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05.12.2007 General News

Deregulation of Electricity: Learning from the failures

By The Statesman

Abstract

In just a few days, government will be having National Energy Symposium on electricity supply deregulation. I will like to use this platform to put forth some of the main problems that have come up as a result of deregulation in countries that have deregulated their electric power supply so that appropriate mechanisms with will put in place to avoid failure of the whole exercise.

Deregulation in Electricity Market Competitive market with cost effective prices are strong, and most likely, necessary to balance energy systems in terms of economic efficiency, reliability and environmental responsibility.

However experience of countries that have liberalized their electricity markets has shown that the assumption that markets will naturally produce a competitive result is not always justified.

The ongoing process to deregulate energy supply in Ghana is without questions; however, with respect to electricity, the exercise has to take with some lead-learning. The free market ideology though works well for many consumer goods, has not been successful in the electricity industry due to the characteristics of the industry.

The fact that electricity can not be cost effectively stored in large amounts, the short-run inelasticity of demand with respect to price, and the perfectly inelasticity of supply as demand approach the level of installed capacity are some of the characteristic that make it difficult for free market mechanism to work.

Electricity prices in many countries have gone up after the introduction of deregulation in the power sector. Market power is one of the problems that has come up in many electricity deregulated countries, as the cause of high retail electricity prices.

Market power is typically defined as the ability to profitably alter prices away from competitive levels (Stoft 2002, p.318). The possible consequences of such market power include not only wealth transfers between customers and operators (which are politically important) but also impacts on operational and investment efficiency.

This issue is of particular importance to policymakers and legislators as the effects of market power can substantially erode the benefits of deregulating and electricity market.

Without wasting much time, I will like to give some examples of what has happened in the United States, as it is seen as the leader of free market economy. The current status of electricity deregulation in the US is something to learn from.

By the year 2000, 24 states in the US had passed laws ordering or allowing their monopoly utilities to sell their power plants to other companies or transfer them to their own unregulated affiliates. Six years later, 8 states have appealed, or delayed their deregulation laws in response to California's energy crisis of 2000/2001(Arkansas, Arizona, New Mexico, Nevada, Oklahoma, Oregon, Virginia and West Virginia). Two additional deregulated states still control retail prices of electricity (Ohio and Pennsylvania).

As at January 2007, the price differences between regulated and deregulated states stood as high as 52% (Slocum, 2007). Apart from companies using different strategies to exercise market power, high deregulated electricity prices is said to have resulted from the mechanism for setting market price for electricity. In America, for example, deregulated market are structured using Location Marginal Pricing, in which the price bid by generator supplying the last MW of power to meet demand set the price paid to all generator in the market.

This so called Market Clearing Price is set by the most expensive-to-run generators (Gas fired power plants). As a result, rates set in deregulated wholesale market are based on the highest cost generators. This results in high wholesale prices which are also reflected in retail prices. On the other hand, in a regulated market, rates are set based on the average cost of all generators necessary to meet demand.

Deregulation and Peak Demand

The margin of installed capacity over peak load is often used as a measure of generation adequacy. Because of the dynamics involve in the production and delivery of electricity, the electricity utilities usually with the ownership of generation and transmission infrastructure keep a certain percentage of generation and delivery capacity above the demand levels to handle unforeseen events.

This mean that plants can go offline for regular maintenance, have accidents or even local fuel shortages without been felt or notice by the consumer. This margin has decreased in most countries where deregulation has been implementing. New Zealand and Australia have witnessed a decrease in their reserve margin. This is largely due the capital intensive nature of the electricity industry and the fact that no company will invest in power plant that will run only a few hour in the year to supply power in the circumstances stated above.

This surplus capacity is shrinking in most places because no one could justify building new power plant on financial grounds. Though economically justifiable, decrease in the margin has made the electricity supply system unreliable in many countries and has resulted in blackouts and brownouts in many places.

Conclusions

Deregulation is not magic fairy dust that you can sprinkle on a problem and it goes. It is easy to tell somebody to do something but it is much harder that it happens. The government has the most important role to play in making sure that electricity is delivered to the consumer in affordable, reliable and environmental friendly manner.

These three can not easily be brought about with deregulation or privatization. We may attract private investors only if they know that they can make huge profit, but where will the money come from-: from the consumers and most especially from the residential sector where unemployment is still high.

Samuel Gyamfi

BSC (KNUST), MSC Energy (Aachen, Germany), PhD Candidate*

*Department of Mechanical Engineering, University of Canterbury, Private Bag 4800, Christchurch, New Zealand

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