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August 12, 2005

VERNON SMITH'S ELECTRICIY OP ED IN TODAY'S WALL STREET JOURNAL

Lynne Kiesling

This weekend marks the two-year anniversary of the Northeast blackout. Today the Wall Street Journal has published a commentary from my colleague Vernon Smith that reflects on the state of electricity restructuring. One main theme of his commentary is that our failure to separate the energy commodity transaction from the wires transaction has stifled creativity and technological innovation at the retail level.

The failure to liberalize the provision of retail energy is the fundamental reason that there has been so little technical innovation in the local distribution of energy to the end-use customers. The electronic age of switching, metering and monitoring has found little application between the end-use customer and the energy supply system. The dead hand of historical cost pricing is hostile to innovation. Without the free entry/exit trial-and-error discovery process there is no way to know how technology, pricing and differential customer preferences can be matched.

No state has yet tried a mandate to separate electricity from the wires monopoly to allow competition in energy sales. In the natural gas industry, however, one state has separated the customer's commodity purchases from the utility's delivery system. Georgia voted to separate the local pipes business from the sale of the natural gas that comes through the pipes. The rental rate for the pipes continues to be regulated as a monopoly, but there are now a dozen competing companies that supply the end-use customer with gas: Each pumps gas vapor into the distribution pool in response to its customers' decisions to burn gas. The gas is metered at the household and the company bills only its own customers. The same model applied to electricity could yield great benefits since over half of total retail cost is the energy component and that is likely to grow.

Since peaking energy is much more costly to produce than base-load off-peak energy, competition would be expected to lower off-peak prices and raise peak energy prices to reflect their differential costs. But peak-energy pricing is only part of the story. The capacity of the grid is determined entirely by peak-energy demand. Reduce peak consumption and you relieve transmission congestion and increase reliability and security. Hence, regulatory reform needs to address how we price the wires infrastructure.

He ends with what I hope will be a thought-provoking challenge:

Is there a state out there willing to mandate separation of the wires monopoly from energy provision, and allow free entry by retail energy merchants?

Right now, Texas is pretty close. Will Texas, the UK, Australia, New Zealand, and Chile be our natural policy experiment in the value of separating the sale of energy from the wires rental? Retail competition is the key to a vibrant, consumer-focused electricity industry.