The same thing ... only different
I recently came across a post with a point in it that I considered to be irresponsible, especially coming from environmental economist John Whitehead. In it, he claimed that "Electric utilities are natural monopolies -- business firms that must operate on a massive scale in order to bring costs down so that the product can be priced affordably." What on earth does "affordably" mean, exactly? That's a forgivable error if made by a laymen, but not by a practicing economist, especially an environmental economist interest in conservation.
The entire argument surrounding electric utilities and natural monopoly seem to be circular when "affordability" is taken as the reason. From what he's saying, it was recognized that electric utilities realize economies of scale, in other words, that marginal costs fall as the scope of the organization gets larger. It's true that coal-fired plants are extremely efficient on a large scale, and a single centrally planned distribution system is cheaper. So then why do they want them to change (the focus of the rest of the article)? Apparently because the system of franchised electric delivery has external costs like forced global warming, pollution, and the like, bringing into question whether the existing system is cheaper when comparing social cost instead of private cost.
But, focusing on private cost, the current system is "cheaper" in comparison to what, exactly?
The alternative to the current organization of the electric industry is not "the same thing but without regulatory controls on the prices". John even comes close to touching on this when he says, "The natural inclination of monopolies is to raise prices so that profit is maximized ... but electric utilities are heavily regulated in return for government's gift of monopoly status." If the government has given them monopoly status, it may not be a natural monopoly at all. Yet everyone treats the subject as if they are a natural monopoly and that regulation was necessary.
What is the purpose of regulation? Assuming no self-interest, we could say that suppliers favor it because there are increasing returns to scale, that politicians prefer it because they are looking out for the common good, and that consumers prefer it because energy is cheaper. It is true that the current scheme for generating and delivering electricity would be more expensive if there were no regulations. However, if there were no regulations, the industry would not be so organized. This reduces to the argument that if the existing system were different, than it would not be the existing system.
Further, what happens when we relax the assumption of no self-interest from above? We understand that suppliers favor regulation because they are rent-seekers and politicians prefer it because they are power-seekers. I don't have any source for these conclusions, but it seems easy to extrapolate from Gabriel Kolko's findings in the railroad, banking, and other regulated industries.
How does such regulation work? Competitors aren't banned outright, but rather are thwarted by "public benefit" clauses. If I decide to start my own utility -- let's say I'm going to use a solar system -- I must first obtain a license. At the hearings, the license will be opposed by someone (a lawyer for existing utilities) who will argue that because my method of generating electricity is more expensive, then it will not benefit consumers and therefore my license should be denied. In fact, arguing only on private cost, this will be correct because solar costs about $0.20/kW-h to generate, compared to about $0.02/kW-h to generate from a nuclear plant and $0.03/kW-h to generate from a coal-fired plant. But if that is the case, I will fail on my own without need for a regulatory agency to interfere -- what purpose do they serve? If it is redundant to prevent high cost competitors from entering competition, it seems obvious to conclude that the purpose of the regulatory agency is to prevent lower cost competitors from entering competition, which largely undermines the argument that regulated monopolies are the low cost method of providing energy.
I have now asserted that the current organization of energy utilities is the low-cost method, but that the method by which they protect the organization undermines the claim about being low cost. What gives?
Electricity generation was pioneered by Thomas Edison and underwent significant innovation by Westinghouse and his genius engineer, Nikola Tesla, in the late 1880s and early 1890s. Urban areas were the first to be electrified because of the population density. Rural areas were electrified by a distributed system (windmills) until the advent of the REA. I propose that the following alternative history may have shaped the industry if natural monopoly regulation never appeared in the lexicon: Competitors would set up on opposite sides of each town and begin building distribution systems until they hit the territory supplied by other producers. The redundant generation and distribution systems would indeed have been more expensive to producers. If you were in the neighborhood supplied by a less well managed producer, your electricity would be more costly and/or less reliable. People in the marginal neighborhoods could entice the better supplier to build inroads, so prices would be tempered by competition. Businesses would relocate to the better-supplied neighborhoods, depriving the higher cost suppliers of revenue and opening them to bankruptcy, failure, and takeover. Weaker competitors would have reason to combine efforts, for example by sharing lines as well as by merging. Some companies might sell generation capacity and specialize in distribution while others did the opposite. The market for electricity would tend toward consolidation, but would also be tempered by new entrants and competition between large rivals in much the same way as the auto industry is.
Electricity would in fact have been more expensive to the consumer as well as the producer. But that does not necessarily leave consumers worse off than they are now for two reasons: first, more expensive electricity means less generation and less pollution, and second because of the increased importance of conservation measures.
Some measures were already available to consumers with the technology available to them at that time, but there can be no doubt that consumer technology would have taken a different course. Electrical heating is just about the least efficient method of heating a house, but it grew in popularity because the price of electricity was held artificially low compared to natural gas until deregulation in 1980. Passive methods for cooling and heating were largely abandoned because fans, air conditioners, and central heating were so cheap and convenient. Fluorescent lights were invented by Tesla and displayed at the 1893 World's Fair and were in wide use by 1938, but were not made compact and inexpensive enough for household use until the 1990s. Would there have been more emphasis on developing them if incandescent lighting were more expensive? Skylights are an easy alternative, but only recently exploited by Wal-mart in the design of their stores. Low ambient lighting and focused task lighting might have come into vogue earlier instead of the high levels of ambient lighting now almost universally used.
Furthermore, consider what might have been the case if we had developed distributed methods of generation. Currently, about 2/3 of the energy that goes into electric generation is lost as waste heat. Windmills already existed and are currently the favored method of renewable energy, but only in large windfarms. What if every household had one of those old Aermotor windmills like they used to? Surely, a method for sharing my excess power with my neighbors would have grown up, even if it meant that we paid someone to run lines and then run interconnection and backup systems. In such an environment, it would be more feasible for the average homeowner and business to install solar on the roof in order to decrease costs or even improve profitability.
I propose that all of the methods currently advocated for lowering household energy bills would have been more highly developed had there been no public utility regulation. The current organization is the low cost method of delivering energy, but not of consuming it, its uses (lighting, heating and cooling, etc.), or its substitutes (passive design, renewable sources). It's even arguable whether the current system is the low cost of delivering energy given the potential benefits of distributed generation (heat loss, land lost to powerlines, lower susceptibility to system-wide failures). Yes, the centrally planned public utility has an efficient generation and distribution system, but the alternative is not the same system with unconstrained pricing. The alternative is a collection of substitutes, distributed and competitive generation, innovative distribution schemes, and so on.
These are the same outcomes for which advocates of fuel, gas, or other energy taxes implicitly hope. More expensive gasoline is thought to both push consumers toward more efficient vehicles, mass transportation, and different living circumstances (denser communities), while simultaneously coaxing suppliers into developing the more efficient vehicles as well as alternative forms of energy.
The use of energy on roads was made possible by the Progressive "Good Roads" movement of the early 20th century as a direct assault on the supposed market power of the railroads (which, at that time, were ironically almost all in bankruptcy because of the pressure of competition, hence their interest in the Interstate Commerce Commission and its ability to act as a cartelizing agency). The substitution of electricity for passive lighting, cooling, and heating was made possible by the Progressive public utility regulation movement of the early 20th century as a direct assault on the supposed market power of the electric utilities. We are suffering as a result of both of these attempts to scientifically organize society from that era, but the central planners never seem to learn their lesson.
It is arguable that had this regulation not been adopted, we would have seen slower economic growth over the last century. We would not have the same magnitude of environmental concerns that we have now, nor would we have the same means to address them. However, growth would not be so slow as we would calculate if we simply increased the price of electricity over the past century because the pace and direction of consumer technology would have been different, too. In this way, central planning is focused on short term outcomes and market solutions are more flexible in the long term, which is exactly opposite to what central planners will tell you.
The entire argument surrounding electric utilities and natural monopoly seem to be circular when "affordability" is taken as the reason. From what he's saying, it was recognized that electric utilities realize economies of scale, in other words, that marginal costs fall as the scope of the organization gets larger. It's true that coal-fired plants are extremely efficient on a large scale, and a single centrally planned distribution system is cheaper. So then why do they want them to change (the focus of the rest of the article)? Apparently because the system of franchised electric delivery has external costs like forced global warming, pollution, and the like, bringing into question whether the existing system is cheaper when comparing social cost instead of private cost.
But, focusing on private cost, the current system is "cheaper" in comparison to what, exactly?
The alternative to the current organization of the electric industry is not "the same thing but without regulatory controls on the prices". John even comes close to touching on this when he says, "The natural inclination of monopolies is to raise prices so that profit is maximized ... but electric utilities are heavily regulated in return for government's gift of monopoly status." If the government has given them monopoly status, it may not be a natural monopoly at all. Yet everyone treats the subject as if they are a natural monopoly and that regulation was necessary.
What is the purpose of regulation? Assuming no self-interest, we could say that suppliers favor it because there are increasing returns to scale, that politicians prefer it because they are looking out for the common good, and that consumers prefer it because energy is cheaper. It is true that the current scheme for generating and delivering electricity would be more expensive if there were no regulations. However, if there were no regulations, the industry would not be so organized. This reduces to the argument that if the existing system were different, than it would not be the existing system.
Further, what happens when we relax the assumption of no self-interest from above? We understand that suppliers favor regulation because they are rent-seekers and politicians prefer it because they are power-seekers. I don't have any source for these conclusions, but it seems easy to extrapolate from Gabriel Kolko's findings in the railroad, banking, and other regulated industries.
How does such regulation work? Competitors aren't banned outright, but rather are thwarted by "public benefit" clauses. If I decide to start my own utility -- let's say I'm going to use a solar system -- I must first obtain a license. At the hearings, the license will be opposed by someone (a lawyer for existing utilities) who will argue that because my method of generating electricity is more expensive, then it will not benefit consumers and therefore my license should be denied. In fact, arguing only on private cost, this will be correct because solar costs about $0.20/kW-h to generate, compared to about $0.02/kW-h to generate from a nuclear plant and $0.03/kW-h to generate from a coal-fired plant. But if that is the case, I will fail on my own without need for a regulatory agency to interfere -- what purpose do they serve? If it is redundant to prevent high cost competitors from entering competition, it seems obvious to conclude that the purpose of the regulatory agency is to prevent lower cost competitors from entering competition, which largely undermines the argument that regulated monopolies are the low cost method of providing energy.
I have now asserted that the current organization of energy utilities is the low-cost method, but that the method by which they protect the organization undermines the claim about being low cost. What gives?
Electricity generation was pioneered by Thomas Edison and underwent significant innovation by Westinghouse and his genius engineer, Nikola Tesla, in the late 1880s and early 1890s. Urban areas were the first to be electrified because of the population density. Rural areas were electrified by a distributed system (windmills) until the advent of the REA. I propose that the following alternative history may have shaped the industry if natural monopoly regulation never appeared in the lexicon: Competitors would set up on opposite sides of each town and begin building distribution systems until they hit the territory supplied by other producers. The redundant generation and distribution systems would indeed have been more expensive to producers. If you were in the neighborhood supplied by a less well managed producer, your electricity would be more costly and/or less reliable. People in the marginal neighborhoods could entice the better supplier to build inroads, so prices would be tempered by competition. Businesses would relocate to the better-supplied neighborhoods, depriving the higher cost suppliers of revenue and opening them to bankruptcy, failure, and takeover. Weaker competitors would have reason to combine efforts, for example by sharing lines as well as by merging. Some companies might sell generation capacity and specialize in distribution while others did the opposite. The market for electricity would tend toward consolidation, but would also be tempered by new entrants and competition between large rivals in much the same way as the auto industry is.
Electricity would in fact have been more expensive to the consumer as well as the producer. But that does not necessarily leave consumers worse off than they are now for two reasons: first, more expensive electricity means less generation and less pollution, and second because of the increased importance of conservation measures.
Some measures were already available to consumers with the technology available to them at that time, but there can be no doubt that consumer technology would have taken a different course. Electrical heating is just about the least efficient method of heating a house, but it grew in popularity because the price of electricity was held artificially low compared to natural gas until deregulation in 1980. Passive methods for cooling and heating were largely abandoned because fans, air conditioners, and central heating were so cheap and convenient. Fluorescent lights were invented by Tesla and displayed at the 1893 World's Fair and were in wide use by 1938, but were not made compact and inexpensive enough for household use until the 1990s. Would there have been more emphasis on developing them if incandescent lighting were more expensive? Skylights are an easy alternative, but only recently exploited by Wal-mart in the design of their stores. Low ambient lighting and focused task lighting might have come into vogue earlier instead of the high levels of ambient lighting now almost universally used.
Furthermore, consider what might have been the case if we had developed distributed methods of generation. Currently, about 2/3 of the energy that goes into electric generation is lost as waste heat. Windmills already existed and are currently the favored method of renewable energy, but only in large windfarms. What if every household had one of those old Aermotor windmills like they used to? Surely, a method for sharing my excess power with my neighbors would have grown up, even if it meant that we paid someone to run lines and then run interconnection and backup systems. In such an environment, it would be more feasible for the average homeowner and business to install solar on the roof in order to decrease costs or even improve profitability.
I propose that all of the methods currently advocated for lowering household energy bills would have been more highly developed had there been no public utility regulation. The current organization is the low cost method of delivering energy, but not of consuming it, its uses (lighting, heating and cooling, etc.), or its substitutes (passive design, renewable sources). It's even arguable whether the current system is the low cost of delivering energy given the potential benefits of distributed generation (heat loss, land lost to powerlines, lower susceptibility to system-wide failures). Yes, the centrally planned public utility has an efficient generation and distribution system, but the alternative is not the same system with unconstrained pricing. The alternative is a collection of substitutes, distributed and competitive generation, innovative distribution schemes, and so on.
These are the same outcomes for which advocates of fuel, gas, or other energy taxes implicitly hope. More expensive gasoline is thought to both push consumers toward more efficient vehicles, mass transportation, and different living circumstances (denser communities), while simultaneously coaxing suppliers into developing the more efficient vehicles as well as alternative forms of energy.
The use of energy on roads was made possible by the Progressive "Good Roads" movement of the early 20th century as a direct assault on the supposed market power of the railroads (which, at that time, were ironically almost all in bankruptcy because of the pressure of competition, hence their interest in the Interstate Commerce Commission and its ability to act as a cartelizing agency). The substitution of electricity for passive lighting, cooling, and heating was made possible by the Progressive public utility regulation movement of the early 20th century as a direct assault on the supposed market power of the electric utilities. We are suffering as a result of both of these attempts to scientifically organize society from that era, but the central planners never seem to learn their lesson.
It is arguable that had this regulation not been adopted, we would have seen slower economic growth over the last century. We would not have the same magnitude of environmental concerns that we have now, nor would we have the same means to address them. However, growth would not be so slow as we would calculate if we simply increased the price of electricity over the past century because the pace and direction of consumer technology would have been different, too. In this way, central planning is focused on short term outcomes and market solutions are more flexible in the long term, which is exactly opposite to what central planners will tell you.
Labels: energy
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