Commentary: Don't Be Shocked By Surges In The Price Of Power

In late June, Steven R. Teitelman, the vice-president of trading for Newark (N.J.)-based Public Service Enterprise & Group Inc., smugly told a British electric-industry executive that deregulation of the U.S. electricity market was proceeding in an orderly fashion. The U.S. market would never see prices for electricity spike as high as $1,000 a megawatt-hour, as they had in Britain. It was too stable--$300 per megawatt-hour would be about tops.

Oops. Within days, a Midwest heat wave left the U.S. wholesale electricity market scrambling for power. A pair of energy trading companies defaulted on delivery contracts, triggering a stampede as companies that had contracts to resell energy from the brokers scrambled to cover themselves. For eight hours, Chicago-based Commonwealth Edison Co. had to pony up $5,000 per megawatt-hour to buy juice on the spot market--more than 100 times the regular price. For one hour, it actually paid $6,000. The strapped utility cut power to manufacturers and begged customers to conserve electricity.

POWER PLAYS. The traumatic episode has led to calls for reregulation of electricity prices, including caps during periods of supply-demand imbalance. Fear of large-scale power outages is prompting politicians, such as U.S. Senator Richard S. Durbin (D-Ill.), to wonder aloud if the market is becoming unreliable and poses a threat to public health and safety.

It was a frightening time, all right. The national transmission grid--usually a seamless web of interconnections among utilities--suddenly unraveled in part because market forces were undermining the cooperation the system requires. But reregulation is not the answer. Volatile pricing must be expected in a market that's just opening up to competition. The same thing happened in natural gas.

Making the decision to deregulate means we will accept the occasional freakish price spike as a trade-off for having lower prices for power most of the time. Establishing arbitrary caps would only suppress market signals--depriving buyers and sellers of the information required to make calls about where to invest and improve the system.

To be sure, the market is far from perfect. Power producers can deliberately withhold electricity to drive up the price, and some customers suggest that's what happened in June as some producers tried to undermine deregulation. "I'll tell you what happened: The empire struck back," says John R. Hughes, technical affairs director for the Electricity Consumers Resource Council, a coalition of large users of electricity. "They will do anything to protect their monopolies."

The Federal Energy Regulatory Commission says it is looking into the behavior of several utilities, including American Electric Power, whose parent company, AEP Corp., owns many of the transmission lines leading into the Midwest. AEP admits that it broke a contract to provide 1,300 megawatt-hours to Commonwealth Edison. But AEP's executive vice-president for finance, Henry W. Fayne, says the company did nothing wrong. He says it had an unusual number of plants out of commission and needed the transmission capacity to serve its own customers.

TRAFFIC CONTROL. That's for regulators to decide. And for that matter, it is for them to make sure that owners of the transmission grid can't hold customers and competitors hostage by exploiting artificial bottlenecks to drive up prices or prevent access to alternate power sources. The solution: an expanded network of independent system operators, similar to one established on Mar. 31 in the deregulated California market. These ISOs' job is to avoid brownouts and blackouts by acting like air-traffic controllers for electricity. In California, the ISOs have maintained reliability even though that state, too, has experienced price spikes.

Such hikes are not always bad things either. Thanks to the June price spike, it's likelier that an independent power producer will be willing to spend $100 million to build a new gas-turbine generating unit close to Chicago, points out Kenneth Rose, an economist with the National Regulatory Research Institute. Says Commonwealth Edison's Paul McCoy, the senior vice-president who bought the costly juice last month: "If we expect independents to build units and be able to recover their costs, there have to be some hours where there is going to be a healthy market."

Ultimately, the goal of deregulation is not to avoid price spikes at all costs but to create a reliable, low-priced electricity infrastructure through competition. Price volatility, unsettling as it is, simply comes with the territory.