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What is Deregulation?

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Why Deregulation? A Historical Perspective

Historically, the cost of generating power declined as utilities built ever-larger power plants, which increased efficiency and reduced production costs. Utilities routinely requested rate reductions based on declining costs as well as to increase electrical demand. Increased electric demand required more and larger plants, which reduced costs further as well as increasing the utility rate base. This era was a win win for everyone. Consumers had abundant, low-cost power; regulators oversaw declining rates, increased electrification, and economic growth; and utilities and stockholders gained financially.

The Arab Oil Embargo of the 1970s changed that in a hurry. Rapid increases in the cost of fuel to operate power plants translated into equally large jumps in retail power prices. Continued increases in oil prices and unstable fuel supplies led electric utilities to construct new power plants that relied on domestic coal and uranium. These plants cost much more to build than simple oil or natural gas-fired generators. Consequently, the fixed costs of utility operations increased, further increasing retail electricity prices. The natural consequence was consumer complaints and increased regulatory oversight.

For a variety of reasons, including a poor economy and customer resistance to higher rates, demand declined and many utilities ended up building more power plants than needed and/or plants that were very expensive. By the early 1980s, the situation appeared to be out of control, with most utilities requesting routine, often significant, rate increases and several utilities on the verge of bankruptcy. As a result, regulators began to take a much more active role in utility planning. One response was for regulators to require utilities to evaluate conservation and other alternatives rather than automatically building new plants. This process, called integrated resource planning (IRP), was successful in keeping retail rates in check, although rates were still thought to be too high.

The 1970s and 1980s saw the launching of several trends that paved the way for electric utility deregulation. The first was the energy-efficiency efforts resulting from the oil price shocks. Rising fuel prices hit the transportation industry especially hard. In response, engine manufacturers designed more fuel efficient motors. The jet turbine engine used by the airline industry is identical to that used in peaking power plants. Consequently, power plants based on these new, aero-derivative turbines had lower production costs than older designs, significantly so. Utility demand for natural gas as a generating fuel could not be satisfied at 1970 levels of production owing to peculiarities in natural gas industry regulation. Solving this problem led to the second trend, deregulation.

Deregulation of the natural gas industry paved the way for electric industry deregulation both by unleashing market forces to free up natural gas for electricity generation and through FERC’s experience with gas industry restructuring.

Source: A Primer on Electric Utilities,
Deregulation, and Restructuring of U.S. Electricity Markets – May 2002

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