Friday, May 03, 2002

Column for April 24, 2002:

I'm posting this column because after a long recess, I took on electricity deregulation once again--which prompted a response from my sparring partners at the Goldwater Institute, which in turn will show up in this week's Trib column. So here's the initial column from April 24th that started this latest series of exchanges.

But first, the background: The Tribune devoted the April 21 Perspective section to letters, then did four anti-enviro pieces for Earth Day on Monday, had other stuff to do on Tuesday, but put me in a package with former state Sen. Stan ("New Blood") Barnes on electricity deregulation today, which even runs above right-wing fave Marianne Jennings. (Sorry, it was time to write about electricity deregulation again. I'll try to do something less eye-glazing this week.) Stan is listed as "president of Arizonans for Electric Choice and Competition, which supports competition in the electric generation industry." I'm going to try to get my tag to read that I'm "president of Arizonans for Virtue and Rectitude, which supports mom, the flag, apple pie, and the election of Janet Napolitano as Governor of Arizona." Sounds about as fair.

Deregulation Ignores Need for Capacity Cushion

Last Monday, the earth moved: The Tribune had a second thought about electricity deregulation.

It was only a small one, over an Arizona Corporation Commission deregulation rule requiring retailers, beginning Jan. 1, 2003, to buy half their electricity on the wholesale market. Thus, Arizona Public Service couldn't use its subsidiaries for more than half its customers' power needs unless APS charged itself less than the market price.

Developing a robust wholesale power market probably demands this rule. If utilities aren't required to buy from outsiders, competition may never arrive. Even with market-based intra-company prices, new suppliers won't enter Arizona without knowing they'll actually have wholesale customers.

If APS can buy power at the same price from itself or from some stranger, why would it let a competitor profit instead of APS's own subsidiary?

Unfortunately for the 50 percent rule, it's not guaranteed that a sizeable Arizona wholesale power market will exist in eight months. Serious bottlenecks hamper regional power transmission, and Enron's bankruptcy and California's experience have cast a pretty dark pall over the industry.

APS believes it has plenty of generating capacity, but can't tell if others will supply half its needs beginning Jan. 1. But if APS limits its outside purchases of electricity, a robust market may never develop.

The Tribune editorial had no answer, only that the commission should "proceed cautiously" and consider "possibly scaling back" the requirement, "at least initially." For an editorial page that is not always right but is never in doubt, this hesitation is big news. Maybe this first doubt will lead some less-committed deregulation partisans to rethink the entire experiment.

Maybe you should listen to Warren Buffett, CEO of Berkshire Hathaway, and generally considered one of the world's best investors. The "Oracle of Omaha" holds forth each year at the Berkshire annual meeting, called the "Woodstock of Capitalism." Last May, responding to shareholder questions, Buffett and fellow Berkshire director Charlie Munger both remarked that electricity deregulation ignores the most important thing about the power system: Our need for surplus capacity.

Markets are efficient mechanisms for balancing the desires of numerous buyers and sellers--for equalizing supply and demand. But in electricity, we don't want supply and demand to balance; we always need extra supply in reserve.

Munger used the analogy of designing a bridge to handle exactly the maximum likely load, and no more. You'd rather drive on a bridge designed to handle a substantially greater load. For both bridges and electricity supplies, you always want a margin of safety.

You never know when less rain in the Pacific Northwest means less hydroelectricity, or if natural gas deliveries get interrupted in Texas, or when two generating plants serving Arizona need to shut down for maintenance or accidents simultaneously.

We need an electrical power system that rewards people, with a decent return on their capital, for building excess capacity that may not be used for years. Not too high a return or too much capacity; too much costs too much.

But without top-down regulation, why would any supplier enter a market just to provide a necessary--but almost always unused--15-20 percent cushion in supply?

Deregulation gives suppliers a disincentive to maintain excess capacity. Each supplier wants higher electricity prices; they make more money that way. But increasing supply makes electricity cheaper, and costs suppliers lost revenue.

Nobody would invest the kind of serious money needed to build generation capacity to make less--especially when tight supplies mean making more. As Buffett said, deregulation creates a situation "where the interests of the utility companies have diverged in a significant way from the interests of society."

The old regulatory system clearly isn't perfect; it's inefficient and rewards mediocrity. But, as Buffett noted, "the problems that would arise from, say, a little bit of sloppy management are nothing compared to the problems that arise from inadequate generation."

So explain to me again: Why are we deregulating electricity?

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