The Globe and The Mail
January 20, 2001

While electricity deregulation has proved a disaster in California, it has been a shining success in Europe

Beginning in Britain in 1990, the trend spread through Scandinavia and then to other European Union countries such as Germany and Spain, all seeking lower electricity prices in a more competitive environment. Parts of Australia have also deregulated their electricity systems, and prices have fallen as a result.

Of course, there have been many bumps along the way to success, but these experiences stand in stark contrast to California, where prices are soaring and shortages are severe. The state’s major utilities are on the verge of filing for bankruptcy, and blackouts have hit northern California in the past few days.

Yesterday we considered the mistakes made by California, the first U.S. state to adopt full deregulation. Today we’ll look at the success stories that could guide Canadian legislators.

Perhaps the most important success of Britain’s electricity system is the creation of excess supply, which has kept prices from soaring as a result of shortages. This surplus is due in part to overbuilt facilities, a legacy of government ownership. It is also due to the deregulation rules put in place by Margaret Thatcher’s government.

Britain’s pricing mechanism not only pays power suppliers for the short-term cost of supply, but pays them a fee to encourage the development of long-term reserve capacity. Indeed, supply has grown so plentiful that this incentive payment is now going to be dropped supporting the industry adage that deregulation is a 10-year process.

In several U.S. states, the priority has been on building adequate supply before full deregulation. Texas, Pennsylvania and Wisconsin have all encouraged new supply as a first step. Wisconsin has extended its transmission grid to boost import capacity, while Texas has streamlined the approval process, so that it takes just two to three years to build a new generating plant.

Alberta completed deregulation of its electricity sector on Jan. 1, and rates have soared. As in California, Alberta has inadequate supply for the voracious demand, leading to immediate price increases. And, as in California, Alberta has built in no direct incentives for new supply.

Clearly, this track record shows the wisdom of focusing on new supply to ensure a competitive market.

Britain did other things right as well. It did not cap the rates paid by consumers, allowing reasonable returns for generators. California imposed caps that are now bankrupting the two largest utilities. Caps distort market pricing and discourage construction of new plants, because investors don’t know whether they will be able to operate profitably down the road. Appropriately, caps are not planned in Ontario, which is now designing its own electricity deregulation.

In Britain, consumers were encouraged to sign long-term supply contracts to lock in prices, providing more price stability. Few consumers have done that in California, and they have been buffeted by all short-term movements in the price of natural gas.

Hedging has also been a success in Australia, where most electricity purchases are arranged with advanced contracts and utilities have little unprotected risk. California forbade hedging, fearing it would allow the biggest utilities to lock up the cheap electricity and stifle competition. The ban has created huge instability as utilities buy electricity in the daily spot market, and the practice is being abandoned as California learns its lesson.

Experience also shows there need to be careful controls to prevent price manipulation by generators who have held back electricity to create critical demand. Although California tried to guarantee true competition by forcing the two largest generators to sell off their plants and by requiring generators to sell to a centralized computer exchange system, a November report by the Federal Energy Regulatory Commission still found evidence of price manipulation in the market.

Ontario is planning a similar centralized pool sales system, and its design has been one of the issues delaying the announcement of a deregulation date in the province. It’s hard to protest against such a delay if it ensures a better-functioning system.

The point of deregulation is to encourage efficient competition. Australia embraced deregulation because of terrible productivity in its operations. Since then, not only have companies invested in generation and transmission, but efficiency has greatly improved. In the state of Victoria, there are 2,000 employees in the generation business compared with 10,000 employees 10 years ago, and they are producing far more electricity.

In Germany, industrial users saw prices drop by as much as 60 per cent initially. Consumers faced a raft of cut-price deals sooner than even the system designers had hoped. The savings came in part from greater productivity at generating plants, where cost-cutting was severe.

By ensuring adequate supply and protecting against unnatural price manipulation, Ontario and presumably other Canadian provinces can also cut costs and increase productivity. It’s essential to get it right before marching into disaster. But with ample experience to draw from, there is no excuse for getting it wrong.