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A Few More Unfriendly Comments on Electric Deregulation

The main driving forces behind electric deregulation are ideology and carelessness. The first of these involves a comparatively small number of movers and shakers, and their foot soldiers, who – consciously or otherwise – have come to believe that high deregulated electricity prices are preferable to low regulated prices. As for the second, this is an unfortunate defect on the part of many voters who, for one reason or another, prefer to abstain from the modest amount of systematic thinking that is useful when dealing with a topic of this nature.

We are now able to study and teach economics from a number of brilliant textbooks. One of these is Microeconomics and Behavior (6th edition) by Robert H. Frank. Early in his book, Professor Frank alludes to the lure that irrationality has for Mr and Ms Consumer, while later he points out that governments in virtually every part of the world intervene in the price and output decisions of important natural monopolies like electric utilities. The problem is that he questions whether – on purely economic grounds – these interventions do more good than harm, implying that this is a matter that will have to be settled in the future. The position of this short ‘discourse’ is that where electricity is concerned, it is already settled. It is impossible these days to avoid being told by friendly bystanders that economics is a non-experimental science, but in truth important experiments are taking place all the time. For example, the fully regulated and fully integrated Southern Company (with headquarters in Atlanta, Georgia) sells electricity at a much lower price and higher reliability than the major electric companies of Texas – a state that, only a few years ago, was often referred to as a role model of deregulation.

Let me put this the way that I enjoy putting it in the lectures that I have given on the present subject: electric deregulation has failed, is failing, or probably will fail in the near future in California, Pennsylvania, Texas and Illinois in the United States; Alberta and Ontario in Canada; Brazil, South Australia, Sweden, Norway, New Zealand, and the United Kingdom. There are almost certainly many more candidates for this negative role of honor, but further inquiry into the deregulation tribulations of those given above should be sufficient for impartial observers to determine which way the wind is blowing. Before moving on I would like to note that in my former home state, Illinois, consumers can look forward to an increase in electricity prices of at least 30 percent in 2007, due to agreements of some weird sort that were entered into when deregulation was launched.

What do I mean by failure? Undoubtedly the most important reason for the initial popularity of deregulation was the promise by various enthusiasts and their paid or unpaid propagandists of lower prices and higher or unchanged reliability, both of which would be served up against a background of increased choice for households and businesses. In addition to these delights, the expression ‘higher efficiency’ was used by the head of the European Union’s Energy Directorate at a conference in Brussels recently, however given his obvious inability to distinguish between fact and falsehood, I sincerely doubt if that gentleman had any real insight into the formal meaning of the expression. In any case, the reality for the countries mentioned above is not lower prices but lower reliabilities. For the most part prices are higher, and expectations are that they will continue to increase. As for increased choice, we have that in Sweden, but what difference does it make when it is impossible to avoid an increase in electricity prices that is considerably more than twice the consumer-price inflation rate.

When the crank idea of deregulation was first broached in Sweden, one of the local poster boys praised it to the high heavens because, on the basis of the low-rent economics in which he and his colleagues specialize, it was pictured as ameliorating any electricity shortages that might appear in the future. On the surface this might have appeared to be a sensible proposition, but it so happened that Sweden produced the lowest cost electricity on the face of the earth, even though it possessed one of the highest reserve margins and had perhaps the highest reliability. In addition, this electricity was sold to the industrial sector at the lowest price in Europe, or perhaps in the world. Exactly how this situation would be improved by installing cables between Sweden and Germany – where the electricity price was the highest in Europe – somehow failed to register with this humble teacher, although apparently it held some attraction for those drowsy colleagues at Swedish universities who had come to the absurd conclusion that there was absolutely nothing for households, small businesses and energy intensive heavy industries to lose if the remainder of Europe was provided with access to the Scandinavian electricity market.

There were of course a few winners in this travesty. As predicted by many journalists, these were the large generating companies and, especially, the Swedish government, which obtained many additional billions of Swedish crowns (i.e. kronor) to squander on the nonsense so dear to Swedish hearts.

VOTE EARLY AND VOTE OFTEN

In theory, though perhaps not in fact, there may be a modicum of good news on the deregulation horizon. The present French government once announced that it intends to privatise 50% of Electricité de France (EdF), but even though they said that they would invest 40 billion Euros in capacity expansion, and would also restrain the rise in electricity prices, the reaction from many of the unions in France was so threatening that a change in plans became necessary, and at present the intention is 15%.

I prefer zero percent, and although not certain, this may be possible if Laurent Fabius takes command in that country after the next election, because he has promised that if given the opportunity he will deprivatise EdF. Some experts do not believe that this option is open. For instance, when the good professor Shmuel Oren (of the University of California) visited Sweden in 2004, he stated that although deregulation in this country was far from perfect, it could not be rescinded.

This happens to be the opposite of the truth, although I doubt whether Dr Oren could get more top-shelf names on his dance card if in his travels he advertised an opinion of this nature. However, if the curse of deregulation can be liquidated in France, it might provide an incentive for the same thing to take place elsewhere. This is why I would like to give colleagues in France the kind of advice that was passed out by the reigning political machine in the Chicago of my youth, but which was actually coined by the criminal mastermind Murray (the camel) Humphries: “vote early and (if possible) vote often”. This may sound anti-democratic, but please note very carefully that in e.g. the United States, there has not been a (ballot) referendum on deregulation in any state, nor will there be one in any state, city, county, precinct, or ‘hood’ in any part of that country where voters prefer more money to less.

On another level, I would like to stress that by quashing electric deregulation, Monsieur Fabius would be placing himself in the same moral category as General Dwight D. Eisenhower, commander of allied forces in Western Europe during WW2, and later a two-term president of the United States who, although one of the most conservative presidents in the latter half of the century, refused to endorse the deregulation of natural gas because of the negative effect it would have on low and middle income families. (This does not mean, I might add, that according to the economics I teach, the regulation of natural gas at that time made a lot of sense.)

Gas deregulation is also on the EU agenda for Europe. I will not take it up here, but in many respects it is even higher on the crazy list than electricity, because what it will mean is a deregulated Europe on the buy side of the gas market having to deal with external suppliers that are monopolies or strong oligopolies. This could be a very unpleasant experience for the former, even if it might turn out to be trivial in comparison to the mental or financial discomfort that some of us are presently subject to because of things like the ignorant closing of two highly efficient Swedish reactors.

THE BASIC ACADEMIC ECONOMICS ARGUMENTS

Suppose that I was a reputable academic member of the deregulation booster club, and in order to keep the consulting fees, research grants and travel money coming my way, I was given the opportunity to clarify for the television audience why electricity deregulation was even more beautiful than love’s young dream compressed to a video clip. I would start by dramatically insisting that every economics textbook in the world spells out in detail the advantages of a wider and more thorough competition (or what on the electricity scene has come to be called liberalisation). What I would not say is that this story-line appears in the first part of these books, while in later chapters – which neither students nor their teachers usually bother to read – we often find a detailed explanation of why it doesn’t work in the case of industries like electricity and gas. In non-technical but unambiguous language, this reduces to the following.

1) The inability to establish the kind of (theoretically) ideal competitive arrangements found in the first part of your favourite textbook. This is due, for the most part, to increasing returns to scale (i.e. decreasing unit costs) up to a certain output. The way this potentially embarrassing topic was originally handled by deregulationists was simply to state that economic (as opposed to technical) increasing returns to scale do not exist. How did they get this brilliant result? The answer is that they assumed that there would be a fall in the rate of growth in demand for electricity and gas, and so investments that were intended to take advantage of technical returns to scale would take so long to pay off that, in terms of discounted profits, they did not make economic sense! This was perhaps the most looney-tune reasoning of all.

2) Lack of investment in new capacity. As it unfortunately happens, deregulation has provided firms with an increased opportunity to engage in strategic behaviour (as it’s called in game theory), or gaming the system, as it is often labelled in common parlance. Accordingly, they utilize the well known fact that the less the capacity, the higher the price, and depending upon costs, the greater the profits and bonuses. This is why, in Sweden, the major power firms have been so reluctant to shout bloody murder at the government for their nuclear retreat. Moreover, the Swedish government is even more in favour of deregulation than the power companies, because deregulation in Sweden is configured so that when prices for electricity rise, so do government incomes. In addition, a government that is systematically reducing health care for everyone from children to pensioners, as well as eliminating a range of other welfare amenities, is hardly inclined to be overly attentive to the price of electricity, particularly when one of their partners – the environmental party – feels that this price is too low.

3) As pointed out at one time by many deregulationists, and correctly, for deregulation to be successful, adequate facilities must be available for hedging (i.e. insuring against) the price risk that accompanies deregulation. Despite what these fine people believed, and perhaps still believe, these facilities are not available, and they are unlikely to appear. This dilemma is constantly referred to in the business press.

4) Because of its importance, allow me to stress that electricity price risk/uncertainty cannot be hedged on conventional derivatives (e.g. futures and options) markets of the kind that function excellently for various commodities and financial assets. As we found out in California – and especially New South Wales (Australia) – the electricity market is radically different. In fact, there is a simple way to approach this difference. Professor Lennart Berg teaches financial economics at Uppsala University, and he has about 100 finance books of all types in his room. Every new book that is published on this subject comes to him. I have examined at least half of these books and estimate that there are probably less than five pages on electricity and gas derivatives in all his books, or for that matter in any collections of finance books between Uppsala and the Capetown (South Africa) naval yard. Five pages out of thousands or tens of thousands of pages. What none of them bothers to point out is that the most important derivatives exchange in the world, NYMEX in New York, delisted its electricity contracts several years ago, along with at least one of its gas contracts. They may, of course, have reinstated these in one form or another, because the memories of many people who lost money in these markets are too short for their own good, and neither the persons who use or write about platforms of this type are prepared to admit that in theory it would be in the interest of almost every household and business on the buy side of the electricity market if Interpol’s fraud squads were reinforced and given carte blanche to investigate just why electricity deregulation, electricity derivatives, and the exchanges specializing in them came into existence, when these enterprises are provably detrimental to the interests of almost all consumers and small business, as well as energy intensive large industries.

CONCLUDING REMARKS

About a month ago one of electricity deregulation’s poster boys kindly paid Uppsala University a visit in order to act as discussant on a monograph about electricity pricing. I won’t bother going into details, however to my great annoyance I was left with only a few minutes to introduce that gentleman and his small audience to the realities of electricity deregulation, as compared to the bizarre fictions that he and his colleagues have energetically peddled during the last decade.

An hour after suffering through this tedious burlesque, I found myself staring at a full page ‘Comment and Analysis’ in the Financial Times, with the title ‘POWER STRUGGLE: BRITAIN’S BATTLE TO ADAPT ITS LIBERALISED ENERGY MARKET TO A NEW CLIMATE’ (October 6, 2005). Journalists are often smarter about this matter than charter members of the deregulation booster club, however they have their shortcomings too, and so a number of important issues that should have been investigated were overlooked. But there were two important observations. The first was that domestic electricity prices in the UK have increased by more than 30 percent since the start of 2004, while gas prices have increased 35 percent over the same period, with “further increases on the way.

There was also a reference to the future use of gas by the UK, and somewhere in the exposition it was noted that the investment bank Goldman Sachs predicts a ‘gas glut’. This sounds to me like the kind of off-the-wall thinking that at one time took place in New Zealand, where oddball theories about the availability of natural gas led to electricity deregulation being painted in brighter colors than warranted by the facts. Although not certain, I suspect that any heavily industrialized country that becomes dependent on gas to the extent that was forecast for the UK in that article is asking for trouble. We hear a lot about the price of oil, but the present and anticipated price of gas is just as ominous.

When all is said and done, the most important question associated with the electricity deregulation farce is HOW DID IT HAPPEN?

A few years ago a behavioral economist gave a talk in the economics department at Uppsala University, at the end of which I took the liberty of informing him and everybody else present that as long as I was allowed in that building, behavioral economists would find it difficult to ply their trade. But it’s likely that I was wrong. The empirical side of their work still strikes me as a pretentious waste-of-time, but they may be correct in contending that a very large number of people are burdened with a hardwired lack of self-control that prevents them from making rational decisions in crucial matters. I woke up to this phenomenon during my last year in the army, although gradually I came to the conclusion that it was no more significant or widespread than carelessness. The kind of unthinking carelessness that often – but not always – leads intelligent and alert persons to behave irrationally, and to make or support crackpot decisions like electricity and gas deregulation that are completely out of step with the best interests of themselves and their families.

One final observation might be useful. I’m mostly concerned with the fate of consumers like myself under the deregulation of electricity and gas, but in the middle of October the managing director of one of the largest firms in Sweden (SCA) said that his firm would not be making a planned very large investment because of the high price of electricity. Somewhat earlier, the directors of other large industries stated that they will form a syndicate in order to purchase electricity from countries in East Europe.

It thus seems that what deregulation is doing by raising electricity prices is to partially eliminate the comparative advantage that Sweden has enjoyed in some of its major export activities over the past 40 years, and which to a considerable extent accounts for the prosperity of the country. I’m especially thinking of the industries for processing forestry products. If the present situation is not remedied, these firms will not only cease to invest, but eventually move everything movable out of the country, and Sweden will find itself having to deal with the kind of unemployment and social problems that were unthinkable just fifteen years ago. There was a time when Swedish politicians would have understood this, but that was before their judgements were corrupted by dreams of high-paying, non-jobs in some tax-free paradise far from the consequences of their handiwork.

REFERENCES

Banks, Ferdinand E. (2001). Global Finance and Financial Markets. Singapore, London and New York: World Scientific.

______. (2000). Energy Economics: A Modern Introduction. Dordrecht and New York: Kluwer Academic.

Braconier, Fredrik (2005). ‘Utsläppsrätter gör energin dyrare I Sverige’ Svenska Dagbladet (5 October).

Casazza, Jack A. (2001). ‘Pick your poison’. Public Utilities Fortnightly, (March 1).

Costello, Kenneth (2003) . ‘The shocking truth about restructuring of the US

Frank, Robert H. (2006). Microeconomics and behaviour. New York: McGraw-Hill Irwin

Haas, Reinhard and Hans Auer (1998). ‘The relevance of excess capacities for Competition in European electricity markets’. Stencil, Vienna University of Technology.

Mork, Erling (2004). ‘NordPool: A successful power market in difficult times. International Association for Energy Economics Newsletter, 2nd Quarter.

Treblicock, Michael J. and Roy Hrub (2005). ‘Electricity restructuring in Ontario’. The Energy Journal (Vol 26, No 1).

Wallace, Charles P. (2003). ‘Power of the market’. Time, (March 3).
Woo, C.K. and M. King, A. Tishler and L.C.H. Chow (2005). ‘Costs of electricity Deregulation’. Energy. (Forthcoming)

*Condensed version of talk given at a conference sponsored by the European Public Services Unions in Brussels, Belgium, November 3-4, 2005.

Ferdinand E. Banks's picture

Thank Ferdinand E. for the Post!

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Discussions

Martin Homec's picture
Martin Homec on Dec 23, 2005 7:00 pm GMT
The consulting fees, research grants and travel money mentioned above are most of the reason for articles for deregulation. So, why is there no money for those who state the other views? I believe it is because deregulation allows proponents to try different methods of providing utility service and be assured of a large profit if their ideas are forced upon millions of ratepayers. It doesn't matter whether the methods are practical or economically efficient, all that matters is convincing government authorities to implement a scheme. Regulated utility service and municipal power entities provide utility service at cost of service rates, so there is no "extra" money to hand-out to government officials so that they implement a program.

The problem is that there is no open discussion of the best way to provide utility service to ratepayers because proponents of deregulation can get paid and those who oppose it don't get paid.

Len Gould's picture
Len Gould on Dec 23, 2005 7:00 pm GMT
When you state "what on the electricity scene has come to be called liberalisation" in describing deregulation you accurately use the formal definition of the word Liberal as "supportive of policies which benefit the wealthy merchant and business class". Excellent point, and entire article.

I find it curious that politics in the US has come to the point where right-wing republicans can effectively insult the democrats by calling them "liberal". How has it become too left-leaning for the average US voter to be supportive of pollicies which favour bankers (liberals) rather than trust-fund inheritors (conservatives)? Strange and powerfull influences at work.

Jose Antonio Vanderhorst-Silverio's picture
Jose Antonio Vanderhorst-Silverio on Dec 23, 2005 7:00 pm GMT
Thank you, Professor Banks, for outlining the dark side of power sector restructuring (faulty deregulation). As I told you before, I have auto financed my research on Customer Oriented Electricity (COE), which becomes an entirely new paradigm that addresses the core problem identified by Jack Casazza in "Pick Your Poison." As an engineer, under the vertically integrated paradigm, I completely agreed with Jack’s article under faulty deregulation. By the way, I have followed his good work and papers with interest for some time. I agree also with Prof Banks: How did the farce happen?

However, under COE, even with oligopolies on the wholesale market, true retail competition can be organized to pursue economic efficiency (I don’t claim to be an economist), leading to maximum welfare. Please take a look at my comments (and their hyperlinks) under the following article, where I explain uniqueness of the electric industry, price reductions only after a while, the need for a new value chain, physical hedging (related to item 3 and 4 academic arguments at the end of Prof. Banks article), etc. As you can see my work is not based on ideology, but on careful insights, systems architecture and design. Below I add additional comments as an antidote to the faulty deregulation poison, which by all means are not based on ideology at all.

Jack’s assumption that there can be no product (actually service) differentiation is true under a deterministic world, but false on a probabilistic one. Every customer has a perceived supply security requirement (which can vary) that minimizes his/her costs of electricity in the long run. By developing and applying demand response technology, an opportunity to develop new competing business designs innovations can be implemented to satisfy long run least cost power sector development and benefit from increases in scale (item 1 of Prof. Banks academic arguments: is discussed in my last comment to said article). Actually, under systemic competitiveness that would change from least cost to maximum value added.

Under the old paradigm, I also agree with Jack that “Busy signals are not acceptable when a user flicks a switch to light a room.” However, under the new paradigm demand response becomes a condition of service, meaning that customers with low supply security requirements need to respond more frequently, but don’t have to pay (for something they don’t need) the same average rates as customers with high supply security requirements. The result is (or will eventually be) positive, when transaction costs are lower than the value destruction produced by the average rates (see my comments under the article, about some utilities that have justify the investment on other benefits).

On today’s faulty deregulations, short run spot prices do not signal correctly the lack of reserves permitting gaming. On true deregulation, competitive retailers will develop strategies to control price spikes from developing in the first place. They will do that by deploying demand response and energy efficiency investments (item 2 of Prof. Banks academic arguments).

Mr. Casazza though that customers purchasing small generators was due simply because low reliability. Today is known that the penetration of distributed resources is due to disruptive technologies that replaces in many cases efficiently costly peaking units located far from load centers, as well as to represent very well the differentiated requirements of customers supply security (reliability).

Clearly, places that have deregulated already (with agreements of the weird sort, as Professor Banks calls them) will find very difficult and costly to change to true deregulation (and very real choice) of electricity. Under true deregulation efficient generators will be able carry high power factors, but will be unable to earn the huge profits they got under faulty deregulation. So I agree with Professor Banks that to be the case for those countries he mentioned unable to migrate to true deregulation.

Closing questions to Professor Banks:

1. Do you think that Jack’s comment “The changes resulting in these massive errors were a reaction to many years of unfair regulation by often-incompetent regulators, many of whom were concerned with their political and professional futures rather than protection of the consumers” is going to go away anytime soon? It seems that Southern Company isn’t the rule. I prefer to do without with utilities winning cases to regulators under vertical integration, and limiting it only to the wires investments monopoly regulation. 2. Do you see the possibility to organize true retail competition (no price controls) under prudential regulation, even when there are generating oligopolies? 3. What do you see lacking in the approach I suggest? 4. As some retail marketers will become global companies that compete in several local

Jose Antonio Vanderhorst-Silverio's picture
Jose Antonio Vanderhorst-Silverio on Dec 23, 2005 7:00 pm GMT
Continued

4. As some retail marketers will become global companies that compete in several local markets, can they become the target for fusions and acquisitions to develop oligopolies? Do you anticipate how to mitigate it? 5. I see retail marketers’ economies of scope, by taking charge of other services, like telephone, gas, water, and even insurance. Can this be a means for mitigation under question 2? 6. Knowing that value added electricity will come from knowledge intensive coordination of highly distributed activities (some optimal percentage of demand side risk management), instead of physical investment on peaking reserves to be used just a few hours a year (100% supply side risk management). Do you still think that vertical integration is a real vision for the future?

Those are my friendly comments on true retail deregulation.

Merry Christmas to you all.

© José Antonio Vanderhorst-Silverio, PhD. 2005.

Jose Antonio Vanderhorst-Silverio's picture
Jose Antonio Vanderhorst-Silverio on Dec 23, 2005 7:00 pm GMT
Forgot to change color to article

On question 5, where is says question 2, just above, it should say question 4.

Ferdinand E. Banks's picture
Ferdinand E. Banks on Dec 24, 2005 7:00 pm GMT
Thanks for the questions and comments, as well as other questions, comments and denunciations that I have received since mounting my electric and natural gas anti-deregulation soapbox at Nanyang University in Singapore, many moons ago.

I'm afraid however, that I cannot tell Jose Antonio Vanderhorst-Silverio exactly what he wants to know, because everything considered, my knowledge of this subject is relatively limited. For instance, I don't know as much of the engineering as I should and could know. What I do know, however, is the academic economics, and more important I know when people who know the economics as well as I do, or better, have decided to depart from the truth because it pays them to do so. And when I say "pays" I'm talking about real money, and not cigar store coupons or feelings of relief. I'm also specifically talking about economists, because as Larry Chow at the Hongkong Energy Research Centre once said, when engineers hear economists talking about electric deregulation, it makes their heads spin.

Almost as important, I think that the arguments of Jack Casazza, and the people at the Carnegie Mellon Electricity Industry Center are unbeatable.They also have all the evidence on their side, which helps. (And here I can suggest examining the blog of Jesus M. Martin-Giraldo.) I certainly respect the knowledge and interest of Vanderhorst-Silverio in this matter, and I hope that his ideas receive a wide circulation, but in terms of the economic theory that I study and teach, I would really be surprised if I were able to endorse those suggesting that there is an acceptable deregulation agenda out there somewhere if only we take the time to find it. In the present paper I mention deregulation failures in a number of countries, but I have studied only two in detail, California and Sweden, and at the present time am capable of discussing only one, which is Sweden. And that's enough: the electric deregulation 'experiment' in this modern, well ordered, and until recently comparatively honest country tells me everything that I want to know about deregulation, with the emphasis on EVERYTHING.

The economic success of Sweden was largely built on two things: inexpensive and reliable electricity, and a highly efficient educational system. The Swedish entry into the EU will eventually cut the ground out from under the Swedish economy, as well as the quality of life in this country, with the deregulation of electricity helping to speed up the process. The devil may be in the details, but this is the bottom line.

Jose Antonio Vanderhorst-Silverio's picture
Jose Antonio Vanderhorst-Silverio on Dec 24, 2005 7:00 pm GMT
Thanks Prof. Banks for your humble response.

I certainly can only claim to know about deregulation in the Dominican Republic myself, which is one of the worst cases in the world. Our educational system is lousy, and our power system has been expensive and unreliable for many years. Our power sector is right now is under systemic collapse, totally unsustainable, and kept going only on very large, and unsustainable subsidies and 20-25% rotating interruptions ordered by the World Bank and the IMF. Most customers with economic capacity have backup systems. However, I am not an anti-deregulation ideologist, because I firmly believe that our power sector can be turned around with true deregulation, as can be inferred from my presentation at the Spring 2005 Peak Load Management Alliance Conference.

Recently, I have sent an email to Mr. Casazza, and have gone to Jesus M. Martin-Giraldo, Power Encounters blog, where I posted comments in Spanish about 1) a misunderstanding of Fred C Schweppe's Homeostatic Utility Control in the literature review he posted; 2) my blog in which I have posted well over 900 notes, most of them in Spanish, related to what I believe is my meaningful aim of true deregulation (which started on 1995); and 3) CME Industry Center (CMEIC) admission of incomplete (=faulty) deregulation and lack of physical demand side risk management, and referring him to the link of my comments under the article "Strategic Perspectives on Utility Enterprise Solutions," by Warren Causey on EnergyPulse.

I have received no reply from them yet. I agree that under the old paradigm, CMEIC and Mr. Casazza are unbeatable, because they are based on "facts" of the faulty deregulation. However, I humbly think taht under COE hypothesis many of the arguments just don't hold. However, I received a kind reply from Dr. Alfred E. Kahn, but I am not allowed to forward it yet (the email has some legalese at the bottom).

I will send all of them, including the CMEIC the link of this article to see if they may have answers to the questions I asked you.

Best regards,

José Antonio

Jose Antonio Vanderhorst-Silverio's picture
Jose Antonio Vanderhorst-Silverio on Dec 25, 2005 7:00 pm GMT
J Martin's picture
J Martin on Dec 27, 2005 7:00 pm GMT
Dear Mr. Vanderhorst-Silverio, I have the following comments to do: 1) Fred Schewppe supported regulation. In Chapter 5. "A Possible Future: Deregulation", page 111 of the book "Spot Pricing of Electricity" by Fred C. Schweppe, Michael C. Caramanis, Richard D. Tabors and Roger E. Bohn (Kluwer Academic Publishers. 1988 ISBN 0-89838-260-2), we can read: "This chapter shows how the establishment of a spot price based energy marketplace in a regulated environment (which we do advocate) can evolve towards or into a deregulated system. The reader may be surprised to learn that the trip from regulation to deregulation need not be very long (although it may be bumpy)." To me is important to remark that the origins of restructuring are not in the thought of Schweppe, although many people could think so nowadays. Why?. Please pay attention to the first sentence between parenthesis: "Which we do advocate". Schweppe advocated regulation. By extension, this means there is not necessarily a relationship between "deregulation" and "demand response", thus "demand response" could take place in a restructured or non-restructured environment. In my opinion it is more easy "demand response", (or load management, demand side management, market transformation or whatever name adopted along last 30 years you want to call it), takes place in a regulated environment and carried out by a vertical integrated utility under the once very popular IRP (Integrated Resource Planning.). 2) Since its inception, the control scheme of a power system is hierarchical. Id est: a vertical one. This vertical control scheme observes a time scale which comply with the power system states: electromagnetic, transient, and steady states, and short term and long term planning. And this vertical scheme control obeys the organization of a vertical integrated utility as well. With restructuring and unbundling the utility lost verticality and become horizontal. To enlarge my view in this point it could be interesting for instance you pay a view to the Economics book "Markets and Hierarchies: Analysis and Antitrust Implications", by Oliver E. Williamson, Free Press. 1983 ISBN: 0-02934-780-7). There has been a change in the firm organisation, but has NOT been the corresponding change in the control scheme. Now, the point here is whether the classical control scheme affords horizontal utilities. The facts seem to tell no. Then, how to add to the present vertical control scheme a new full horizontal one such the required by "demand response" without provoking clashing?. Neither the multi-agent systems technology is still ready, nor the Agent-based Computational Economics has been developed. See ACE. 3) In present times I would liket to remember a quote of Charles Maurice de Tayllerand-Périgord, that argued French politician who once said: "When something become dark to you, go to the origins". Sincerely yours J Martín-Giraldo Power Encounter
J Martin's picture
J Martin on Dec 27, 2005 7:00 pm GMT
ACE right link. Soory.
Tom Tanton's picture
Tom Tanton on Dec 27, 2005 7:00 pm GMT
In every cited case of the failure of 'deregulation' or 'liberalization' the failure has been the REGULATIION of the ensuing market, not the deregulation per se. In most cases there have been MORE rules than prior to the change. Before you assign the blame on the lack of regulation, take a close and unbiased look at GOVERNMENT failure. You may call me an idealogue, but there can be no question that more creative minds making more creative decisions (on the part of consumer and the part of supplier and all the middles) will lead to higher value (no, not the same as low price)--consumers should be afforded the opportunity to pay more for higher quality and more varied electric service, while those wanting to pay lowest possible for basic quality and service should be allowed to do so. Why should I pay for high quality power for my refrigerator--that cares less--in order to subsidize the computer manufacturer who needs perfect power? Comparing Texas and Southern Company is silly given differences in regions, loads and resources; and recognize price volatility and innovation over years and decades ot just a snap-shot comparison. The arguments for deregulation come primarily from the regulators themselves who fear (mostly sub-conscientiously) they will become stranded assets.
Michael Rothkopf's picture
Michael Rothkopf on Dec 27, 2005 7:00 pm GMT
I commend to those of you interested in this discussion the wisdom of the pseudonoumous Dr Watts to be found in Price C. Watts, “Heresy? The Case Against Electricity Deregulation,” The Electricity Journal 14(4), pp. 19-24, May 2001.
Ferdinand E. Banks's picture
Ferdinand E. Banks on Dec 27, 2005 7:00 pm GMT
Thomas Tanton says that it's silly to compare the situation in Texas with that involving the Southern Company. I don't think so, but he could be right, and so for the present I'll leave that matter to other participants in this forum.

As for the rest of it, well, I think that I will continue to sing my old song about how everywhere I look I see deregulation failures. But at the same time I agree with him about the way that deregulation has meant more rather than fewer rules. This is why when I began my work on electricity deregulation I talked about reregulation rather than deregulation, and that was before the California meltdown. Of course, in some cases those additional rules were necessary, because without them there wouldn't have been failures, but catastrophes.

As for this business of consumers being given the right to pay for higher quality if higher quality- whatever that means - rather than a lower price is what they want, I'm willing to go along with that. Speaking for myself though, I prefer lower prices and higher reliability - which is what we have lost here in Sweden; and according to a mail I received earlier today from a Norwegian gentleman, they have also lost the same in his country.

Richard McCann's picture
Richard McCann on Dec 27, 2005 7:00 pm GMT
While Professor Banks raises some valid points about the failure of "deregulation" (actually "restructuring" in the case of California), he fails to acknowledge some of the issues that lead to deregulation/restructuring in the first place--essentially "regulatory failures."

I'm most familiar with California, so I'll list those. To begin with, all I need to say is "Diablo Canyon." This boondoggle cost 10 times the original estimate (and then this impact was enhanced by a poor contractual arrangement) solely due to the failure of regulation. Several other large utility-managed power projects (including those managed by municipal utilities) also experienced huge cost overruns in the late 1970s and early 1980s. From California's perspective, the utilities had lost the ability to effectively manage the costs of their power plants. The only apparent solution was to turn to the private unregulated sector to construct needed capacity. California has gone through at least four different approaches, each foiled due to faulty regulatory intervention (i.e., the QF "gold rush," FERC stopping the BRPU, FERC failing to enforce market rules, and CDWR's poor contracting negotiations.)

Perhaps the main driver though in the 1990s was the use of electricity pricing as an income redistribution tool. Industrial customers wanted to escape the various subsidies to the residential class. Using pricing policy to achieve such goals always ends up with significant unintended consequences.

Another important factor was changes in technology, which Professor Bankes professes to know little about. The technology improvement that had hidden the inefficiencies of regulatory failure through the 1960s ended in the early 1970s. It was widespread across the economy, not just in electricity, and lead to the stagflation of the period. This exposed the weaknesses of the status quo and sent us looking for solutions. The fact is that we probably would still be building steam turbines instead of combined cycle plants if deregulation had not imposed cost containment on generators. In a related way, the dramatic reduction in coal consumption in the UK can be traced to deregulation and the construction of new gas-fired generation.

The acceleration of decentralized technology (think PCs) also allowed customers to think about generating their own electricity. In California, the threat of industrial customers walking off on their own lead to the brokered restructuring deal in 1995 (and ratified by the Legislature in 1996).

What generally has lead to the failure of deregulation has been the belief by regulators that if industrial (i.e., noncore) customers are allowed to leave, small customers will be left holding the bag of bad utility investments. Losing the large margins provided by industrial customers also reduces the redistributive pot that is the manna of politicians everywhere to gain favor. The resulting schemes were set up to fail again due to attempts to address "equity" concerns that in reality either did not matter or could not be fixed.

The answer, proposed at least in part by CPUC Commissioner Jesse Knight in 1995, should have been an upfront severance payment to the utilities and allowing industrial customers to go off and sign their own contracts. Residential customer advocates should have been left to hide behind the "security" of utility power plants alone.

The other problem is the overemphasis on generation reliability. Customers actually experience substantial unreliability at the distribution level. The current generation reliability standards are at least ten-fold beyond what customers experience today. The focus should be on setting standards at the meter, not the substation transformer. Demand would become more elastic and the market would be less open to manipulation.

Several solutions exist to the current problem, including Oren's proposed reliability call option market. Another is to allow customers to choose how much of their power should be bought as long-term hedges versus from the spot market, following a proposal by Severin Borenstein at UC Berkeley.

Finally, natural gas deregulation in the US has been a roaring success. Even at $12/mcf, the real price of gas is less than it was in the early 1980s before deregulation. The question is what is it from that model that we need to apply to electricity.

Ferdinand E. Banks's picture
Ferdinand E. Banks on Dec 27, 2005 7:00 pm GMT
Mr McCann's contribution to this discussion deserves a few comments. I use the term deregulation instead of restructuring because, although restructuring is correct, it might cause some confusion. Most people say deregulation and so I go along with it.

As for my lack of knowledge about technology, this may or may not be the case, however as far as I am concerned it's irrelevant. I was able to predict the failure of deregulation in California and Sweden on the basis of my background in economics, and this is one situation where economics - if you really understand it - tells you everything that you need to know. EVERYTHING. The same is true in examining what happened in those other places that I named in my article. Of course, the details are different in each case, but where this topic is concerned, I'm not sure that the details are important.

About the suggestions of Professor Oren and Borenstein. Those suggestions are for the chumps, for the know-nothings. As it happens, the rest of us don't have any more space on our dance cards. As I told someone else recently, there is no silver bullet out there that will make a winner of this deregulation travesty. Professor Oren was an honored guest at a seminar/workshop that I attended at Lund University, and he didn't say a word about a reliability call option market. If he had I would have laughed, and more important, so would everybody else - even though, like him, they ostensibly have bought deregulation lock, stock and smoking barrel. The emphasis here is on the word "ostensibly". There might, however, be interest in the work of those two researchers in Norway, because unless I'm mistaken NORDPOOL is constantly on the lookout for novelties to elevate the scam that they have been perpetrating the past four or five years

The proposal of Professor Borenstein is attractive enough to win a place in a nice prestigious academic economics journal, but unfortunately nobody with anything upstairs reads prestigious academic economics journals these days. If you think that they do, try visiting a graduate seminar at your local institution of higher learning. I can also note that if Professors Oren and Borenstein want to turn these deregulation travesties around, they should begin by trying to figure out how to increase investment in generating capacity.

And finally, you say that natural gas deregulation in the US has been a roaring success. In their book on natural gas deregulation, Professors DeVany and Walls predicted that this would be the case. Since I have the greatest respect for both of these scholars, I'm glad to hear this, although one thing is certain: it isn't a success because of what they wrote in that book, because for the most part they got it wrong. And by the way, gas at $12/mcf is very bad news indeed, regardless of its real price. If he is still interested in the subject, I think that Sir Alan Greenspan would be glad to confirm that.

Jose Antonio Vanderhorst-Silverio's picture
Jose Antonio Vanderhorst-Silverio on Dec 27, 2005 7:00 pm GMT
Thank you very much Mr. Martín-Giraldo for your timely comments.

I agree completely that Fred C. Schweppe supported regulation, but a very distinct kind of regulation, which I believe is completely unnecessary today. Experience with faulty deregulation, experience with regulation, the development of new technologies, and additional insights into electric business, suggest serious consideration to the development of a “true” deregulated electric marketplace. The comments that follow are in addition to my earlier article on An Alternative Business Case for Demand Response, as well as my comments dispersed on EnergyPulse.

I believe there has been a big misunderstanding of Fred C. Schweppe proposal. Trying to clarify his proposal, lets consider four general structures for the electric business: A) a traditional vertical integrated utility; B) a faulty deregulation or re-regulation that keeps a largely irresponsive and obsolete utility business model; C) Fred C. Schweppe “Regulated Spot Price Based Energy Marketplace” with homeostatic utility controls, where the utility is the only middleman; and D) a true deregulated electricity market, with retailers innovative business models, without price controls, a new value chain (generator, retailer & customer), while re-regulating the wires monopoly.

As you will see, moving from the regulated Space A to the regulated Space C involves a very large undertaking, while moving from Space C to Space to D no such a large one. The regulated (Space C: see page 11 of Spot Pricing of Electricity) “energy marketplace involves the utility and its customers operating as partners… Utility implementation concerns include real-time calculation/prediction of hourly spot prices, metering-communication-billing, and system control center operation using the new control signal called price… customers who choose to exploit the energy marketplace potentials must implement the appropriate response systems (today demand response), which could range from simple manual response to sophisticated digital controls.”

That explains why on page 123, Schweppe, et al, conclude “that there are many similarities between the regulated energy market place… and the deregulated system.” That also explains very clearly the shortcomings (i.e. price spikes) of, Space B, faulty deregulation.

In addition, on page xvii of Spot Pricing of Electricity, Fred C. Schweppe (et al) understood that “there is a need for fundamental changes in the way society views electric energy... In general terms: …the spot price based energy marketplace involves a variety of utility-customer transactions… These transactions may include customers selling to, as well as buying from, the utility.” Read “fundamental changes” not cosmetic changes in the utilities business models.

On page xviii, they add “A spot price based energy marketplace has many benefits for both the electric utility and its customers. These benefits include improvements in operating efficiency, reductions in needed capital investments, and customer options on the type of (reliability) of electricity to be bought. A spot price based energy marketplace is a win-win situation for both the regulated utility and its customers. The customer’s lifestyles improve because the customers are receiving more service from the use of electric energy per dollar spent. The utility has a more controllable, less uncertain world in which to operate.” That is exactly the opposite of what has been happening, by leaving the customer out in the re-regulation efforts. Demand response will change that.

My hypothesis is that time and reality are given us the opportunity to bypass Space C and go directly to Space D. It does not make any sense today to develop a Regulated Spot Price Based Energy Marketplace. It does not make any sense either to stay at Space A. Maybe my contribution, if there is one, is recognizing that a very simple restructuring, which keeps the wires utility out of the competitive business, creates an opportunity for retail marketers to develop the Deregulated Spot Price Based Energy Marketplace. That I suggest is the required change in firm organization that goes satisfies the control scheme, on the need to develop the corresponding innovative business models.

I add my response to your well documented comments with the dedication of the book “Spot Pricing of Electricity,” that says: “Fred created spot pricing and proved, again, that “The forecast is always wrong!” (Unnumbered page, placed on what should be page v). Schweppe was a feedback genious, which understood (see page 7) that “In the energy marketplace, there is a closed-loop feedback between the utility and its customers. The whole electric power system (generation, transmission, distribution, and customers) is controlled and operated in an integrated fashion, without removing the customers’ freedom of choice. This is made possible by the diversity in costumer’s characteristics, desires and n

Jose Antonio Vanderhorst-Silverio's picture
Jose Antonio Vanderhorst-Silverio on Dec 27, 2005 7:00 pm GMT
continued...

This is made possible by the diversity in costumer’s characteristics, desires and needs… The benefits of well-designed, real time, utility customer feedback are clear, or will be after reading this book.” My hypothesis of “true” deregulation is centered on those perceptions of the customers, which introduce the need for retail marketing and retail competition, which, unfortunately, is the “true” deregulation that the late Fred C. Schweepe had no time to see.

Now I like to respond some of your comments: • To me is important to remark that the origins of restructuring are not in the thought of Schweppe, although many people could think so nowadays. My response:

I believe that sufficient time has past to assign the proper credits, which I am trying to integrate in a true deregulation of electricity. However, I firmly believe that the theory and practice of restructuring of electricity originated with Fred C. Schweppe leadership. The book “Spot Pricing of Electricity” is the place to respond to Charles Maurice de Tayllerand-Périgord, argument: "When something become dark to you, go to the origins."

I believe that Schweppe proposed a “real” restructuring, when he said “New directions for the utility industry are being sought by many interested parties in the government, the private sector, and the universities. One such direction has been widespread interest in utility-customer cooperation through innovative rates characterized by broader options and better use of information on utility costs and customer needs. The goal of this book is to provide a theoretically sound, yet practical foundation for the implementation of utility-customer transactions based on today’s needs. Our goal is to meet four criteria: 1. “Freedom of Choice: provide customers with options on the cost and reliability of supply and how they choose to use electric energy.” 2. Economic Efficiency: Motivate customers to adjust their own electric energy usage patterns to match utility marginal costs. 3. Equity: Reduce customer cross-subsidies… 4. Utility Control, Operation and planning: Consider the engineering requirements for controlling, operating and planning an electric power system.” Commenting the criteria in reverse order: Item 4: is what Mr. Jack Casazza, yourself, myself, and others have been asking all along, which were forgotten in the “deregulation” frenzy. Item 3: had a note: “there are other definitions of equity.” I characterize a supply security (or quality) cross-subsidy, just to cross-subsidize, for example, the computer manufacturer, as Thomas Tanton has rightly pointed out. Average rates to customer classes forbid that. Item 2: motivation underscores the need for retail marketing, which utility minded people find unnecessary. I have to admit that Mr. Schweppe didn’t got that far. Item 1: This is the key element on the differentiation of customers. Technology for a complete market is already here. In the End-State (which is within the next five years) price controls become completely unnecessary, given my article and the comments have made in the EnergyPulse discussions.

Jose Antonio Vanderhorst-Silverio's picture
Jose Antonio Vanderhorst-Silverio on Dec 27, 2005 7:00 pm GMT
Your comment:

• Why?. Please pay attention to the first sentence between parenthesis: "Which we do advocate". Schweppe advocated regulation. By extension, this means there is not necessarily a relationship between "deregulation" and "demand response", thus "demand response" could take place in a restructured or non-restructured environment.

My response:

While the words seem correct, the intent is not. As was seeing from my first response, Fred C. Schweppe advocated a much more different regulation than the re-regulation that California experimented. In fact, Schwepe had suggested very big restructuring effort, with the following 4 above goals. Had they follow Fred C. Schweppe spot pricing “regulation” model; the experiment would have been completely successful. That is why you need to add the sentence “The reader might be surprised to learn that the trip from regulation to deregulation need not be very long…”

Your comment:

• In my opinion it is more easy "demand response", (or load management, demand side management, market transformation or whatever name adopted along last 30 years you want to call it), takes place in a regulated environment and carried out by a vertical integrated utility under the once very popular IRP (Integrated Resource Planning.)

My response: I suggest you to read my response to Bob Lieberman in what I believe is The Birth of the Global Electric Retailer.

Best regards,

José Antonio Vanderhorst-Silverio, PhD

J Martin's picture
J Martin on Dec 28, 2005 7:00 pm GMT
Dear Mr Vanderhorst-Silverio,

I beg your pardon, but you do not answer my question: "how to add to the present vertical control scheme a new full horizontal one such the required by "demand response" without provoking clashing?." I do understand that you have a good command of the Electromagnetic Theory and the Control Theory of Large Scale Control Systems, as well as you have handed on Communications Systems and have coded, installed and kept running computer programs of SCADA Control Center. By other side I would like to know your opinion about whether multi-agent systems and Agent-based Computational Economics will have a role or not in the future of electricity industry.

The electricity restructuring has been approached as a colossal language game, in the sense that Wittgenstein grants to it. In such a game the legitimization of the knowledge comes from the kindness of the plays and counterplays of the language that the players do, but not from the scientific bases of the knowledge that one handles, and that in our case is summarized for the four Maxwell equations which synthesize the whole Electromagnetic Theory. This is what facilitates that besides electricians, every time there are more types of different players intervening in the game of electricity restructuring.

In short. Electromagnetic Theory is not a "beliefs system" such a religion. It is based on scientific knowledge. Power systems do not change their behavior because a law is passed. I am not interested in debating beliefs but facts, and the facts trend to be obstinated: restructuring has failed. I am sincerely very sorry but I am not interested in being involved on a dialectical debate about your beliefs in regulation. I am not have time enough for that. This is my last comment.

PD. En otras palabras. Se acabó la clase.

J Martin's picture
J Martin on Dec 28, 2005 7:00 pm GMT
Dear Mr Vanderhorst-Silverio,

I beg your pardon, but you do not answer my question: "how to add to the present vertical control scheme a new full horizontal one such the required by "demand response" without provoking clashing?." I do understand that you have a good command of the Electromagnetic Theory and the Control Theory of Large Scale Control Systems, as well as you have handed on Communications Systems and have coded, installed and kept running computer programs of SCADA Control Center. By other side I would like to know your opinion about whether multi-agent systems and Agent-based Computational Economics will have a role or not in the future of electricity industry.

The electricity restructuring has been approached as a colossal language game, in the sense that Wittgenstein grants to it. In such a game the legitimization of the knowledge comes from the kindness of the plays and counterplays of the language that the players do, but not from the scientific bases of the knowledge that one handles, and that in our case is summarized for the four Maxwell equations which synthesize the whole Electromagnetic Theory. This is what facilitates that besides electricians, every time there are more types of different players intervening in the game of electricity restructuring.

In short. Electromagnetic Theory is not a "beliefs system" such a religion. It is based on scientific knowledge. Power systems do not change their behavior because a law is passed. I am not interested in debating beliefs but facts, and the facts trend to be obstinated: restructuring has failed. I am sincerely very sorry but I am not interested in being involved on a dialectical debate about your beliefs in regulation. I am not have time enough for that. This is my last comment.

Power Encounter

PD En otras palabras. Se acabó la clase.

Jose Antonio Vanderhorst-Silverio's picture
Jose Antonio Vanderhorst-Silverio on Dec 28, 2005 7:00 pm GMT
Thank you very much Mr. Martin-Giraldo for your last comment. I forgot to say that I didn’t have time to make my comment shorter, even though I spent many patient hours developing it. Certainly, I did not take into account all the details of the issues concerning “Agent-based computational economics,” which I touch now as the item.

I believe, however, there are other readers interested in the dialogue, which deserve and expect to see a reply. I will then add other considerations, based on my humble and limited knowledge.

I am not considering the addition of a new structure to the old one. I am actually using a simpler structure. Instead of two intermediaries, a regulator (with limited industry knowledge) and a utility (with better industry knowledge and in some cases not interested in innovation), following suggestions by EPRI (Electric Power Research Institute, Electricity Sector Framework for the Future, Volume II, pages 4 and 12) to have just only one commercial intermediary: the competitive retailer to manage horizontally the customer side, restricting the wires activities of T&D to the natural monopoly and an independent system operator.

The supply chain of electricity remains unchanged: generation, transmission, distribution, and utilization. The physical equations don't change as well. Evidently, I agree entirely that Electromagnetic Theory is not a "belief system," such as a religion. However, power systems consumers do change their behavior, which is the underlying basis for a demand response system as the basis for Fred C. Schweppe book. Last year I made a presentation to the Peak Load Management Alliance (PLMA) entitled Achieving Electricity Market Value Through DR Technologies, which suggests how to change from a supply orientation to a customer orientation to add value with demand response technology, taking into account the physical operating restrictions.

Except for chapter 5, which treats deregulation, Schweppe's book develops the theory and practice for a vertically integrated, and regulated, electricity market (a large undertaking reserved for innovators). I suggest to the remaining readers to think of a demand response system as an efficient rationing system in the short run. At any moment (under previous agreement with the retailer), customers will “purchase” electricity on the market when the price is right. With the correct mix of supply side and demand side risk management, no price spikes will develop under such a system.

Fred C. Schweppe thought that one combined T&D company would develop, plan, and operate a demand response system as a sole purchaser under vertical scale integration. He thought of a Utility Marketing System, as part of the responsible electric utility, which he mentioned on the paper Homeostatic Utility Control (IEEE PAS May-June 1980). My hypothesis is to change that to several Retailers Marketing Systems (which integrates customer responses) to provide better demand side risk management mitigation than can provide a monopoly utility. Retailers will compete with each other under prudential regulation, such as the banking and financial industry.

The value chain I suggest is different from the supply chain. Repeating myself, it is wholesale, retail, customer. Under a free market (without price controls) every customer will be able to choose the best plan (maximum perceived value addition) under a long run contract from all the offerings of all the retailers. If every customer can do that, the economy as a whole will have the maximum perceived value addition. Initially, however, every retailer is going to try to develop an innovative business design. Water, gas and other services, might give retailers economies of scope. Eventually those with the wrong designs will lose and go bankrupt.

However, If the monopoly develops the wrong design, for example by choosing the wrong AMI (automated metering infrastructure), all customers will lose by paying more than required for electricity. That is why I don't believe in a metering monopoly. Instead, I believe in the development of global retail providers, which select their portion of the AMI to fit their business designs. I believe retailers will be interested in developing specific markets segments, just as in other industries.

Jose Antonio Vanderhorst-Silverio's picture
Jose Antonio Vanderhorst-Silverio on Dec 28, 2005 7:00 pm GMT
Continued...

Basic Issues concerning Agent-based computational economics - some humble initial ideas:

What form should electricity restructuring take? To what extent should regions be permitted to design their own systems rather than adhere to a centralized design -- e.g., FERC's wholesale power market platform (aka standard market design) in the U.S.?

--- I believe that a completely free market can be developed by operating the system under a standard market design different from that of FERC. The philosophy of such a system is underlined on the presentation to the PLMA mentioned above.

How should transmission grid constraints and congestion be properly accounted for in electricity market design?

--- Planning and operation of power systems, coordinated with generators, transmission, and retailers agents should plan and operate the power system to satisfy the reserve requirements to meet the risk management objectives

What role might "financial transmission rights" (PTP, flowgate, ...) play?

--- No direct “financial transmission rights” are required. That was an invention under faulty deregulation.

How important is demand responsiveness for the effective functioning of electricity markets?

--- Demand response, and energy efficiency are the key tools the retailers will manage to participate in a fully functioning market.

To what extent can strategic participants "game the system" under currently proposed/implemented electricity market designs?

--- Prudential regulation review of risk management of retailers is the key to avoid participants “game the system.”

To what extent should independent system operators and other regulatory agencies intervene in electricity markets in an attempt to mitigate market power and inefficiency problems?

--- Independent system operators are to review inadvertent scheduled reserves deviations by retailers and generators, signaling proper prices.

Are the goals of "market efficiency" and "reliable flow of electricity to consumers" necessarily at odds with each other?

Not at all. The retailer system should develop as an efficient rationing system: customers with the least value destruction are to be rationed at every moment.

How can electricity markets be protected against hackers, insider trading, and other illegal disruptive activities as these markets come to depend more heavily on Internet transactions?

--- That is the sole responsibility of each agent (specilly the retailers), that should invest in its own security and mitigation system.

Len Gould's picture
Len Gould on Dec 29, 2005 7:00 pm GMT
Jose: Though I agree in part with your concept I disagree with your required imposition of a "retailing" entity between every customer and every supplier. There is no logical requirement for that provided the customer's own meter itself can automatically select from among available suppliers in a central ISO or distribution-operated electronic marketplace, and record the resuting consumption in that electronic market.

Implementing the structure you advocate a) simply adds another level of infrastructure between the customer and the supplier, an area whcih already accounts for almost half of most electricity bills. b) is already tried and imho failed in several jurisdiction eg. Ontario, where the sole outcome has been much higher costs.

As long as we need to implement more intelligent meters on every customer anyway, as I think everyone is coming to agree is necessary, then in the process we might as well go the extra step and put high-quality continuous communications and some useful central information systems in place as well.

Jose Antonio Vanderhorst-Silverio's picture
Jose Antonio Vanderhorst-Silverio on Dec 29, 2005 7:00 pm GMT
Many thanks Len, once again.

As in any no longer specialized market, some customers can purchase at the wholesale level. Let’s call those wholesale customers. Usually those are large customers. However, there are also some special customers that might be served at wholesale. Those are two market segments, similar to many business environments.

I am not imposing anything, what I believe is that is the simplest way for mass market retail customers to be served by a retailer as I explained to you earlier (see below). The retailer substitutes two intermediaries - the regulator and the distributor. So I reduce a level of infrastructure for retail customers, instead of increasing it. Did Ontario retailers have offering with several supply security options as I suggest? Did Ontario fully implemented demand response?

I now repeat your earlier comment and my (a little bit edited) answer of the 21st of December on the "Free all Wisconsin…" article:

Your comment: Jose: You're close, just not going quite far enough. You need to eliminate your "Retail marketers" by implementing intelligent software within the customer's meters which takes over the simple task of selecting either a lowest-cost supplier from among all available in a central electronic "marketplace", or alternatively choose to not purchase, and shut down some of the customer's less critical loads if the price exceeds customer-set limits.

My earlier answer: Being conservative, I agree with you if there were only the short run market problem. However, there is also a long run problem for which retailers need to coordinate in the wholesale market. This is where I understand boom bust (long run risk management) power system behavior should be managed from the demand side by retail (and wholesale) marketers. Marketing service offerings need to be designed based on what will be coming up in the future.

In addition, while most price response marketplaces have been designed with real-time, day ahead, and hour ahead markets segments, I strongly believe there is an important week ahead market segment (some industries would classify also) mainly for the low end residential market, where retailers need to participate on the wholesale market to complete week-ahead unit commitments.

However, I don’t dismiss "just not going far enough," because I am over 60 years old now, having work through design, operation, planning, management, and research of vertically integrated and (faulty) deregulated power systems, which don’t let me see very well outside of the box. For those simple reasons, Len, maybe I missing something really important, so please (once again) advise! I am looking forward to see the article you promised published.

Regards,

José Antonio

Jose Antonio Vanderhorst-Silverio's picture
Jose Antonio Vanderhorst-Silverio on Dec 30, 2005 7:00 pm GMT
Yesterday, I received the following message from Mr. Jack Casazza

Dear Jose Antonio, I have been reading thje discussions between you, Prof. Banks and others and did not comment previously because I did not have anything to add. I thought perhaps I could be helpful at this time by providing a few comments, as follows: - The restructuring and deregulation of the electric power industry was a serious mistake in the USA and in many countries, harming the general public. - Competition has produced some benefits, particularly in the improvement in the operation of generation plants, but caused a severe decline in the cooordination needed between the participants in the planning, design and operation of the generation and transmission systems of electric power grids. The reduction in the number of companies involved can produce some future savings. - Generation dispatch is based on quoted prices rather that incremental production costs, increasing total production costs. - Present and long range costs have been increased significantly since each company made decisions based on its own profits and not what was best for the overall grid in the long run, i.e., the overall public interest. (In the USA past studies hace shown that the savings from coordination exceeded $20 billion a year before restructing. Many of these prior benefits have been lost.) - In most cases the changes that have been made in the industry structure and procedures cannot be undone, so we have to proceed by trying to use what is good from restructuring and removing or correcting the many harmful things that have resulted. - I believe the greatest harm has been the loss of cooperation and coordination between those involved in the power industry. A way to correct this learned from the past is through "coordination contracts" signed by the participanting companies that provide for the planning, design and operation to be performed as if they constitued a single company. In such contracts the long range lowest total cost solution and lowest cost operation procedures were selected even if it meant that one company had to spend extra funds or give up some profits, as long as it resulted in a lower overall cost or was necessary to preserve reliability, even if in another system. These contracts provided for the compensation of a company for its extra costs or profits foregone plus a share of the overall benefits resulting to the public. (I have negotiated such contracts as far back as 50 years ago.) There is much more analysis needed, but perhaps the comments above will get you thinking about the power system, not the markets. Best regards, Jack Casazza Note to others receiving this message. Please feel free to quote or use it as you wish. Jack Casazza

Jose Antonio Vanderhorst-Silverio's picture
Jose Antonio Vanderhorst-Silverio on Dec 30, 2005 7:00 pm GMT
I repeat the above message to make it more readable

Dear Jose Antonio,

I have been reading thje discussions between you, Prof. Banks and others and did not comment previously because I did not have anything to add. I thought perhaps I could be helpful at this time by providing a few comments, as follows:

- The restructuring and deregulation of the electric power industry was a serious mistake in the USA and in many countries, harming the general public.

- Competition has produced some benefits, particularly in the improvement in the operation of generation plants, but caused a severe decline in the cooordination needed between the participants in the planning, design and operation of the generation and transmission systems of electric power grids. The reduction in the number of companies involved can produce some future savings.

- Generation dispatch is based on quoted prices rather that incremental production costs, increasing total production costs.

- Present and long range costs have been increased significantly since each company made decisions based on its own profits and not what was best for the overall grid in the long run, i.e., the overall public interest. (In the USA past studies hace shown that the savings from coordination exceeded $20 billion a year before restructing. Many of these prior benefits have been lost.)

- In most cases the changes that have been made in the industry structure and procedures cannot be undone, so we have to proceed by trying to use what is good from restructuring and removing or correcting the many harmful things that have resulted.

- I believe the greatest harm has been the loss of cooperation and coordination between those involved in the power industry. A way to correct this learned from the past is through "coordination contracts" signed by the participanting companies that provide for the planning, design and operation to be performed as if they constitued a single company. In such contracts the long range lowest total cost solution and lowest cost operation procedures were selected even if it meant that one company had to spend extra funds or give up some profits, as long as it resulted in a lower overall cost or was necessary to preserve reliability, even if in another system. These contracts provided for the compensation of a company for its extra costs or profits foregone plus a share of the overall benefits resulting to the public. (I have negotiated such contracts as far back as 50 years ago.)

There is much more analysis needed, but perhaps the comments above will get you thinking about the power system, not the markets.

Best regards,

Jack Casazza

Note to others receiving this message. Please feel free to quote or use it as you wish.

Jack Casazza

Jose Antonio Vanderhorst-Silverio's picture
Jose Antonio Vanderhorst-Silverio on Dec 30, 2005 7:00 pm GMT
Below is my first response to Mr. Casazza.

Mr. Jack Casazza, President American Education Institute Distinguished Fellow of the IEEE

Thank you very much Jack for your very valuable, although free, contribution and advice. I am honored for the pleasure of your remarks, which I believe will be taken very well by all of the stakeholders of the power sector of the Dominican Republic and the world.

While I plan to use them for other contexts, the initial and most relevant context is a message, about the deregulation that has taken place here, to all of the power sector agents in the Dominican Republic, its government officials, the multilateral institutions that are aiding us, and our private sector representatives.

I can tell you first hand that our faulty deregulation has made more damage than many other places, because of the lack of institutions that has kept the vicious circle of financial unsustainability alive. The damage here has led to 20 to 25% rotating blackouts, basically by the widespread misunderstanding of many experts that the electric power sector ends at the customer's meters.

Under an IMF program, the Dominican government bought the idea from an expert economist contracted by the World Bank (WB), that (suggested incorrectly) financial sustainability meant to ration customers according to how much is collected from the circuits, without suggesting (I believe) to compensate paying customers. The lack of compensation has distorted even more the situation, increasing unnecessarily the need for subsidies in the year 2005 from 350 million dollars programmed to near 600 million dollars executed. A much stronger vicious circle underlies the situation now.

The government has scheduled over 800 million dollars for subsidies in 2006, which the WB and the IMF have not accepted. Starting before 2005, I advised freely in many occasions that paying customers should be compensated to complete the necessary feedback to turn the vicious circle into a virtuous circle. I believe that the value destruction in our economy is the largest per capita in the world, the power infrastructure cost us more than two or three times what it should cost. Most of the value destruction is not captured by any party, as it becomes lost food and materials, a lot of noise, and smoke, and inefficiently burnt fuels, etc., because of the lack of coordination of un-programmed rotating blackouts.

The most important aspect of coordination is to balance risk of system crashes and the cost to the economy in a well designed system. As a system planner, at the beginning of the 80s, I learned first hand from Puerto Rican planners, which had made a terrible mistake of installing 2 oversized units, how to use probability theory (LOLP ideas) to plan the expansion of generation and transmission system. Later at the end of the 80s I made an expansion plan myself. I have been recently synthesizing that idea as supply side risk management.

As you know perfectly well, the same basic ideas apply to power system operation, using contingency planning to avoid risk of system crashes. A robustly designed system has no substitute. However, deregulation investor looking to gain market power was moved to develop oversize units. For example we have a 300 MW unit for a system operating at 1,200 MW after 25% "demand management." Total lack of coordination has increases as a result.

Jose Antonio Vanderhorst-Silverio's picture
Jose Antonio Vanderhorst-Silverio on Dec 30, 2005 7:00 pm GMT
Continued...

Recently the Dominican government had a plan to develop 2, 1 x 600 MW coal based remote sites. After complains I made, they change to 2, 2 x 300 MW coal based remote sites. I believe they are still too large for our system, but no probabilistic minimum cost simulations have been made by the government office in charge.

In our country we use incremental cost for generation dispatch (short run marginal energy cost). However, oversized units, and many transmission restrictions, and very high costs generating units have made dispatch very inefficient. In addition, the lack of short run marginal supply security cost, I believe, is the reason why gaming the market was and is so easy, here, and everywhere. Professor Schweppe recommended that, but as far I know nobody took it into account.

We have an institution named the "Coordinating Body (CB)," which is not doing at the right level the coordinating and cooperating job it should be doing. It was borne with a contract signed by all market agents, under private decision making which the regulator may overturn. I was on the board of director of the initial CB administration, but were unable to sell my cooperation and coordination suggestions most of the time.

Today the CB is controlled by the government and its politics, although the agents as contractual parties are free to take your bright suggestions an amend it. Although I may be wrong, I perceive that the new foreign managers of the CB, instead of being the leaders, as the first foreign managers try to, are following and "respecting" the regulations, which needs a lot of updating. I hope the agents and the government takes your wise advice and greatly reduces the harm done by the lack of coordination and cooperation.

On September 2004, I decided to become an Interdependent Consultant on Electricity. The reason of being "interdependent" is, as Steven R. Covey says, because interdependence is much more valuable than independence. Interdependence is systemic, not based on simple cause and effects, just like coordination and cooperation are. I have been available, but have not landed one consulting job yet from the CB.

I was contracted on 1996 to offer a solution to the power sector problems of the Dominican Republic. My conclusion was that electricity could be transformed into a business just like most businesses (wholesale, retail, customers), and that Dominicans had the opportunity to become leaders on underdeveloped countries on retail marketers of electricity. In 1998, I identified the emergence of a vibrant retail marketing cluster. This year I made the following presentation to the PLMA, which can turn around the electricity business of the country, by making it very reliable with the complement of demand side risk management to the supply side risk management.

I completely understand your message to concentrate on the power system, but I tell you that I am actually doing a balance effort on both counts. A true deregulation as I am suggesting takes care entirely of the coordination and cooperation difficulties of faulty deregulation. Retailers become in essence very knowledgeable customers that participate in both the wholesale and retail markets, for the long run (centered on energy efficiency) and short run (centered on demand response). The T&D Companies concentrate their effort with the help of CB on the implementation of the new regulations, for planning and operating the system.

Thank you again,

José Antonio

CC: Power system agents Government of the Dominican Republic Multilateral institutions Private sector representatives

Jose Antonio Vanderhorst-Silverio's picture
Jose Antonio Vanderhorst-Silverio on Dec 30, 2005 7:00 pm GMT
This is my second response. Now I will offer two humble comments about Mr. Jack Casazza's suggestions and the world context.

1) In general terms, Jack Casazza suggests repairing Space B (faulty deregulation) with coordination agreements to assure that coordination of the system to produce long and short run minimum costs. To do that I have found that the best signal to private agents is that customer’s interruptions should be compensated under any circumstance. Behind that, by Coase's Theorem, the electricity market is borne, since customers supply security needs now vary widely under each customer class. If that means bridging the gap between the insurance industry and the power industry, then it should be done.

2) If I understand correctly, Jack is concentrating on either/or thinking (concentrate on the system, that the results will follow). As comment 1 introduces important changes to the market, repairs to the market are needed as well. As Toyota showed in the automobile industry, in the power industry we should go for increase quality (and reliability) and reduced costs. To do that we need both efficient markets (no regulator can represent the customer better than himself – shout for no price control) and outstanding systems planning and operation. I suggest we go for both. I believe that calls for the development of true deregulation, as outlined in Space D above, without going into Space C. If a coordination agreement is to be done, do it on both counts, to reduce as much as possible the value destruction to the economy and society.

Patrick O'Rourke's picture
Patrick O'Rourke on Jan 5, 2006 7:00 pm GMT
Professor Banks:

Few would contest that the delivery (wires) portion of the business is a natural monopoly with increasing returns to scale, but that idea is highly debatable when considering generation. Additionally, your characterization of deregulation proponents as relying on “(theoretically) ideal competitive arrangements found in the first part of your favourite textbook” omits the lessons of a field called Industrial Economics, which demonstrates that even oligopolies can reach more efficient outcomes than a monopoly, and sometimes, even a monopoly can be driven to efficiency if there is a real threat of entry into the market.

This one sided presentation, along with the jilted tone of your diatribe, lead me to believe that you in fact, are the ideologue.

Deregulation has theoretical legitimacy, empirical successes, and real life failures. Restructuring this industry will be more complicated than others, but it will require the innovation of market participants, not the engineering of bureaucrats.

Regards,

Patrick O’Rourke

Ferdinand E. Banks's picture
Ferdinand E. Banks on Jan 6, 2006 7:00 pm GMT
Patrick

What I am not going to do is to claim that just about everything you say is wrong, although if you ever had the pleasure of attending one of my lectures, that is exactly what you would hear, and as Humphrey Bogart once said: you would take it and like it.

Instead let me say: NOT IN MY BACK YARD! What they do or don't do with this deregulation scam in the Kalihari or in Monte Carlo doesn't concern me at all. At the same time I have to admit that this particular 'not in my back yard' mantra is strictly bombast, because in this country (Sweden) the dumb politicians (and even dumber academic economists) convinced the drowsy electorate that they would gain if cables were strung between Sweden and Germany, although Sweden had the lowest cost electricity in the world, and Germany the highest in Europe. So much for what you might call theoretical and empirical legitimacy, although I have another name for it.

Outside of that, I think that you should examine the comments of other members of this forum on other papers that dealt with this topic, and also letters to EnergyBiz. Unlike my good self, most of these contributors are probably low-key where ideology is concerned. They'll tell you what you need to know. I'm sure of it.

Strangely enough, nobody but a few (closet) ideologues believe in the future of electricity deregulation any longer- ideologues and academics who have been rewarded with research and travel grants. As far as I can tell, most sensible ideologues have gone on to better things. As for the academics, well, they'll never learn - at least as long as those free plane tickets keep coming.

Thank you.

Jose Antonio Vanderhorst-Silverio's picture
Jose Antonio Vanderhorst-Silverio on Jan 6, 2006 7:00 pm GMT
I find Patrick O'rourke EnergyPulse Command and Control Markets still very timely. The next frontier in electricity is to make use of new technologies, like AMI, and demand response, which need to be "crossing the chasm." Patrick's comment need to be read as a great example of what price controlling agencies are "hard-wired" to do to keep vertical integration alive.

Maybe we need a new expression different from "true" deregulation to convince experts that non-market solutions to electricity industry are (or will soon be) innefficient. Neither utilities, nor regulators, are prepared to cross the chasm. We need competitors to cross the chasm, and so far I have received no acceptable arguments from the expert quoted by Prof. Banks. A simple (but not simplistic) architecture centered on retailers, while keeping the vertical control supply chain structure based on demand response, is worth a try.

Professor Banks decided not to answer my questions and refer them to experts and to a widespread audience, which I am glad that he did. I think he saved face while giving me the benefit of the doubt, which I had documented earlier on my blog . As far I humbly learn, non of the experts had anything substantial against my propossal of true deregulation yet.

While not claiming to be an expert on Sweeden, the problem experimented with price spikes and insufficient reserves, due to faulty deregulation, can be mitigated (unless they are of the wierd sort) by completing the market so that customers become part of the system. A hint to that effect is to ensure that electricity sold Germany is priced on short run marginal costs of energy and supply security. However, that proposition depends on answering apparently tough questions, like my earlier cuestions, for which I want feedback. I repeat them again in a readable format:

1. Do you think that Jack’s comment “The changes resulting in these massive errors were a reaction to many years of unfair regulation by often-incompetent regulators, many of whom were concerned with their political and professional futures rather than protection of the consumers” is going to go away anytime soon? It seems that Southern Company isn’t the rule. I prefer to do without with utilities winning cases to regulators under vertical integration, and limiting it only to the wires investments monopoly regulation.

2. Do you see the possibility to organize true retail competition (no price controls) under prudential regulation, even when there are generating oligopolies?

3. What do you see lacking in the approach I suggest?

4. As some retail marketers will become global companies that compete in several local markets, can they become the target for fusions and acquisitions to develop oligopolies? Do you anticipate how to mitigate it?

5. I see retail marketers’ economies of scope, by taking charge of other services, like telephone, gas, water, and even insurance. Can this be a means for mitigation under question 4?

6. Knowing that value added electricity will come from knowledge intensive coordination of highly distributed activities (some optimal percentage of demand side risk management), instead of physical investment on peaking reserves to be used just a few hours a year (100% supply side risk management). Do you still think that vertical integration is a real vision for the future?

Finally, unless we find a new name for "true" deregulation, I wish Prof. Banks would change his article to A Few More Unfriendly Comments on "Faulty" Electric Deregulation. I undestand that the EU is now questioning competition in electricity and gas, and I humbly think it is the right moment for Sweden to get a better deal. Finally I hope Prof. Banks NIMBY refers only to faulty deregulation.

Ferdinand E. Banks's picture
Ferdinand E. Banks on Jan 7, 2006 7:00 pm GMT
Sorry José, but you'll have to take this discussion up with somebody else. Deregulation was sold to the electorate/television-audience (and their political masters) on the basis of lower prices for their electricity. They don't care about the rest of the soap-opera, and neither do I.

Incidentally, given the structure of the electricity generating industry in this part of the world, your suggestion about short-run marginal cost pricing is completely wrong. Somebody else who got this wrong was Fred Schweppe, which is interesting, because teachers of electrical engineering at MIT are not encouraged to make mistakes.

Former students and colleagues are constantly asking me for advice about career choices, and so I'll pass some out here. Electric deregulation isand always has been a lost cause: its failure wasn't predicted in the stars, but in the economics books that outstanding teachers of that subject like myself used. So, as the great tennis player Bill Tilden said: "Never change a winning game; always change a losing game".

Jose Antonio Vanderhorst-Silverio's picture
Jose Antonio Vanderhorst-Silverio on Jan 7, 2006 7:00 pm GMT
Dear Prof. Banks,

This is both a respectful apology (to show one of my humble weaknesses), and a rebuttal (from my systems training). I am sorry it is too long, but I have no time to make it shorter.

Once again, I might lose my possible allied on what I expected was the “truth” and the “decency” side (an ideology). I thought that no agendas were being promoted (I promote one to offer value added services to the Bottom Of the Pyramid - BOP), but who knows (maybe for you the nuclear industry, but only you can say so).

This time I admit to have exceeded my written language (once again - see Mr. Martin-Giraldo second response above), by careless saying, among other things, that Prof. Banks "saved face" and maybe by placing myself on Patrick side. I admit my second mistake on public, as I have no means to take it back. I thought we were supporting truth as PEST claim to do. That ends the apology, but keeps myself open to an interesting (and hopefully useful) dialog

However, I don't understand, Why do I have to take my discussion with others than the "experts" on faulty deregulation? I don't see anybody else actively discussing about deregulation, but you - this article is a great example - Power Encounter, and PEST (please advice of any others). Faulty deregulation was sold based on the existence of 4 models, under 2 dimensions in a sequence: 1) Vertical integration; 2) Sole purchaser - i.e. PURPA; 3) Wholesale competition; and 4) Wholesale and retail competition. I completely agree with you, Power Encounters, and PEST, that much wrong doing was made and is being made under models 2, 3 and 4, as the engineers were replaced by “market” economists as the leaders of the industry.Professor Schweppe proposed a different model, which respected the accumulated knowledge of the power industry, under a new dimension, called it Model 5: Retail choice, under vertical integration. I repeat that is what his book covers, except for chapter 5 on deregulation. I repeat again (see above under my first response to Mr. Martin-Giraldo) that the new dimension is "Freedom of Choice: Provide customers with options on the costs and reliability of supply and how they choose to use energy." He made not mistake whatsoever, since his model was not implemented yet. His spot pricing of electricity was not considered at all by the "economists" that took control of the power industry, as his feedback system avoids completely the price spikes (hailed by economists as the key to the markets) experienced under faulty deregulation. The technology required to do that is now being allowed to surface: it is today's demand response. The book of Spot Pricing of Electricity is as outstanding as any book that any economist has written. In his plenary address to the International Systems Dynamics Conference, under the title "Economic Theory for the New Millennium," another MIT professor (I hope he is no wrong too), Jay Forrester, has suggested to change economics from a social science to a system profession. I suggest that will give economist the need to file for insurance coverage on their suggestions that affect society with a large bill. I hope that will mitigate contracts of the weird kind.

Demand response is in all plausible future scenarios. It is what is called a predetermined element: What we know we know. It is the key to retail competition, and efficient electricity markets. All ambiguity is somewhere else. I believe that late Prof. Schweppe will receive the Novel Price of Economics (or Physics, or both) sometime in the future.

This is the most important remark I will make on this comment. Since demand response is a predetermined element, as “Energy Bill 2005” call for all states of the union to investigate it, we are bound to see again and again what Patrick O’Rourke has discovered (see my earlier comment above), unless we unite our efforts to avoid Model 5. The same is bound to happen in the European Union, which has committed to a July 1st 2007 complete deregulation. I see two real stable states for the power industry: 1) 2nd Wave Vertical Integration, under Model 1, and 2) 3rd Wave Complete Markets, under Model 6. On both states risk management is under complete control, which is lacking on models 2, 3 and 4. Model 5 is stable, but can turn out to be very expensive. My humble model is Model 6: Retail-marketing competition. It develops the required marketing to produce workable retail competition. It is complemented by wholesale spot prices which signal the expected risk of system failure. That is the type of signal needed. However, if the agreements done on your part of the world were of the weird king, I am sorry for them.

Those that took the discussion on lower prices were doing something different, just not to call it completely wrong. The discussion needs to be on lower costs (as was the discussion under ve

Jose Antonio Vanderhorst-Silverio's picture
Jose Antonio Vanderhorst-Silverio on Jan 7, 2006 7:00 pm GMT
Continued...

Those that took the discussion on lower prices were doing something different, just not to call it completely wrong. The discussion needs to be on lower costs (as was the discussion under vertical integration for the whole power sector): supply costs plus shortage costs. See slides 4 and 5 of my Fall 2004 PLMA Presentation. I will not tell my students - the readers of my blog - to narrow their focus that anything is right or wrong. I operate under the idea that I am not my opinion. I think that way, I am open to new knowledge, can get to the (new) truth faster, and learn from the real experts.

Hoping to get a second chance from you.

Best regards to you and your relatives on 2006.

© José Antonio Vanderhorst-Silverio, PhD. 2006. Interdependent Consultant on Electricity Grupo Millennium Hispaniola Santo Domingo, Dominican Republic

Jose Antonio Vanderhorst-Silverio's picture
Jose Antonio Vanderhorst-Silverio on Jan 7, 2006 7:00 pm GMT
Repeating again the above message to make it more readable:

Dear Prof. Banks,

This is both a respectful apology (to show one of my humble weaknesses), and a rebuttal (from my systems training). I am sorry it is too long, but I have no time to make it shorter.

Once again, I might lose my possible allied on what I expected was the “truth” and the “decency” side (an ideology). I thought that no agendas were being promoted (I promote one to offer value added services to the Bottom Of the Pyramid - BOP), but who knows (maybe for you the nuclear industry, but only you can say so).

This time I admit to have exceeded my written language (once again - see Mr. Martin-Giraldo second response above), by careless saying, among other things, that Prof. Banks "saved face" and maybe by placing myself on Patrick side. I admit my second mistake on public, as I have no means to take it back. I thought we were supporting truth as PEST claim to do. That ends the apology, but keeps myself open to an interesting (and hopefully useful) dialog

However, I don't understand, Why do I have to take my discussion with others than the "experts" on faulty deregulation? I don't see anybody else actively discussing about deregulation, but you - this article is a great example - Power Encounter, and PEST (please advice of any others). Faulty deregulation was sold based on the existence of 4 models, under 2 dimensions in a sequence: 1) Vertical integration; 2) Sole purchaser - i.e. PURPA; 3) Wholesale competition; and 4) Wholesale and retail competition. I completely agree with you, Power Encounters, and PEST, that much wrong doing was made and is being made under models 2, 3 and 4, as the engineers were replaced by “market” economists as the leaders of the industry.

Professor Schweppe proposed a different model, which respected the accumulated knowledge of the power industry, under a new dimension, called it Model 5: Retail choice, under vertical integration. I repeat that is what his book covers, except for chapter 5 on deregulation. I repeat again (see above under my first response to Mr. Martin-Giraldo) that the new dimension is "Freedom of Choice: Provide customers with options on the costs and reliability of supply and how they choose to use energy." He made not mistake whatsoever, since his model was not implemented yet. His spot pricing of electricity was not considered at all by the "economists" that took control of the power industry, as his feedback system avoids completely the price spikes (hailed by economists as the key to the markets) experienced under faulty deregulation. The technology required to do that is now being allowed to surface: it is today's demand response.

The book of Spot Pricing of Electricity is as outstanding as any book that any economist has written. In his plenary address to the International Systems Dynamics Conference, under the title "Economic Theory for the New Millennium," another MIT professor (I hope he is no wrong too), Jay Forrester, has suggested to change economics from a social science to a system profession. I suggest that will give economist the need to file for insurance coverage on their suggestions that affect society with a large bill. I hope that will mitigate contracts of the weird kind.

Demand response is in all plausible future scenarios. It is what is called a predetermined element: What we know we know. It is the key to retail competition, and efficient electricity markets. All ambiguity is somewhere else. I believe that late Prof. Schweppe will receive the Novel Price of Economics (or Physics, or both) sometime in the future.

This is the most important remark I will make on this comment. Since demand response is a predetermined element, as “Energy Bill 2005” call for all states of the union to investigate it, we are bound to see again and again what Patrick O’Rourke has discovered (see my earlier comment above), unless we unite our efforts to avoid Model 5. The same is bound to happen in the European Union, which has committed to a July 1st 2007 complete deregulation. I see two real stable states for the power industry: 1) 2nd Wave Vertical Integration, under Model 1, and 2) 3rd Wave Complete Markets, under Model 6. On both states risk management is under complete control, which is lacking on models 2, 3 and 4. Model 5 is stable, but can turn out to be very expensive.

My humble model is Model 6: Retail-marketing competition. It develops the required marketing to produce workable retail competition. It is complemented by wholesale spot prices which signal the expected risk of system failure. That is the type of signal needed. However, if the agreements done on your part of the world were of the weird king, I am sorry for them.

Jose Antonio Vanderhorst-Silverio's picture
Jose Antonio Vanderhorst-Silverio on Jan 7, 2006 7:00 pm GMT
Continued...

Those that took the discussion on lower prices were doing something different, just not to call it completely wrong. The discussion needs to be on lower costs (as was the discussion under vertical integration for the whole power sector): supply costs plus shortage costs. See slides 4 and 5 of my Fall 2004 PLMA Presentation. I will not tell my students - the readers of my blog - to narrow their focus that anything is right or wrong. I operate under the idea that I am not my opinion. I think that way, I am open to new knowledge, can get to the (new) truth faster, and learn from the real experts.

Hoping to get a second chance from you.

Best regards to you and your relatives on 2006.

© José Antonio Vanderhorst-Silverio, PhD. 2006. Interdependent Consultant on Electricity Grupo Millennium Hispaniola Santo Domingo, Dominican Republic

Ferdinand E. Banks's picture
Ferdinand E. Banks on Jan 8, 2006 7:00 pm GMT
I first saw the concept 'faulty deregulation' right after the California deregulation meltdown, and it was put forward several times at a fairly recent conference in Hong Kong. Needless to say I tuned out, because I'm too smart to become involved in taking something simple and making it complicated.

More important, everything that I ever wanted/needed to say about electric deregulation I say in the above article. I am - as I note - supported by the evidence, but I don't really care about that, since my specialty is theory. From the point of view of theory, the right kind of theory, electric deregulation is a loser. I also suspect that it's a bad career move to try to sell deregulation to persons who have been badly burned by it.

As I mentioned, I met the late Professor Schweppe, and was duly impressed. But he was wrong about deregulation. As for him receiving a Nobel Prize, as you suggest, Nobel prizes in economics are passed out by the ignorant members of the Nobel committee on the basis of what they can or think that they can receive from the laureates. This would very likely have put Fred Schweppe out of contention even if he were still alive.

Finally, Patrick O'Rourke suggests that I am an ideologue. No, Patrick and José, I am not an ideologue: where this topic is concerned I am a fanatic, because it involves my MONEY. Why should I give up a long weekend in Paris this year because busybody politicians have listened to some crank academics, and try to keep this deregulation scam on the rails?

Jose Antonio Vanderhorst-Silverio's picture
Jose Antonio Vanderhorst-Silverio on Jan 9, 2006 7:00 pm GMT
Thank you again Prof. Banks,

Again, for lack of sufficient time to make it shorter, here is another relatively long note.

I have done my research on Costumer Oriented Electricity (COE) under the philosophy of my hero (since early 1980s), the late Dr. Uno Lamm, who wrote extensively on social issues…often critical of the Swedish government. Dr. Lamm, the father of HVDC (High Voltage Direct Current), was evidently from Sweden. He has been quoted saying something like this (from my Spanish version): “for example, here is the opportunity to work with ideas far from our field of specialty. I can enjoy the enthusiasm based on partial ignorance, which, as you know, is bigger and greater that any other enthusiasm.” All my work into other fields is done with such enthusiasm.

This time I will suggest a new title for your paper “A Few More Comments on Electric Reregulation.” The reason for the change comes from Mr. Jack Casazza.s Letter to the Editor or PES Governing Board, published on the IEEE Power Engineering Review, April 1996. Mr. Casazza said, among other things, the following about an article by John Flory et al on “Electric Transactions in an Open Access Market:

“Since 1989, I have represented the United States in a CIGRE activity in which institutional changes going on in various countries were reviewed an analyzed. I have also been personally involved in the management and analysis of many electric utilities in the United States, particularly their economics.”

He continues saying: “I fully understand the need for large industrial companies to lower their electricity costs to be competitive and the potential roles of power marketers and brokers. I believe in competition. Its course is not further however by data such as that presented in this article.”

It is important to note that Mr. Casazza says “The article attributes all of the changes that are occurring to deregulation. In fact, deregulation is not taking place anywhere in the world. In all countries including the United States, the government continuous to exercise some control over electricity prices. What is happening is the development of new forms of regulation, some call it reregulation.”

Finally, he says: “My hope is that this letter will cause others to investigate and not accept claims of the type in this article at face value. The question is not whether the lights will stay on with the new procedures being considered, but will they save the American public and the American economy any money. Customers want more choice. The problem we face is finding the best way to give that choice.”

Well aware of Mr. Casazza’s letter, in July 1996, I wrote one of three papers on how to solve the electricity crisis of the Dominican Republic, finding the way to give that choice. However, my paper was not placed under public opinion, because the government had already decided to implement reregulation.

Thinking realistically, my economic hypothesis (maybe it will become theory in the future), under COE, is that a retail market that offers customers choice of minimum perceived cost of electricity, in the long run, is the best way to save any country and any economy a lot of money. Such simple, but not simplistic, hypothesis will lead to electricity deregulation (forget “faulty” and forget “true”) or electric service without price controls, by developing retail-marketers innovative business models.

Lastly, as John D. Maxwell says, in “Thinking for a Change,” page 137, “if quitters never win, and winners never quit, then why should I quit while I am ahead.”

Best regards,

© José Antonio Vanderhorst-Silverio, PhD. 2006. Interdependent Consultant on Electricity. Grupo Millennium Hispaniola. Santo Domingo, Dominican Republic.

Jose Antonio Vanderhorst-Silverio's picture
Jose Antonio Vanderhorst-Silverio on Jan 9, 2006 7:00 pm GMT
A new idea: electricity WPC (without price controls).
Ferdinand E. Banks's picture
Ferdinand E. Banks on Jan 10, 2006 7:00 pm GMT
You mention Uno Lamm. I'm impressed. I called his name at a conference a few years ago, and the Swedish participants thought that I was talking about a rock star. I can assure you of one thing however: Lamm would never have bought the deregulation scam being practiced in Scandinavia today.

And let me also take this opportunity to congradulate the authorities of the Dominican Republic for deciding to reregulate. As they say in the United States, way to go!

Jose Antonio Vanderhorst-Silverio's picture
Jose Antonio Vanderhorst-Silverio on Jan 10, 2006 7:00 pm GMT
Reregulation is now a confusing name: it is what you call deregulation, and recently also going back to vertical integration. Deregulation is WPC. Uno Lamm would have bought a WPC, as a R&D genius of HVDC, since as Jack Casazza explains needs to be WPC to be the best way to give choice to the customer. I agree that Uno Lamm would never bought the reregulation scam being practice everywhere, just as Mr. Casazza explained in his letter. As Mr. Casazza also said, deregulation is not being practice anywhere.

You have jumped to the wrong conclusion about reregulation in the Dominican Republic. Here agreements of some weird sort were entered into effect, when our reregulation was launched in 1999. The government administration 2000-2004 renegotiated the agreements in Madrid (not in Santo Domingo) and now the new administration wants to renegotiate them once again. My recommendation is that they renegotiate the contracts under a big picture to allow electricity WPC to develop.

Right now in the Dominican Republic we have the underside of reregulation mixed with the underside of large subsidies mixed with the underside of disrupting technologies: in sum we have a completely unsustainable power sector, which is a text example of systemic collapse. Our situation is similar (if not identical) to that of the great depression in the banking industry. That incredible problem, however, is the source of the greatest opportunities to be the first to cross the chasm towards electricity WPC. That is the reason why I have been funding by myself the research of COE.

The customer, the economy and the country needs to have the opportunity to have the maximum perceived value addition from the electricity infrastructure. EPRI’s Electricity Sector Framework for the Future, a stakeholder’s vision for the 21st century, published on August 6th 2003, approved unanimously by its board of directors, the following overarching goals (predetermined elements):

1) Stabilize electricity markets;

2) Provide for the public good;

3) Protect the environment;

4) Educate and empower the customer; and,

5) Unleash innovation.

None of the 5 elements are supported by reregulation. As demand response is the 6th predetermined element, reliance on markets is the way to the future since electricity WPC:

1) Coordinated long run and short run supply and demand side risk management mitigates prices spikes and assures sufficient reserves 24/7;

2) Customer demand response is performed to reduce the least value destruction and thus to provide for the public good;

3) Costly combustion generating units get much less opportunity to be dispatch as demand response takes place to protect the environment;

4) Retail marketers educate and empowered the customer; and,

5) Retail-marketing business model are developed unleashing innovations.

As old dog cannot play new tricks, utilities won’t be able to cross such chasm. Electricity WPC needs to be cared for to reach all five overarching goals under a big picture approach. Engineers, economists, investors, and entrepreneurs need to unite efforts to satisfy them all.

Ferdinand E. Banks's picture
Ferdinand E. Banks on Jan 12, 2006 7:00 pm GMT
José and others

I don't have the slightest intention of cooperating with anyone in order to try and make deregulation work - not even if they give me the long weekend in Paris that I have lost because of this scam.

In the latest issue of the Energy Journal there is a long and rambling article by Professor Paul Joscow of MIT about deregulation. Deregulation has been as good as it gets for him, because I doubt whether he has done any pro-bono research in order to come to the rather trivial conclusion that there are major challenges ahead in order to make this travesty "effective".

In case anyone is interested, The Energy Journal is probably one of the least read publications taking up valuable space in some university libraries. What this unfortunately means is that the important articles that it occasionally contains receive little or no attention. If you bump into the good professor, please tell him that if he wants valuable information about deregulation, he should check out the articles and comments in this forum and in EnergyBiz..

Jose Antonio Vanderhorst-Silverio's picture
Jose Antonio Vanderhorst-Silverio on Jan 12, 2006 7:00 pm GMT
Thanks Prof. Banks, once again.

I understand that you are placed on the “Skeptics” segment, far away after "crossing the chasm," of the Technology Adoption Life Cycle. There are many others that have decided to be there with you. That is perfectly normal.

I stopped reading Paul Joskow's paper on section 2, where it says: "The foundation of any well-functioning competitive electricity market system (with or without retail competition for all end-use customers) is a well-functioning wholesale market and supporting transmission network operating and investment institutions."

He can be proved wrong very easily, because a wholesale market without a retail market must have as much reserves as a vertical integrated system, making it costlier than the original. That is why PJM works. However, when electrical reserves get tight, the re-regulation becomes unstable, just as any third world country. That is why California re-regulation didn't work.

I don't need to read anything else on that paper, because it is evident that he is talking about re-regulation and doesn't comprehend Fred C. Schweppe theory and practice of "Spot Pricing of Electricity (SPoE)." As far I know, there are no implementations of SPoE.

A regulated retail market can be developed giving independent customers’ choice. Please look at page 5 of SPoE to see the five ingredients of a successful marketplace, being the last: "No monopolistic behavior on supply side." Schweppe et al said: "Relative to the fifth ingredient, electric energy is not an ideal textbook example for a marketplace because the supply side is a monopoly that is either government regulated or government own. However, rate-of-return regulation is used today to limit the ability and incentives to behave monopolistically. This would continue with spot pricing."

Describing what I named Model 5, he adds: "Throughout almost (except Chapter 5) all of this book, we define Energy Marketplace: The buying and selling of electric energy between independent customers and a regulated or government owned utility... The energy marketplace is designed explicitly to include engineering issues associated with power system control and operation. Hence all four of the original criteria (efficiency, freedom of choice, equity, and control/operation) are met."

Retail competition is what I promote as electricity Without Price Control (WPC) – Model 6 - based on SPoC. Please see earlier comments.

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