FERC Filings
COMMENTS OF THE ELECTRIC POWER SUPPLY ASSOCIATION-Comments Regarding Retail Electric Competition-V010003
IV. Artificial Price Caps
The price customers see for retail electricity service needs to account for changing market conditions, as well as the full costs of providing the service. For competition to work, consumers must see real market prices and the pricing of electricity service should be responsive to changes in wholesale market prices. Knowing the real economic cost of electricity will enable consumers to make informed decisions about when and how to use electricity efficiently. Regulators should not allow administratively fixed or artificially capped or controlled rates in a competitive market, as it will only stunt the development of such a market. Controlled prices do not protect consumers, turning high prices into shortages instead. In addition, price controls do harm in four areas. They (1) stifle competitor entry into the market, (2) stifle the introduction of risk-mitigation products, (3) prevent demand-side response to supply shortages, and (4) divert attention from the need for structural change.
Price controls stifle entry by inhibiting market prices from rising to a level necessary to justify investment. It is not appropriate for policymakers to guess at what that price is and to set a cap based on that guess. Market conditions vary too much to expect that guess to be right. A well-structured market is self-correcting. If prices rise above the level necessary to justify entry, then market entrants responding to these price signals will bring those prices down. Accurate price signals are needed to encourage suppliers to make capacity and energy available to provide ancillary services and replacement reserves or, if necessary, to finance and develop new generation projects. Manipulating the market price by imposing price controls will distort market price signals and chill development of new generation because of uncertain market prices. Price-controlled markets are inherently viewed as both riskier and less profitable to competitive power suppliers. Price controls and trading limits increase risk, because there is no guarantee that, once set, such caps or limits would not be tightened in the future. Moreover, price caps and trading limits would deny suppliers of electricity the opportunity to cover their fixed costs during those important, but transitory, periods when market prices substantially exceed long-run average costs. Nor is this increased risk offset by symmetric assurances of price floors. In short, the best defense against price spikes is to encourage greater numbers of suppliers to enter the market, not to restrict the payments to existing suppliers.
Price controls can also stifle the introduction of risk-mitigation products. Without an incentive to manage demand or hedge risk, load-serving entities (LSEs) create a “vertical price curve,” in which the value of the “last megawatt” is infinite. In this scenario, price caps become the only logical solution. This approach, however, is self-perpetuating and fails to lead to a more lasting solution. Price controls eliminate incentives for LSEs to hedge risk, either physically or financially. In fact, LSEs are given a free regulatory hedge to the disadvantage of other competitive market participants who invest in hedging “tools” and learn to manage risk appropriately. With perpetual “training wheels,” LSEs never learn to manage the risks inherent in a competitive market. Problems are postponed, but not solved.
Price controls also prevent demand-side response to rising prices. For competitive markets to flourish, supply and demand must interact freely to determine the price, thereby allowing market participants to make intelligent resource allocation decisions. At just the time when we need to attract capital for new generation and to expand and improve the electric system infrastructure, price controls will create uncertainty that will discourage and delay this much-needed investment. This narrow speculation regarding demand-side responsiveness amounts to a high stakes gamble that consumers will be harmed more by short-lived, infrequent price spikes than by long-term delays in generation investment needed for reliability. Rather than speculative short-term outcomes, the wiser approach to both price spikes and reliability concerns is to unleash free market forces and the investment capital they will provide.
Finally, price controls divert policymakers from making the structural changes necessary to assure a fully competitive market that offers competitive prices, low risk, high reliability and superior environmental performance. Policymakers should concentrate on developing market-oriented solutions to any remaining market flaws, rather than engaging in heavy handed intervention by capping competitively-determined prices.