“Sky-high”electric bills on the front page. Europe? The U.K? No, just north of New York City, where local politicians criticized Consolidated Edison of NY, the local electric utility. And further, local business people noted that they had warned of this potential problem a decade ago when the last governor decided to close down the nearby nuclear power plant, Indian Point. Some customers complain that their supply bill (for their electricity usage, not the lines or wires) has tripled in past months. For the typical consumer this is a noticeable increase.
Con Edison—which in the past has taken the stand that it just delivers the electricity (they don’t actually produce it) so go complain somewhere else—announced that it “was reviewing our practices…” and will work out programs to help customers who are struggling to pay these rapidly escalating electricity bills. Meanwhile the staffer of a local member of Congress said, “At the end of the day, it is Con Edison that bills New Yorkers, and, therefore Con Ed that bears direct consumer responsibility for this egregious price hike…” Politicians have focused on how to help consumers pay their bills this winter, both here and in Europe. They don’t focus on the possibility that the existing wholesale electricity market, set up three decades ago to make electricity competitive, may bear responsibility for the mess as well.
Here is how it works. The local utility is a delivery mechanism. It delivers a product (electricity in this case) produced and marketed by somebody else. In theory, the delivery company should not care about the price or quality of the product. And most local delivery utilities do not. They are simple delivery vehicles (“like the milkman”, a former Con Ed executive explained) that charge fixed costs for their regulated service. Which from a business point of view is not a great set up. High prices or poor service on the part of electricity producers encourages consumers to either go off the grid or cut back on consumption. The local distribution utility’s business and relationship with the customer depends on another company’s skills and probity. Is that a good business strategy? Doesn’t sound like a good one for Con Edison.
Now for the second issue, a little more technical. The unregulated electricity market sets prices on the basis of marginal cost. Generally speaking, natural gas is the marginal fuel and gas-fired generators frequently set the price for our region’s electricity. Remember that in a marginal cost market, every generator gets the same price regardless of production costs. So if the price of gas goes up the price of all electricity (not just that generated by gas) goes up equally as well. (In this instance low cost electricity producers like hydroelectric facilities reap a huge financial windfall). This differs from the old electricity pricing model which added up the prices of all fuels used to generate electricity and raised or lowered prices on the basis of their aggregate cost. In theory, prices go up quickly when marginal fuel price rises and falls just as quickly when the price drops. Although, in practice the price of electricity tends to fall a lot more slowly than the price of sometimes volatile fuel. Generators manage to keep the difference when that happens.
The third issue is one of prudence. The market organizations that manage our electricity grid look for the lowest price electricity. They don’t require a mix of fuels to be on the safe side. They don’t pay generators to run facilities with more expensive fuels in order to maintain diversity. They go for the low price. So, there is not much extra supply to bring on line when the cheap fuel (in this case natural gas) suddenly becomes expensive. This is the literal price we pay for our partly deregulated energy system. The previously regulated system was financially incentivized to maintain redundancy and dampen overall price volatility. But—and this is key—the old regulated utility was designed to absorb the financial risk associated with volatile fuel expense and then settle up later with state regulators. A deregulated system may lower costs somewhat but all of the fuel volatility risk is transferred directly to the consumer. Some members of the public are discovering the true meaning of deregulated energy markets this winter.
Does this sound like a discussion of European dependence on Russian gas rather than New York State power generation? Well, in a way, utility deregulation almost always results in the same outcome. Go for the cheapest fuel source and assume nothing will go wrong. And when it does, let the consumers pay. The only thing we find remarkable here is that consumers continue to accept this.
By Leonard Hyman and William Tilles for Oilprice.com
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