sábado, mayo 06, 2006

Please Blame the Deregulation and Regulation Fiascos Parte 14

Prof. Banks and other Gentlemen,

Ferdinand is correct about riots in the Dominican Republic. The riots came by a big misunderstanding of consultants and multilateral organizations about the impact of irrational rationing. My work has been to suggest a rational way of rationing.

The expert Vivianne Blanlot of Chile was retained by the World Bank to suggest a solution to the financial crisis of our electric sector. She proposed to manage demand starting at a level 70 to 75% of load average. Such commitment was written into an agreement with the International Monetary Fund.

The approach was to divide circuits in 4 groups in accordance with the level of cash recuperation. The source of the riots was customers with lowest level of cash recuperation were having less than 12 hours of service a day.

Underneath the approach is a misunderstanding of the value of electricity to the customers. Most of the rioting customers were getting apparently free electricity that instead of adding value was actually destroying value.

In general, the electric sector of the Dominican Republic is a textbook example of a systemic crisis. Last year I posted Getting the Power Sector out of Systemic Collapse which explains what I understand is happening in my country. System thinking is a tool that helps confront the complexity of the collapse.

For a discussion of Dominican, Brazilian and California deregulation, I suggest to look at the articles (and my comments) of Rafael Herzberg 2006: New Challenges and Opportunities in the Brazilian Electric Energy Arena and Like It or Not, Deregulated Energy Contracting Is Here to Stay. In the first one I wrote that: “We have the best example of a failed “deregulation” effort in the Dominican Republic, which I have recently characterized as a black hole. Investors came to the Dominican Republic, and in their due diligences didn’t see that a disruptive technology (on-site generation) was making an inroad. A systemic process called “the boiling frog” was at play, resulting in an exponential growth of individual solutions. However, that big problem is giving us great opportunities, as demand response can be developed to transform a very unreliable, disintegrated, and unarticulated system, into the opposite.”

I agree that Electricity WPC is a difficult sale, based on the open wounds. It is still more difficult for me to convince other Dominicans. That is the main reason why I am using EnergyPulse as a vehicle to test my findings. The taste of deregulation in the Dominican Republic is awful. The law, however, is being partially applied. The government mental model is about average prices. However, the system operator is executing monthly transactions based on a marginal wholesale market reality.

Thank you,

José Antonio

Please Blame the Deregulation and Regulation Fiascos Parte 13

Ferdinand E. Banks added another comment to EnergyPulse on this series,

Jose, do you know the song 'I hear you knocking but you can't come in? ' Well, we've almost got the same problem here, except that although the door is open and the invitation mat is out, only people like Mr Maclay and MrGolden are anxious to enter.

It will take a few years before the taste of failed deregulation is out of the mouths of rate-payers in California, Sweden, Norway, Brazil, Ontario and Alberta, South Australia, etc who have, are, and will be burned. But I wouldn't worry if I were you: if enough untruths and misunderstandings about electric deregulation are published, it should eventually be possible to get the deregulation swindle back on the road again.

Please Blame the Deregulation and Regulation Fiascos Parte 12

Another article can be written with the title of Avoiding the Separation Fallacy, to show that the extension of Schweppe's mental model might be the winning form of restructuring. Most of the arguments are dispersed in EnergyPulse and the Grupo Millennium Hispaniola blog.

The hypothesis of the article could be what I said earlier in my last comment to the article The Gap Between Demand Response Potential and Demand Response Reality: “I repeat a restructuring mistake was made to justify open transmission access without understanding that Spot Pricing of Electricity marketplace required non monopsonistic demand responsiveness and engineering requirements for controlling, operating and planning a reliable electric power system. Instead of a stakeholder arrangement for reliability, the power system needs to be designed with ultra-quality, just as nuclear power systems are designed and operated.”

However, the extension to Schweppe’s mental model focuses also on mitigation of external shocks, like fuel volatility, and as such does not support well arguments on paragraph 5 and 6 very well. Instead, it helps generating and T&D investments financing by increasing plant factors, emulating take or pay actions without contractual arrangements. Please recall my comment of April 6, that start with “Well said Mr. Maclay!”, to the article The Gap Between Demand Response Potential and Demand Response Reality.

I repeat once again that the above is not a final word, but an architecture design work in progress.

© José Antonio Vanderhorst-Silverio, PhD. 2006.

Please Blame the Deregulation and Regulation Fiascos Parte 11

Mr. Maclay and other Gentlemen,

Thanks Dick for your comment. I like very much the qualifying insights to my humble posts. My response has two parts. In this one I address paragraphs 2, 3, and 4. In the second I will write about the separation fallacy of transmission and distribution and address paragraphs 5, and 6.

That Enron's mental model is different from Hogan's mental model can be traced to the following quote:

"The debate in California has changed remarkably over the past year or two. Discussion now focuses not on whether retail competition or direct access is possible, but on how to make it happen. The three California investor-owned utilities affected by the commission's decision convened an industry working group, called the Western Power Exchange (Wepex) to address the issues related to implementing the new competitive retail market. Its responsibility has included making three filings to FERC by the end of April 1996, seekiing:

• Approval to create a new institution - the ISO - that will provide comparable open access for wholesale and retail use of the transmission system, plus approval to transfer the control operation and control over a large share of utility transmission facilities to the ISO.

• Approval to create the PX to run a California spot market for power, plus approval for the utilities to sell into the PX at market based prices.

• A determination of the dividing line between transmission, over which the FERC has jurisdiction, and distribution, whose regulation is expected to be left to the states [1]."

The first and second bullets were opposed by Bill Hogan, as the following quote says: "For a different perspective on whether the system operator and the power exchange need to be separated, see "Avoiding the Separation Fallacy," by William Hogan, Electricity Journal, December 1995, pp. 26/37 [2]"

The last bullet is common to Enron's and Hogan's mental models. The origin can be traced to Bill Hogan, as can be seen from my post "Retail Access is Easy" above. As can be seen, Bill Hogan is the most influential person of deregulation.

© José Antonio Vanderhorst-Silverio, PhD. 2006.

Interdepedent Consultant on Electricity

Dominican Republic

[1] Barbara R. Barkovich & Dianne V. Hawk, "Charting a new course in California," IEEE Spectrum, July 1996, pp. 28-29.

[2] Ibid, pp 31.

Please Blame the Deregulation and Regulation Fiascos Parte 10


I forgot to acknowledge that my previous message was also intended to Mr. Casten, Mr. Swinand, Mr. Malinowski, Mr. Pflaum, and Mr. Tanton.

Today I am very busy, but to keep the ball roling I will answer Steve, and partially answer Ferdinand.


Thanks for your comment. I have some answers, but not all the answers. However, as you acknowledge, I try very hard to be consistent.

"Spot Pricing of Electricity" is a seminal book about how electricity prices vary in time and space, with transactions where customers buy from and/or sell to the utility. In some days, wholesale prices vary widely when system is close to capacity unless customers respond. Those events occur randomly, when reserves become insufficient to assure an acceptable expected risk of system failures. That leads me to the next comment regarding complexity.


Thanks for your comment. I accept the remark you make to your finance students. Marketers do it even simpler. Renowned marketer guru, Jack Trout, the author of “The Power Simplicity,” entitled the first chapter of that book "Simplicity: Why people fear it so much." He concludes the chapter with the message: "Complexity is not to be admired. It is to be avoided."

However, before ending chapter 1, when developing an outstanding simple solution, Jack says: "This solution to the problem was simple, though implementing it was a complex process." Let engineers make it easy for the customers by developing the require software based on solid theory and practice, just as nukes are designed and operated. The main problem of deregulation was that economists implemented a simplistic solution - not a simple solution - to electricity deregulation.


José Antonio

Please Blame the Deregulation and Regulation Fiascos Parte 9

Ferdinand E. Banks has posted another comment:

The consumers and legislators who bought the deregulation scam bought it because they were told that electricity prices would be lower. Like me, the average rate payer doesn't care about consumer sovereignty, pressing buttons, checking dials and pulling levers. They just want lower electricity prices. And Jose, didn't they have some riots in your country over electricity prices: please don't tell me that the riots were about the absence of consumer sovereignty.

In Sweden, and probably elsewhere, dumb academics accepted deregulation because it meant research money and plane tickets. On the other hand, you mentioned Bill Hogan. Hogan is a very very smart man, and IF he wanted retail markets separated from wholesale in the way that you say or think, it's because he figured out what could happen if it wasn't. Not what WOULD happen, but what COULD happen. The Enron bosses were also very smart. They just didn't go far enough into mainstream economic theory to get the entire picture.

This concentration on the so-called drought in California is pitiful. Laughable, actually. In Brazil the government asked people to pray for rain, but as the directors of the main generating companies in that country made it clear, the problem was deregulation, reinforced by a crazy belief on the part of the deregulation booster club that if electricity prices fell, there would still be sufficient physical investment. Whether you know it or not, they had the same nutty idea in California, only worse insofar as the details were concerned.

I told my finance students the following: in finance, history, intermediate economic theory and (fairly) elementary math is the way to go. All of them didn't believe me of course, but they still followed my instructions, because they knew that if they didn't, I would fail them with a smile on my face. We have the same problem here: you've taken simple economics and made it complex, and even worse you've gotten the facts wrong. But cheer up gentlemen: five more years and those sensual Californians will have forgotten all about the meltdown, and then you can foist another deregulation swindle on them.

Please Blame the Deregulation and Regulation Fiascos Parte 8

Dick Maclay is suggesting that my insights be considered in the following quote:

Len, Southwest was profitable for years offering lower fares than American, while American lost money. That speaks to overall efficiency. If American beats Southwest on one measure AFTER imitating Southwest that is amusing, but not important to the discussion. The description of how Southwest differs from the pre-deregulation airline model has been written many times, and it is too long to retell here. But if you want to understand how competition upsets inefficient old cartels, do take the time to read about Southwest. Ferdinand, the point is that when customers are no longer denied the full range of choices they choose low cost options, not high cost options.

I bet the failure to deregulate would fail. I would never bet against actual deregulation. You are welcome to your opinion about deregulation, but consider Dr. Vanderhorst-Silverio’s insights.

The great failure in California was that insulating retail customers from wholesale prices was a perfect barrier to a functioning market. When the shortage occurred there was no price signal to reduce consumption. Some described the result as giving everyone market power. It did create an opportunity for everyone to raise their prices, but that is nothing like the economic or legal definition of market power. It was a marvelous demonstration of the basic fallacy of attempting to have half a market.

Dr. Hogan was very influential in the early development of California’s restructuring, and the restructuring did follow the mental of model of isolating wholesale from retail that Dr. Dr. Hogan appears to persist in pushing. I did not locate the description of the Enron model, so I have no way of knowing how it may differ from the Hogan model.

Our modeling of the western interconnect in the mid 1990s forecast prices over $300 /MWh in the 6*16 market if there was a major draught on the Columbia River before 2003, and wholesale markets were isolated from retail customers. Unfortunately, the draught occurred and prices were as forecast. When the generally accepted short-term price elasticity of -.02 was introduced in our model, prices topped out at about $100. Too bad California did not use something along the lines of the Schweppe model.

Even $100 per MWH is high for 6*16, but high prices are part of a major shortage period. Spot prices in all years except 2000 and 2001 have been unsustainably low; too low to justify building new power plants. Some periods with high prices are needed. In context $100 is not bad. The good thing about large variations in prices is that it guides customers away from high cost periods, towards lower cost periods. That is how deregulation resturctures an industry, reducing costs and prices.

Please Blame the Deregulation and Regulation Fiascos Parte 7

Steve Rosenman responded positively to my post on EnergyPulse as follows:

Jose Antonio

I read your recent comments in the above reference. You definitely present a consistent and rational view on the prospect of successfull Deregulation. Digital metering is necessary but not sufficient. What is needed is a digital feedback to the customer of hourly price of electricity. Customer awareness and concern for cost may lead to some feedback control of consumption with set points based on hourly price of electricity