Are customers of Northwest utilities likely to pay higher electricity
rates due to competition?
1997 | Terry
Morlan
Related link: Preliminary Response to the EIA
Report
A common refrain heard in the Pacific Northwest is that because we have
low retail electricity rates compared to other regions, California in
particular, our rates are likely to increase as electricity markets become
more competitive. This perception rests on the assumption that competitive
electricity prices are likely to be an average of consumers? current
electricity prices over a wider market area. This is not the case.
Electricity bills are for more than electricity
Most consumers? electricity bills include far more than the cost of
electricity itself. Transmission and distribution, utility meter reading
and billing, and other services are ?bundled? into one bill along with
the cost of the electricity itself. For most consumers, the electricity
commodity only accounts for about half of their monthly bill. In a
competitive market, each element of electricity service is likely to be
priced separately, or ?unbundled.? Many of these components ? at a
minimum transmission and distribution ? will remain regulated and will
not be directly affected by competition.
Competition won't affect existing transmission and distribution
costs
The fear that rural areas will see higher costs as a result of
deregulation is a good example of confusing electricity commodity costs
with other components of electricity bills. Rural electricity bills tend
to be higher because distribution costs are high, not because the
electricity component of rural residents? bills is more expensive.
There is no reason to expect adverse effects from competition on rural
customers unless those customers? transmission and distribution costs
are currently subsidized by discounts on the price of their electricity.
It will be difficult to sustain such subsidies in the electricity
commodity price in a competitive market because it would mean other
consumers would be paying more than the competitive price to support that
subsidy. However, even if there are subsidies embedded in rural
electricity prices now, some other mechanism could be created to help
rural customers.
Competition will affect the price of the electricity commodity
Unlike transmission and distribution however, the price of the
electricity commodity will be affected by competition. Competition
will result in a fundamental change in the way electricity prices are
determined. In regulated markets, prices are set to recover all utility
costs, so prices are equal to average costs per kilowatt-hour. In a
competitive market, the lowest cost plants would be used first to meet the
demand for electricity. As demand increases, higher cost plants would be
started until the last plant needed to meet demand is put on line. The
variable operating cost of that last plant needed in any time period
determines the electricity price in that period. This is referred to as marginal
cost pricing.
This principle is illustrated by the fact that much of the Bonneville
Power Administration?s competition is from generators in California, an
area that has much higher consumer electricity prices than the Northwest.
Here?s why:
When California generating plants are not needed to meet California
demand, and their power can be sold in the Northwest at a price that is
greater than the plants? variable operating costs (fuel, etc.), the
owners are better off selling at that price and recovering some
contribution to the plant?s fixed capital costs than they would be
leaving the plants shut down. Thus, these plants can undercut Bonneville?s
average costs even if their total costs are higher. The result is that
competition from California can lower wholesale electricity prices in the
Northwest even though consumers? regulated electricity costs in
California remain much higher than consumer prices in the Northwest.
Market prices may not cover all utility costs
In the past, a utility could set prices to recover the full cost of
running its plants because its customers were captive; they could not buy
power from anyone else. Marginal cost pricing in a competitive market may
not allow electric utilities to completely recover their fixed costs ?
primarily their investments in existing generating plants. These
unrecovered costs are referred to in the industry as ?stranded costs.?
Most of the difference between California and Northwest consumers? total
electricity costs will become part of a higher stranded cost in
California.
As policy-makers deal with the restructuring of the electricity
industry, they likely will create provisions for current utilities to
recover some portion of their stranded costs during a transition period.
The stranded cost recovery charge likely will be attached to the
components of electricity service that continue to be regulated (e.g.
distribution wires). If these costs are recovered completely from all
electricity consumers, the total cost of electricity service may not go
down much initially with competition, but the price of the electricity
commodity will.
If a utility?s average cost is below the market price of electricity
? some Northwest utilities may be in this position, but many aren?t
? the utility would earn an extra profit on its electricity sales in a
competitive market. This ?windfall? profit is the mirror image of
stranded costs. It seems reasonable that if consumers are to share in
paying stranded costs, they should also share, in a symmetrical way, in
excess profits created by competition. This could be accomplished through
a credit applied to the utility?s distribution charge, for example.
Higher average costs in California need not mean higher bills for
the Northwest
The fear that low-cost Northwest generators will sell their electricity
to more lucrative California markets leaving customers in the Northwest
with higher electricity prices is not warranted. There are two reasons for
this; one related to competitive electricity commodity pricing, and the
other to stranded cost recovery policy.
(1) A Northwest utility selling in a competitive wholesale market is
likely to net about the same price for its power whether it sells it in
California or in the Northwest. This is because there is already an active
West Coast wholesale market for electricity. As long as competing
generators can ship electricity north and south, significant differences
between wholesale market prices in California and the Northwest cannot
persist. Even when transmission lines are full, the last plant needed to
meet demand in California may be a natural gas fueled generator that is
similar in design and fuel costs to the last plant needed in the
Northwest. As a result, wholesale market prices (determined by marginal
cost) will tend to be nearly equal in California and the Northwest.
(2) Any stranded costs that are created by the restructuring of the
electricity market will be primarily the responsibility of the consumers
originally served by the utility that experiences stranded costs. The
stranded costs may be shared with the shareholders of the utility, but
they will not be shared outside of the utility?s original jurisdiction.
That is, California?s stranded costs will not be recovered from
Northwest purchasers of California generation. Those stranded costs will
be recovered through a transition charge to California users of the
distribution system and paid to the owners of the generation resources
whose costs are above the market price of electricity.
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