI data runs about 3 to 5 days behind the present, so I hand scraped hourly data from the Weather Underground history page which is up to date. All data from Dallas Love Field. Obviously it is a big state so one location does not tell the full story.

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