Semi-Daily Journal

hmmm...the analysis seems a little confused. The 'regulation' currently in place is the level of system security. The ISO is responsible for maintaining that regulatorily determined level of security (ensuring supply can and will meet consumption at each point in time) GIVEN the transmission network. The ISO uses bids from generators to determine the least cost method of doing so (whether or not the generation market is competitive is another question).

I understand that the US system (like most) has regulated rate of return for securing investment in transmission. With thes exception of a few small experiments in market determined transmission investment, this looks much like the previous 'utility' approach.

So the statement 'the reality is that deregulation gave the key energy players self-interested incentives not to waste their own funds on maintenance' seems misdirected. The area where infrastructure may have been lacking is not the 'deregulated' area (of generation supply) but in the 'regulated' transmission area.

Of course, with a similar restructuring approach in Australia it could be that investments in the various 'owned' networks continue properly, but that the bits joining up this networks (the interconnections) falls through the cracks in this environment. But that still won't cause things to fall over.

cheers,
Christopher

In the absence of regulation, which among other things helps assure revenue, what institutional pressures would encourage investing in transmission and other infrastructure, particularly lines that interconnect systems?

I don't really see any. The local utility (which here in PA is the end distributor) maintains its local distribution net because it charges separately for the service, on the common-carrier model. Generation is also billed separately, on the model of long-distance phone carriers billed by the local phone provider. All this depends on the long-distance transmission business, the intermediary link, but no one gets to charge separately for it.

If I were a cost-conscious decision-maker in a local distribution utility, wouldn't I be paring the cheese there? My incentives are all in the direction of slashing costs that I can't directly connect to generating income, aren't they?

So, to the extent that I understand Newman, I agree. I just don't see any way to make the transmission business pay.

For corroboration, look at how well the British rail system works (not!), where a separate company (Railtrack) owns only the tracks and can't be bothered to maintain them without vast public subsidy.

Come to my place to have a look at what privatization can do to a nat'l power system that used to work well (and efficient) when it was run by planning. Planning seldom works, but it did in this case (hydro-power reserves were balanced against limited nuke-power supply and expensive emergency oil-power by the planner's full nowlegdge of all system params). Privatization usally works, but this one left too much information exclusively in the hands of dominant players.

Brad, have you actually read Newman's dissertation chapter? Follow the link--it is really bizarre. He strikes me as quite a head case. His views on the Internet, for example, are somewhat, er, eccentric--don't you think?

Is this a better case for "a prophet in his own country" or "kill the messenger"?

I don't know, it seems to me that there are other issues involved having nothing to do with markets per se.

I am struck by the systems aspects. We invited disaster by constructing mechanisms that take capacity off line (in the interest of preserving the equipment from surges) while also investing in mechanisms that distribute demand more widely when this happens (thus adding to the burdens on capacity elsewhere in the network). Unhealthy positive feedback.

Isn't this just myopic design? Sounds like a public policy failure of a different sort.

"Isn't this just myopic design? Sounds like a public policy failure of a different sort."

The public policy failure, as I understand it, is that generation has been significantly deregulated, while transmission remains regulated. Transmission should be deregulated.

Especially good would be variable pricing. During an emergency, owners of key transmission lines should be able to charge 10x, 100x, 1000x, or 1000000x what they normally charge.

That would allow the users...especially the big users, to say, "Yoicks! We don't even want this electricity, if it's going to cost us 100x what we usually pay!"

Oh, I see Jerry Taylor and Peter Van Doren have already addressed some good market responses to The Big Blackout of 2003:

http://nypost.com/postopinion/opedcolumnists/3491.htm

"Instead, why not try deregulating the grid? Kill the cap on transmission profits. Jettison the state regulations that protect transmission companies from competition. Cease the endless political debate over how the transmission lines ought to be organized and managed and let grid owners discover for themselves how to most efficiently run their businesses - something market agents are more adept at learning than legislators or regulators."

I know I'm ignorant, but just you let the rest of you in on the secret, I'm gonna ask a really dumb question.

Why is the electrical transmission grid a natural monopoly that should be gov't regulated, while the oil and gas pipeline system can be, and is, more nearly private/corporately owned?

Ah, so it was regulation that kept the Northeast blackouts of 1977 and 1965 that I lived through from occurring. I always wondered why they didn't happen. ;-)

More to the point, Newman's analysis is backwards. Power generation has been deregulated in some places, but interstate power transmisstion is still highly regulated 1930s-style, the most regulated part of the power system -- and it was the failure of the transmission system, not of generators, that caused the blackout.

Lynn Kiesling of Northwestern writes on this here: http://www.techcentralstation.com/1051/techwrapper.jsp?PID=1051-250&CID=1051-081803F

Note her point about power transmission pricing:

"Under the decades-old regulatory rules controlling the retail sale of power, customer rates are set as averages over the entire year.

"Averaged rates do not take into account the fact that the cost of supplying power to customers can vary hourly. Averaged rates also give customers no incentive to conserve when the cost of providing them with power is high, such as during the late afternoon on a warm summer day like last Thursday.

"Grid operators saw power flow anomalies as early as three hours before the blackout that spread in nine seconds, and in those three hours, if we had market-based retail pricing, even the shifting of a few large customers could have lowered the peak demand and prevented the power surge.

"Both reality and laboratory experiments show that electricity customers do respond to price changes, and that both suppliers and customers are better off from doing so..."

How many other industries do we recommend should be regulated to have retail prices set on year-long averages (other than medical care, of course)?

"I know I'm ignorant, but just you let the rest of you in on the secret, I'm gonna ask a really dumb question."

Such an introduction is seldom followed by a dumb question:

"Why is the electrical transmission grid a natural monopoly that should be gov't regulated, while the oil and gas pipeline system can be, and is, more nearly private/corporately owned?"

As Jerry Taylor and Peter van Doren point out, electrical generation and transmission is not really a natural monopoly. Local generation of electricity is possible, using natural gas...which is what most of the new centrally-located generation systems use, anyway.

So centrally-located electrical generation and long-distance transmission has a competitor in locally generated electricity, due to the presence of natural gas pipelines:

"Most analysts are convinced that the transmission system is a natural monopoly, and so recoil at the very thought of competition to the grid. But it already exists, in the form of natural-gas pipelines."

"All new power plants, after all, are natural gas-fired. They can be located far from urban areas and their product shipped to urban areas via the electricity-transmission system, or they can be located in urban areas and their output shipped locally."

"The competition between gas and electric transmission is no worse than the competition between cable and satellite television service providers."

An editor's note: Not "all" new electrical power plants are fired by natural gas. This is especially so, due to the recent surge in natural gas prices. But as I remember in my check of a couple years ago, something like 80+% of new generation was going to be fired by natural gas.

"Since 1990, electricity demand has shot up by 25 percent since 1990, [while] construction of transmission systems has declined by 30 percent." People will point to why this regulation or that regulation was not in place, but the reality is that deregulation gave the key energy players self-interested incentives not to waste their own funds on maintenance.
~~~~

Well, being that it is the power transmission system that is the most highly regulated part of the system, and that is the part that failed, maybe the regulators should have allowed a higher rate of return on transmission facilities to power companies so they would have had an incentive to construct more of them. Eh?

I am always puzzled by people who assume that competitive market pricing will lead to underinvestment while regulated pricing won't.

Just as if competitive businesses find it profitable to fail to meet customer needs.

And as if politically appointed regulators aren't under political pressure to keep prices -- and rates of return to regulated businesses -- as low as they can get away with, until something bad happens.

http://www.nytimes.com/2003/08/19/opinion/19KRUG.html

The Road to Ruin
By PAUL KRUGMAN

Whatever the initial cause...the current guess is that a local event turned into an epic blackout because the transmission network has been neglected. That is, the power industry hasn't spent enough on the control systems and safeguards that are supposed to prevent such things.

And the cause of that neglect is faith-based deregulation.

In the past, electric power was considered a natural monopoly. It was and is impractical to have companies competing either to wire up homes and businesses, or to build long-distance transmission lines. Because effective competition was impossible, power companies were given local monopolies, and regulated to keep them from exploiting customers.

These regulated monopolies took responsibility for the whole system — transmission and distribution as well as generation. Then came the deregulation movement. It argued that a competitive market could be created in power generation (though not in transmission and distribution), and in much of the country utilities were forced to sell off their power plants....

Krugman:

"...a local event turned into an epic blackout because the transmission network has been neglected ... the cause of that neglect is faith-based deregulation ...

"... the companies providing transmission still had to be regulated. But because regulation limited their profits, they had little financial incentive to invest in maintaining and upgrading the system...."

So the problem was deregulation ... but the problem was that the transmission system is still regulated and the regulators deprived firms of the return needed to make the investments necessary to maintain the system.

;-)

Who was it who famously admired the ability to keep two contradictory thoughts in one's head at the same time? F. Scott?

BTW, Nobelist Vernon Smith has a piece in today's WSJ written with Keisling that informatively goes over the actual economic structure of the power industry, rather than just criticizing "faith-based beliefs".

"These regulated monopolies took responsibility for the whole system — transmission and distribution as well as generation. Then came the deregulation movement. It argued that a competitive market could be created in power generation (though not in transmission and distribution), and in much of the country utilities were forced to sell off their power plants.

In fact, effective competition has been elusive even in power generation. In California, deregulation led to one of history's great policy disasters: energy companies drove up prices by creating artificial shortages. This plunged the state into a crisis that ended only after much of its electricity supply was locked up in long-term contracts, and price controls were imposed on the rest.

Incidentally, there seems to be a weird reluctance to face up to what happened in California. Since the blackout, I've seen national news reports attributing California's woes in part to environmental restrictions, while ignoring the role of market manipulation. Huh? There's no evidence that environmental restrictions played any role; meanwhile, even the Federal Energy Regulatory Commission, which strongly backs deregulation, has concluded that market manipulation played a major role. What's with the revisionist history?

Anyway, market manipulation aside, energy experts have long warned that deregulation would lead to neglect of the grid. Under the old regulatory system, power companies had strong incentives to ensure the integrity of power transmission — they would catch the flak if something went wrong. But those incentives went away with deregulation: because effective competition in transmission wasn't possible, the companies providing transmission still had to be regulated. But because regulation limited their profits, they had little financial incentive to invest in maintaining and upgrading the system. And because of deregulation elsewhere, responsibility was diffused: nobody had a strong stake in keeping the system reliable. The result was a failure not just to add capacity, but to maintain and upgrade capacity that already existed."

http://www.nytimes.com/2003/08/19/opinion/19KRUG.html

Jimmy

Go eat a fig. Paul Krugman is absolutely right. Right wingers are just not capable of telling the truth.

Speaking of "faith based" belief:

-----------quote------------
Jimmy

Go eat a fig. Paul Krugman is absolutely right. Right wingers are just not capable of telling the truth.

Posted by Ari at August 20, 2003 11:51 AM
----------endquote-----------

Naughty Jim, cutting out relevant parts of the sentence:

"But those incentives went away with deregulation: because effective competition in transmission wasn't possible, the companies providing transmission still had to be regulated. But because regulation limited their profits, they had little financial incentive to invest in maintaining and upgrading the system. And because of deregulation elsewhere, responsibility was diffused: nobody had a strong stake in keeping the system reliable."

Looks perfectly consistent with "faith-based deregulation caused this" to me. I'm not sure how they expected the transmission system to work in this environment.

Ari, you're missing the point. Serious libertarians and faith-based conservatives never let little things like history, practical experience, or current events get in the way of their 'greed is good' ideology. As long as someone is making a killing, somewhere, it must be good. Understand?

Deregulation is a red herring, both as a cause and a solution. Transmission infrastructure has been underfunded for a long time. Building a new transmission line is capital intensive and has a fairly long lead-time. Although 25% growth in demand since 1990 may sound like a lot until you compare it against the growth of the economy. Throw in the costs, delays and potential shutdowns from NIMBY activity and you can see why the risk adjusted ROI wasn’t competitive with other capital projects. Transmission was a slowly growing market with large upfront capital outlays, long lead times and a fair amount of risk. [As an example, Montana power dumped electricity in favor of telecom because the growth prospects looked much better.] It’s hard to see how deregulation would have changed this. Similarly, it’s hard to see a regulator signing off on the price increases to cover these expenses. In the long run, transmission prices will rise to make the ROI competitive again. In the meantime…

An interesting thing about electricity is that it is we’re most aware of its value when it’s not there. Some customers have very large costs associated with any outage, even < 1sec. They are willing to pay for extra reliability. Power quality/reliability has been one of the few areas with attractive returns but it is difficult to tap. Upgrading the entire grid just to meet the SLA of a single customer would be prohibitively expensive. The customer does have other options, such as cogeneration, backup generators or a large-scale UPS. If the utility has already upgraded their transmission then it could be competitive. So, in addition to the issues brought up in the previous paragraph we can now add the following: The customers who are most willing to pay have other options.

Given these issues, upgrading an existing transmission line is much more attractive than adding a new one. Of course, losing that line becomes that much more of a problem. The grid becomes more sensitive to perturbations. As the grid approaches capacity, cascade failures become more likely. There was an article in Nature about a year back about there being a power-law relationship between the frequency of outages and their size.

Electricity is a commodity, but it cannot be easily stored in meaningful quantities. Power quality/reliability has a price. Some customers have already figured out what reliability is worth to them. The rest of us will have to figure out how much reliability we are willing to pay for. This is true with or without deregulation.

**Naughty Jim, cutting out relevant parts of the sentence:**

OK, lets see...

** "But those incentives went away with deregulation: because effective competition in transmission wasn't possible, the companies providing transmission still had to be regulated. But because regulation limited their profits, they had little financial incentive to invest in maintaining and upgrading the system."
**

So, PK says that "BECAUSE regulation limited their profits, they had little financial incentive to invest in maintaining and upgrading the system."

That sounds like an operative sentence right there.

**"And because of deregulation elsewhere, responsibility was diffused: nobody had a strong stake in keeping the system reliable."**

Nobody?? What was the job of the regulators of the regulated transmission system?

**Looks perfectly consistent with "faith-based deregulation caused this" to me.**

So you are saying that the regulators of the regulated transmission system put too much trust in "faith based deregulation"? Like they believed deregulation of power generation did their job for them??

**I'm not sure how they expected the transmission system to work in this environment.**

The environment where BECAUSE regulation limited the incentives to maintain and upgrade the transmission system, it failed?

I dunno, maybe they should have increased the regulated return on investment in the transmission system, to provide an incentive to maintain and upgrade it?

Of course that would have run counter to the incentives that regulators, as political appointees, have to keep return to producers and thus prices for consumers as low as possible, until something bad happens.

It's a nifty idea though: the failures of regulators result from other people having too much faith in deregulation. ;-)

**Naughty Jim, cutting out relevant parts of the sentence:**

OK, lets see...

** "But those incentives went away with deregulation: because effective competition in transmission wasn't possible, the companies providing transmission still had to be regulated. But because regulation limited their profits, they had little financial incentive to invest in maintaining and upgrading the system."
**

So, PK says that "BECAUSE regulation limited their profits, they had little financial incentive to invest in maintaining and upgrading the system."

That sounds like an operative sentence right there.

**"And because of deregulation elsewhere, responsibility was diffused: nobody had a strong stake in keeping the system reliable."**

Nobody?? What was the job of the regulators of the regulated transmission system?

**Looks perfectly consistent with "faith-based deregulation caused this" to me.**

So you are saying that the regulators of the regulated transmission system put too much trust in "faith based deregulation"? Like they believed deregulation of power generation did their job for them??

**I'm not sure how they expected the transmission system to work in this environment.**

The environment where BECAUSE regulation limited the incentives to maintain and upgrade the transmission system, it failed?

I dunno, maybe they should have increased the regulated return on investment in the transmission system, to provide an incentive to maintain and upgrade it?

Of course that would have run counter to the incentives that regulators, as political appointees, have to keep return to producers and thus prices for consumers as low as possible, until something bad happens.

It's a nifty idea though: the failures of regulators result from other people having too much faith in deregulation. ;-)

Jim, Paul appears to be saying that "regulators only deregulated the production side and then willfully ignored the transmission side." Since the businesses owning the transmission side have no financial incentive to upgrade them, and the regulators didn't require them to upgrade them, the system failed.

I agree, either the regulators should have upped the profit margins on transmission or the deregulators should have found some way to deregulate transmission while they were at it. The problem is that neither occured.

It's a bit like putting a turbocharger on your car without considering the effect on the frame and brakes, ignoring the mechanic who says its a bad idea to do only the turbocharger.

"It's a nifty idea though: the failures of regulators result from other people having too much faith in deregulation. ;-)"

Yes, Paul Krugman says that "deregulation movement" (he doesn't name names) only had enough "faith" to deregulate generation, not transmission. Next, he points out how the transmission part is what went wrong.

Then he critizes the deregulators for having too *much* faith. He should instead be criticizing the deregulators for having too *little* faith (that they didn't also deregulate transmission).

But I suspect that such an argument would be a violation of Dr. Krugman's own religion.

P.S. Dr. Krugman also neglects to mention the big power outages of 1965 and 1977, which occurred before anything was deregulated. But of course, the outages of 1965 and 1977 are inconvenient facts, which any good "scientist" like Dr. Krugman can ignore. ;-)