Energy and electricity markets thrive when bureaucrats get out of the way and allow genuine choice and competition. Unfortunately, that’s simply not happening in far too many states. In the name of “deregulation,” states such as Maryland, New Jersey, and Pennsylvania have barred utilities in the power distribution business from supplying energy to consumers within a vertically integrated framework. While the bureaucrats in charge of this system claim that this enables consumers to choose from a host of energy suppliers – called independent power producers (IPPs) – the truth is that consumers are barred from choosing a vertically integrated option that could lower their costs and bolster supply and efficiency.
Because of this broken system, PJM Interconnection (the grid operator for many of these “restructured” mid-Atlantic states) is woefully incapable of meeting growing electricity demand – and federal regulators are demanding reform. It is time to ditch this broken system and embrace competition in power markets.
In many PJM states, consumers are barred from making a critical choice that could significantly lower their power bills: choosing a vertically integrated utility for bundled power and transmission/distribution. This regulatory framework preempts a choice that is available to consumers in an array of industries.
Vertical integration – basically the idea of keeping everything under one roof – routinely offers significant savings and efficiencies in the private sector. For example, instead of buying input materials from third parties and having to contract out delivery to consumers, Ashley Furniture owns its manufacturing plants and distribution fleet. Similarly, the e-commerce giant Amazon offers its own branded “private-label” goods and often delivers these goods through a dedicated fleet. Even the pizza industry contains vertical integration that benefits consumers. Domino’s largely owns its entire supply chain, including the regional dough-manufacturing and food-distribution centers that supply its stores, and delivers its own pizza to households.
This streamlined strategy is not a market inevitability. But markets operate best when companies are allowed to vertically integrate and use their efficiencies and cost savings to vie for consumers’ business. This is especially true in the utility sector. When a single entity manages the entire lifecycle of power from the power plant to the light switch, it unlocks several specific cost savings and operational advantages.
For example, in an integrated utility, the transmission system operators and generation operators are part of the same organization and can coordinate directly. Because the utility can own both the transmission network and the power plants, it can dispatch or redispatch its generators in response to changing system conditions—such as transmission congestion or severe weather—without relying on an artificially-created auction to determine every adjustment. As Cato Institute adjunct scholar Robert J. Michaels has noted, “The movement to restructure electricity began with generalities about the desirability of markets coupled with claims that vertical integration in utilities was either unimportant or that its effects could easily be duplicated in markets. The econometric evidence, however, makes clear that there are substantial economic advantages associated with vertical integration.”
It’s critical to acknowledge that power provision is different than buying pizza, furniture, or various e-commerce products. To see why, imagine a neighborhood with three competing electric delivery companies. To compete, they would likely need duplicate or triplicate local infrastructure—additional utility poles or pole attachments, separate transformers, distribution wires, and service connections. The enormous cost of building and maintaining parallel distribution networks is one of the primary reasons electric distribution is considered a natural monopoly.
But critically, states with vertically integrated utilities such as Michigan and Virginia have put (limited and imperfect) systems in place to enable competition. Michigan’s Electric Customer Choice program permits business consumers to shop around a market of licensed alternative electric suppliers (AES). While the incumbent utility retains its monopoly over the physical distribution system for consumers who switch, the AES becomes responsible for procuring wholesale power (and matching capacity requirements) to cover the consumer’s hourly load profile and scheduling this power into the regional transmission grid. The utility still bills the consumer for distribution charges and adds a line item reflecting the AES supply contract rate—the payments for which are passed along to the AES.
While the Michigan Public Service Commission notes that “no more than 10 percent of an electric utility’s average weather-adjusted retail sales for the preceding calendar year may take service from an AES at any time,” and legitimate questions remain over whether the distribution charges paid to utilities reflect the “stranded costs” arising from utility power investments, the truth is clear: it is possible to have vertically integrated utilities alongside consumer choice provisions.
If vertical integration was allowed in PJM states, the existing choices consumers have over IPPs and energy suppliers would not go away. They would simply be supplemented by the choice of vertically integrated supply and transmission. This would mean not only more options for consumers but more power supply as utilities would be able to quickly build while going through less PJM bureaucracy and dealing with fewer capacity auction-related hurdles.
Consumers demand more choice and competition in power markets, and state officials must deliver.
