Do Markets Make Good Commissioners: A Quasi-Experimental Analysis of Retail Electric Restructuring in Ohio
Have consumers actually benefitted from electric deregulation? Almost four decades ago, millions of businesses and households were sold on the concept of deregulation. They were promised lower prices and more reliable service. They were told that the free market can do a better job than regulated monopolies.
Since that time, academic research—across a wide array of disciplines—has addressed various aspects of this ultimate question: have consumers actually benefitted from electric deregulation? Unfortunately, most of this research has been inconclusive or muddled by various factors or empirical limitations. Moreover, the lion’s share of this research has focused on wholesale markets (the sale of electricity to public utilities before they distribute it to businesses and households) and entirely ignored outcomes to actual end-users like businesses and households.
New research from the large deregulated State of Ohio has pushed the envelope in this field. In their newly published research, Dormady, Jiang and Hoyt find that while natural gas and wholesale electricity prices have fallen to historic lows, retail electric deregulation has resulted in higher prices to households for most of Ohio, with a direct net welfare loss to households of approximately $1 billion between 2009 and 2015.
A naïve interpretation of these results would suggest that retail electric deregulation is a flawed concept. Such an interpretation might even suggest that a return to regulated service is the correct path forward. However, the authors go beyond a purely empirical analysis, and also provide a detailed case analysis of Ohio’s deregulation laws and policies. Through this, they find that the cause of the adverse effects of deregulation were ultimately due to how deregulation was implemented—informing not only regulatory theory, but longstanding public policy implementation research as well.
The authors find that households generally observed unfavorable outcomes—not because deregulation is a flawed concept—but because important implementation steps were skipped. Scholars and practitioners have known for decades that deregulation requires functional separation between generation (i.e., power plants) and distribution (i.e., local service). This is incredibly important, because deregulated firms must be able to observe losses if they cannot compete in an open market. If these functions are allowed to remain tethered to one another (as they are in a regulated system), a local distribution utility might be tempted to add charges to customers’ bills to compensate for losses of power plants that are supposed to be on their own in the competitive markets.
But, like many states, Ohio did not implement deregulation this way. Rather than requiring utilities to divest their generation portfolios and functionally separate, they required only corporate separation. The state allowed a complex holding company structure to exist that allowed parent corporations to simultaneously own generation and distribution affiliates. In effect, the state skipped the most crucial step in the process of implementing deregulation—functional divestiture.
In their paper, the authors also provide empirical evidence to support this. Ohio provides what economists and public policy scholars call a ‘natural experiment.’ One of the state’s four major utilities (Duke Energy in the Cincinnati metro area) actually pursued functional, rather than simply corporate, separation. Unlike the rest of the state, residents in the Cincinnati metro area observed substantial savings after the implementation of retail deregulation. The utility there had no instrumental incentive to add charges to customers’ bills when their aging coal fleet faced difficulty competing against newer natural gas plants in the post-Shale boom era because they divested (or sold) them. In other words, customers observed savings where key deregulation steps were not omitted, and losses where they were omitted.
One of the empirical novelties of their paper is that their state-provided data allows them to measure those costs. Published research in the field relies almost entirely on Federal data from the Energy Information Administration (EIA). That data is quite limited because it estimates customer prices based on gross aggregations derived from annual revenue reports of utilities. It ignores revenue collected on customer bills, but routed to subsidiary corporations. Dormady, Jiang and Hoyt use complete bill data from the Public Utilities Commission of Ohio (PUCO) that provides a truer reflection of the costs that customers observe, because it reflects actual customer bills.
The paper provides many implications for scholars of the public policy process, regulatory and de-regulatory theory, and energy policy more broadly. The implications would suggest that deregulation is not necessarily a flawed construct, but rather, where it has been implemented consistent with the roadmap provided by early scholars, it has the potential to provide very real benefits to businesses and households. Moreover, the paper would suggest that other sectors of the economy—across a broad battery of fields—can learn something from scholars of the public policy process.
– Noah Dormady, Zhongnan Jiang and Matthew Hoyt.
– The authors’ new Journal of Public Policy article can be read without charge until the end of September 2018 by following this link.