Regulating Power

Ignored in the scandal about Enron's off-the-books
deals is the fact that
Enron's core businesses--trading and selling energy--made little economic sense.
Starting in the early 1990s, Enron claimed it could make electricity generation
more efficient through a system to trade more electric power than regulated
utilities. To that end, the company urged the Federal Energy Regulatory
Commission (FERC) to promote the deregulation of wholesale electric markets.

But whenever there was an opportunity to reduce consumers' electric rates
by trading power at the wholesale level, the old regulated electric utilities had
always done so. Indeed, most electric utilities had already grouped themselves
into "power pools" or other voluntary energy-swapping systems set up to trade
power at its cost of production--the cheapest approach for consumers. If we
calculate the relative costs of producing and selling electricity, new wholesale
traders like Enron could have reduced our national average electric rates by
perhaps 1 percent, if that.

So most of the supposed efficiencies of deregulation were already being
realized by regulated utilities. To the extent that Enron could reap large
profits, it was only by amassing market power, monopolizing transmission lines,
and taking advantage of temporary scarcity--thus raising prices and frustrating
the whole supposed point of deregulation. Any efficiency gains were more than
wiped out by the cost of administering a new, complex trading system pursuing its
own quest for profit.

When it lobbied state legislatures and public-utility commissions to
deregulate electric utilities, Enron promised to sell retail electricity to all
types of customers. Instead, because it was too costly to compete with
traditional utilities for small customers, Enron wound up selling retail
electricity primarily to large industrial and commercial companies under
long-term contracts. Because government takes ultimate responsibility for the
power supply, even in states that have deregulated generation, utilities will
remain providers of last resort for at least the next few years. Regulated retail
rates, meanwhile, have always been a fallback option for large and small
consumers. Enron and other similar companies could seldom beat the regulated

Ultimately, Enron never made a profit in its retail business. The costs of
gaining market share were just too high--and they were probably hidden by some of
Enron's now famous off-balance-sheet debt. In some cases, very large customers
saved a few percentage points on their electricity bills, but often only until
wholesale prices rose, forcing them to turn back to the regulated utilities for
the best rates.

The small savings that deregulation might deliver to some customers must be
weighed against the higher costs to others--and against the huge risks of
overcharges like those seen during the California debacle, well before Enron's
collapse. Analysts who deny that Enron was a failure of deregulation, or who
paint Enron as just an isolated case of corporate mismanagement, forget that the
firm never realized its original promises--even though deregulated electricity
sales, at both the wholesale and retail levels, were its primary reason for

How, then, should we regulate electricity? Contrary to the current
fashion, our old system--state regulation of vertically integrated electric
utilities--makes sense. Regulators need to stress stateof-the-art, "least cost"
planning for new investments in generation and transmission. Traditional
regulation means that utilities charge consumers their costs plus a reasonably
low regulated return on equity.

Utilities should be grouped into power pools--like those we've had in the
Northeast--in order to make possible economically efficient sharing of their
generating plants. Under a regulated system, concentrated market power is a
strength, not a threat, because utilities are prohibited from gouging consumers.

It turns out that it is not economically efficient to divide electric-utility
services and create an unregulated market for each. We probably don't even need a
competitive wholesale power market. Ironically, by the early 1990s many state
regulatory commissions were getting quite good at keeping electric rates in
check, thanks in part to growing investments in energy conservation. It was the
big industrial customers who thought that they could get better deals in a
deregulated market for electricity. On the whole, they didn't. While
co-generation and other energy-saving technology surely make sense, deregulation

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