Deregulation of the electric power industry
|Author:||Mgr. Libor Dušek|
|Year:||1998 - summer|
|Work type:|| Economic Policy
|Awards and prizes:||M.A. with distinction from the Dean of the Faculty of Social Sciences for an excellent state-final examination performance and for an extraordinarily good masters diploma thesis|
|Abstract:||The electric power industry has been traditionally regarded as a standard example of a natural monopoly. In most countries it was organized in vertically integrated monopolies owned by the government or regulated by the government. Exclusive licensing kept competitors out of the market. The concept of a natural monopoly received substantial attention in economic theory, which justified the need to regulate energy monopolies on social welfare grounds and
provided recommendations on efficient methods of regulation.
However, regulation did not work as well as it was originally predicted. Regulatory lag, political abuse of regulation, and incentive failures became new topic for regulatory economists. In addition to that, new technological developments changed the natural monopoly characteristics of the industry. In response to these pressures, countries like United Kingdom, Argentina, the United States, Norway and Sweden decided to rely on competition instead of regulation as a mechanism for efficient production of electricity. Customers were
given choice of their electricity supplier and numerous price regulations were removed. Electricity deregulation has become a hot topic at the European Union level, where large industrial consumers were lobbying for deregulation with a hope to enjoy lower electricity prices. In 1996, the European Parliament passed Directive 96/92/EC that orders all member countries to allow at least the largest consumers to choose their electricity supplier and to adopt some common rules that would open the way for a competitive market in power generation at the pan-European level. There are numerous complicated issues that each country considering a deregulation of the electricity industry has to consider: The speed and range of deregulation, social consequences
of removing cross subsidies, choice of system of access, choice of investment allocation mechanism, generation pricing, transmission pricing, unbundling, ensuring system reliability, regulation of natural monopoly segments, and stranded costs. This thesis focuses on the issues of institutional arrangements in the deregulated electricity industry. More specifically, it compares alternative institutional arrangements for the system of access, investment allocation, and generation pricing, and studies how different arrangements shape the
incentives of market participants as well as the coordinating institutions.
Section 1 presents an overview of the traditional theory of natural monopoly and optimal regulation. Section 2 summarizes the revisionist views of the traditional theory and describes the basic types of regulatory failures. Section 3 describes the mechanism under which a
competitive electricity market can function, even though the electricity grid remains a natural monopoly. I also compare the economic advantages and disadvantages of the two systems of access between which, according to the EU Directive, all EU countries have to choose: the so called single buyer model and third party access model. Section 4 analyzes the two models of investment allocation between which, according to the EU Directive, all EU countries have to choose: the so called tender model and the authorization model. Section 5 focuses on
generation pricing. First, I present an overview of the theory of optimal spot (hourly) pricing of electricity, and then compare two trading mechanisms through which electricity prices may 2 be determined: power pools and bilateral contracts. Finally, in section 6, I present a
mechanism that would give the system operator correct incentives to run the electric system in an efficient manner. I conclude that third party of access, tender model, and bilateral contracts with a voluntary pool is an institutional arrangement that is most likely to promote economic
efficiency in a deregulated electricity market, and that the system operator and the pool should be paid by a fixed fee charged to every MWh of final electricity consumption.