Deregulation's Unkept Promise

Good morning, Maryland. It's June 1, and your electric bill is about go up again. Depending on where you live, the increases have been spread over two years or four, but the impact is the same: roughly, a 70 percent jump in the typical residential bill since price caps were lifted. So we'll understand if you're feeling a bit grumpy right now about electric power deregulation.

The idea was that if competition were injected in the system -- if power generation were separated from power distribution and customers could shop around for the best deal -- prices would fall. In fact, people were so convinced the market would do a better job than regulators and monopoly suppliers that rates in Maryland were immediately cut 7 percent and capped at that level several years after that.

But now that things haven't worked out as planned, Maryland is rethinking the whole deregulation experiment. And no doubt Marylanders are looking longingly across the Potomac to Virginia, which never fully embraced competition and has now decided to return to the good old days of the regulated monopoly. Beginning next month, customers of Dominion Power in Northern Virginia will be paying about 9.75 cents per kilowatt hour for their juice, 40 percent less than their neighbors in Maryland. (Pepco's customers in the District are in between, paying about 11.5 cents per kilowatt hour.)

To be fair, the big driver of Maryland's rate increases is simply the sharp rise in the cost of generating fuels, particularly oil and natural gas, since deregulation began. And Virginia's advantage comes in no small part because Dominion Power relies on cheaper coal and nuclear plants for more than two-thirds of its power.

But there is also no denying that deregulation has failed to live up to its promise, in Maryland and elsewhere.

Not that there haven't been some winners. The big push for deregulation came from big industrial customers who figured they could negotiate better deals on the wholesale market -- and have. Also driving the deregulation bandwagon were the utilities themselves, which figured they could earn bigger profits if allowed to sell their power into an unregulated wholesale market, or sell their plants to some other company that would. While some have stumbled, most have been able to turn deregulation into a plus for their shareholders.

There are various reasons why deregulation has failed to yield much benefit for customers.

Consumers, it turns out, just aren't very interested in shopping around for electric power. The difference in price just isn't worth the hassle. And because of the rate caps that many states, including Maryland, imposed during the transition period, it was difficult for new companies to enter the market with rates lower than those offered by the traditional utilities.

The result is that there are only a few markets with the innovative and robust competition envisioned by the early champions of deregulation. And many now acknowledge that the retail side of the business is likely to remain a regulated monopoly.

The other key feature of the market-based model was requiring utilities to spin off or sell their generating plants. For years, critics had argued that, because they were guaranteed a rate of return, utilities had a financial incentive to build too many gold-plated power plants and run them inefficiently. But it turned out that they were only half right.

Under deregulation, individual plants are indeed operating at lower cost and greater efficiency. That's the good news. But it turns out that in a deregulated market, the incentive is for generators to build too few plants rather than too many, creating periods of tight supply and very high prices that can have a very distorted effect on wholesale markets.

Back in 2001, this was a particular problem in California, where the architects of deregulation had foolishly required all utilities buy all their power on the day-ahead spot market. All it took was a summer heat wave to drive prices to record levels and cause an economic and political meltdown. Only later did we discover that the tight market was made even tighter by energy traders at Enron and other firms colluding to keep prices high by withholding supply from the market.

To avoid repeating California's mistakes, many states required utilities to buy power through long-term contracts at tightly structured and closely monitored auctions. Unfortunately for Maryland, one of its first such auctions came just as the impact of Hurricane Katrina was hitting energy markets, locking in high prices for several years. And while Maryland regulators continue to tinker with the rules governing how and when utilities buy power, it remains unclear whether utilities save more money buying power through long-term contracts than by generating at least some power at their own plants.

If there is any consensus these days, it is that the industry is evolving toward a hybrid model, somewhere between regulation and market competition. And within that context, much of the focus is on finding the most effective mechanisms for getting both residential and commercial customers to reduce their demand for power during peak hours, when the cost of producing or purchasing power is highest. Recent experiments show that even small reductions in peak load demand can yield large reductions in average rates.

Both Maryland and Virginia are now considering various mechanisms for reducing peak demand. Regulation-minded advocates like the idea of giving rebates to customers for buying energy-saving appliances and thermostats.

Market-oriented types, on the other hand, prefer some system of variable pricing, where the cost of electricity goes up during peak hours and peak days. Such a pricing scheme would require a huge investment in expensive new meters that can record how much power is consumed, hour by hour. Whether that investment will be worth it, however, depends on whether customers will have enough interest or incentive to turn off lights and adjust thermostats when prices are high. And like much about deregulation, that remains an open question.

Steven Pearlstein can be reached at pearlsteins@washpost.com.