Electric Power, Market Forces, and the Public Welfare

by John A. Casazza

During my recent visit to Hungary, I was asked if I would prepare a brief article on the U.S.A. electric power experience that would provide helpful insights as Hungary moves forward with its plans to develop its electric power system under private enterprise. While the U.S.A. procedures have many imperfections, they have led to the development of the world's most efficient and reliable electric power system. They have been successful in solving our technical, institutional and financial problems.

In the U.S.A. there are more than 3,000 utilities, of which about 300 are of significant size. About 80% of the nations electric power is produced, transmitted and distributed by investor-owned systems, with the remainder produced by Federally-owned systems, state-owned utilities, municipal systems, cooperatives organized by consumers and independent power producers. These organizations have evolved over one hundred years in a coordinated and cooperative manner. There also has been considerable competition between them. It is this balance between competition and coordination, and the coordination of technical and institutional solutions, that has been the source of the outstanding electric power systems existing today in the U.S.A.

Economic Characteristics of Electric Power Systems

Electric power systems have large capital requirements, large economic inertia and cannot easily be changed, and lead times are long. The selection of compatible technical and institutional alternatives is vital, and they must be coordinated with financial capabilities. Electric power is not like the shoe business, or the steel business, or the automobile business. In none of these businesses must the product be produced the instant it is needed or is it impossible to store the product. These unique characteristics of electric power systems must be recognized in making institutional decisions.

Studies of the historical development of electric power systems throughout the world, and the efficiencies and cost reductions that have been achieved in these systems, have clearly shown that the integration of the portions of an electric power system into a coordinated whole is the key to the economies that have been achieved. The role of the system builders in developing electric power systems has been well documented by Professor Thomas Hughes in his article, "System Builders -- Technology's Master Craftsmen," published in the September 1986 issue of the CIGRE Electra.

Because of the unique nature of electric power systems, their economies are strongly based on the large number of "diversities" that exist only on a total system basis. The diversity between loads allows different facilities in the system to supply different customers at different times. The diversity between outages and equipment breakdowns allows the same system spare facilities to be used many times, thus maintaining reliability of service while reducing system investment in reserves. The diversity in the uncertainties in the future, such as in load growth projections, in fuel cost estimates, in the completion dates for new projects, and in the performance of new equipment, reduces risks to acceptable levels. In many cases such risks would be unacceptable if they had to be taken by individual owners. Taking advantage of these diversities on a total system basis has reduced electric power systems costs by at least 50 percent.

Maintaining System Benefits with Privatization

Those who advocate that the transmission system should be used as a common carrier delivery system, providing any power producer the right to sell power to any customer and any customer the right to buy power from any power producer at any time, are not recognizing the impact of this approach on the transmission facilities required and on power system costs. Increasingly, such proposals are made to operate electric power systems in accordance with this common carrier concept with independently owned and operated power producers supplying power to specific customers through negotiated arrangements. These proposals can create serious economic problems and significant increases in costs.

In cases where this involves the privatization of existing individual power plants to become separate companies, what will happen to the capital savings and operating savings that can be achieved with coordinated operation? These savings are achieved through incremental cost dispatch of all the generating capacity in the system. This arrangement provides at all times that power is being produced by the specific generating capacity which has the lowest incremental production cost. It provides for the coordination in the schedule of maintenance outages of all generation and transmission equipment on a system wide coordinated basis. These is no question among economic theorists that this results in the lowest total production costs for the system. Will there be a change in the resulting dispatch of the system as these independently-owned and operated plants make contracts with specific customers to sell them power and attempt to maximize their individual company profits? There are two possible answers:

1. If there will be a change in the amounts and times that power is produced by the various individual generator units and plants, the cost of production of electricity will increase. Electricity will be produced at times by plants having higher costs and there will be changes in transmission requirements.

2. If there will be no change in dispatch, the change in institutional structure merely results in reallocating costs, not an improvement in economic efficiency. Such a reallocation of costs can be achieved, if desired, in many ways.

Some proposals for privatization call for independent power producers to build new plants and sell power directly to customers even though existing generating plants have adequate capacity. These proposals assume that it will be possible for the new plants to sell power at a lower cost than existing plants and they will be able to have certain customers switch from supply by the existing plants. This will leave the existing plants with capital investments for which the revenues earned have decreased. Because these existing plants have fixed charges and depreciation costs which must continue to be paid on their capital investments, the existing power plants and systems can continues to operate only by increasing the charges to their remaining customers. Thus the economic benefits to one group of customers will be offset by penalties to another group of customers.

If the unnecessary increase in the total capital investment through the addition of a new independent power plant is not fully recovered each year by a very significant production cost advantage of the new plant by the existing plant, it is inevitable that any savings that are made by the customer which buys power from the new independent power producer are much more than offset by these increases of cost to the other customers of the existing plants. This can only hurt the national economy in the long run.

Also, competition between power producers can be truly effective only if each producer can transmit to each potential customer. This requires a transmission system with the capability of delivering from private power producer No. 1, No. 2, No. 3, and No. 4, etc., to each specific customer. The weakness in this whole concept is that if a transmission system is built for these many potential deliveries, only one of the private power producers will be the successful bidder and the transmission facilities that have been built for the other losing private power producers to provide power to this customer can remain unused. Analyses that have been made in the United States show that, for this theoretical competitive system to work, as much as a doubling of the transmission system in a region may be required.

Establishment of National Electric Power Policies

Because of the importance of establishing a national electric power policy even with so many utilities, the approach that has been used in the past by the United States may be of interest. Periodically national power surveys have been made which have looked at the electric power needs for 10 to 20 years in the future and the alternatives available. Professionals from the utilities have participated heavily in these studies. These national power surveys provided objectives and information for development and operation of the power systems in each coordination area and in each privately-owned system. In addition, both the Federal and state governments from time to time appoint special civilian advisory boards. (I personally have served on many of these boards in the past and presently serve on the Energy Engineering Advisory Board of the National Research Council, the Energy Policy Committee of the Institute of Electrical and Electronic Engineers, the Executive Committee of the U.S. National Committee of CIGRE and the United States Energy Association of the World Energy Conference.) These civilian boards review various policy questions and provide needed technical and economic advice to the government.

Market Forces and Social Responsibility

In a free market economy there is still a need to maintain a responsibility to society along with the pursuit of profits. I would like to suggest ten commandments for use by private enterprise which sum up my personal philosophy, the philosophy under which I have worked during all of my professional life:

1. Thou shall use competition to spur improvements in performance and productivity.

2. Thou shall allocate the economic benefits from the resulting improvements in productivity from competition to both the consuming public and those who make the improvements possible.

3. Thou shall use the real costs of money in all economic comparisons and evaluations, not a value based on subsidization by government. Subsidization involves costs to others which must be considered in economic decisions.

4. Thou shall not make decisions based solely on maximizing profits. Good business operation requires full consideration of the welfare of the customer. A business which operates based on maximizing the long-term welfare of the customers will grow and prosper. Those that are concerned solely with immediate profits are doomed to ultimate failure.

5. Thou shall not proceed with projects to achieve economic benefits to one class of customers or one segment of society that are more than offset by economic penalties to another class of customers or another segment of society.

6. Thou shall not proceed with new projects to provide services which can be adequately provided through facilities and investments that have previously been made and are currently in place unless such new projects are more economic on a total national basis. The development of unnecessary and duplicating projects can be a waste of capital, involving an economic penalty to the nation which must ultimately be paid.

7. Thou shall minimize costs on a present worth basis over the long term. The plan of action that is best in the first year, or the fifth year, or the twentieth year is not best unless it results in the minimum present worth of costs over the full period of time the facilities and investments will be used.

8. Thou shall minimize costs over the entire geographic region. Costs that are minimized for one district, or one town, or one company, or one nation at the expense of more than offsetting increases in costs in other regions, or companies, or nations are not good plans. The participants in such regional coordination should equitably share in the increase in net benefits made available.

9. Thou shall minimize costs for the entire business, not one segment of the business. For an electric power system, this means that costs should be minimized for the entire system, not only for a power plant, not only for the transmission system, and not only for the distribution system. Decisions which reduce costs in one power plant but increase costs even more for the transmission system or for another power plant are not good decisions.

10. Thou shall not view profit as the chief incentive for development, competition as the supreme law of economics, or private ownership of the means of production as an absolute right with neither limits nor social obligations. (This was stated in the 1967 Encyclical of Pope Paul VI titled Populorum Progressio.)

The private enterprise experience in the U.S.A. indicates that competition among privately-owned power systems is good, but such competition should be principally on a system-to-system basis that will still allow a high degree of coordination. Privatization of excessively small portions of the system can be harmful.

There is a great reservoir of knowledge in the U.S.A., far in excess of that available elsewhere in the world, on specific methods available in a pluralistic utility structure for the coordinating of plans, the coordinating of operations, the establishment of reliability criteria, the equitable sharing of benefits, intercompany contracting, the establishment and control of electric rates and prices, and the resolution of disputes. There is also a great deal of experience in the governmental arrangements that are possible in a democratic society to regulate and control a privatized electric power industry. We in the U.S.A. are willing to help based on our experience when it is desired.

Published in Hungary/Power Engineering Review

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