Please Blame the Deregulation and Regulation Fiascos Parte 34

Dick Maclay has offer more light to the discussion as follows:

Len, I am not now, and never have been, an academic. I did participate in deregulation of railroads, and set some precedents in contracts I negotiated. I learned from that experience how beneficial deregulation can be, and how it really works. I will read your references.

Steve, the problem with the Hogan Mental Model is that it does not work. Cost-of-service regulation, the Banks Mental Model, works. If regulators could be more innovative (an oxymoron) then space C, the Unextended Schweppes Mental Model, would replace the Banks model, because it would be a better form of regulation. Market competition, also called Space D and the Extended Schweppes Model, works because competition between suppliers and price elasticity discipline prices.

The Hogan model leaves peaking generators with annual losses each year. When we introduce year-to-year dynamics we see there is an incentive to close power plants, but none to build them. Shortages are inevitable with the Hogan Mental Model. When the shortages occur there is no price discipline because there is no cost-of-service regulation and no price elasticity effect.

Ferdinand suggested that I blamed California’s disaster on the drought. That is not the case. Whatever industry structure we use should cover all states of nature, and droughts are one of those. It was the Hogan model that did in California. Both PG&E and the ISO considered bringing in whatever generation could be mobilized quickly to meet the shortages they saw looming. In a cost-of-service world PG&E would have done so, and been paid for it. The ISO thought it should fill those shoes when PG&E realized it was no longer responsible for reliability. But the PUC told the ISO not to proceed. Providing generation is not its role. But without contracts, most generators were not willing to bring in generators to serve short peaks. The unregulated part of PG&E tried to bring in a barge with FT4 generators, but environmentalists kept it out of the Bay. All that was left was demand reduction. But following the Hogan model, there was no retail price signal. Governor Davis could have done what is done when water is short and called for voluntary reductions in use. Instead, he proclaimed that there was no problem. In the circumstance resulting from piling on so many stupidities, wholesale prices could rise to infinity because there was no price discipline. Unlike cost-of-service and open markets, the Hogan model is internally inconsistent. Perhaps it would be more correct to call it internally incomplete.

Various attempts are being made to fix the Hogan model. One way to fix it is to allow mergers among generators until market power is sufficient to raise wholesale prices to levels that justify supplying all the power demanded at regulated prices. But how many mergers is one too far? I suspect a close examination of Ferdinand Bank’s complaints may reveal that he is complaining about such a system. His criticisms are applicable to such a system.

In the U.S., the favored fix for the Hogan model now is capacity markets. This creates an additional revenue stream that hopefully brings total revenues up to cost-of-service levels. My question about this approach is, why bother? We are left with something that has the underlying inefficiencies of cost-of-service regulation, without the consistency of cost-of-service regulation.

I agree with Steve that the average residential consumer is not interested in more complexity in their lives. It is the industrial and commercial customers, typically two-thirds of the load, that are interested in competition. We could reap much of the available efficiency by deregulating those who want to be deregulated. But, unlike the California fiasco, leaving cost-of-service should be a one way street. During a shortage period spot market prices probably will be higher than regulated prices. Those who choose competition and choose not to hedge should not be allowed to take the lower of market or regulated prices.