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11 Regulation 23 (1987)
Currents of Competition in Electricity Markets

handle is hein.journals/rcatorbg11 and id is 85 raw text is: Currents of Competition in Electricity Markets Vemon L. Smith OVER THE PAST DECADE there has been an impressive decline in the scope of eco- nomic regulation. In major industries such as transportation and communications, firms have been exposed to the discipline of the marketplace, and consumers have reaped sub- stantial benefits. Yet the archetypal utility, the electric power industry, has seen little change. This is not, in my view, because electricity is somehow an exception-the one true utility that must remain under the yoke of regulation if it is to serve the public interest. On the contrary, sub- stantial deregulation of electric utilities is both possible and advisable, and promises significant improvements in the efficiency of power production. The infirmities that typically afflict regulated industries are endemic among electric utilities, and they appear to be getting worse. This has been particularly evident in the enormous cost overruns in the construction of nuclear power plants. It is also evident in the inability of the industry to cope with the rapid fluctuations in energy prices in recent years, and with a widen- ing array of new technologies. The regulation that now applies to the electric power industry has been largely incapable of responding to a rapidly changing environment. Vernon L. Smith is professor of economics and director of research at the Economic Science Lab- oratory, University of Arizona. Despite the pervasiveness of regulatory con- trol over electric power, there have emerged within the industry market-like institutions that are competitive and efficient. In this article I ex- amine the potential for building upon these insti- tutions to substitute competition for regulation in the electric power industry. I discuss some of the market-like arrangements that have emerged in recent years and the ways in which they en- hance competition and lay the groundwork for deregulation. I also consider the longer run question of how the market for power might be organized among deregulated firms. The Status Quo The states regulate electric utilities under classi- cal rate-of-return regulation, which involves set- ting prices that permit a firm to recover its costs, including an allowable fair return on invested capital. Investor-owned utilities accede to these price restrictions in return for an exclusive mo- nopoly franchise for distribution, euphemisti- cally referred to as a certificate of convenience and necessity, granted by the state. The Arizona constitution, for example, which states that monopolies and trusts shall never be allowed, grants an exception for electric power: ordi- narily the distribution of electric energy is essen- tially and rightly monopolistic in its application. AEI JOURNAL ON GOVERNMENT AND SOCIETY 23

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