Businesses flip-flop on electricity deregulation

September 22, 2007
The Morning Call
Sam Kennedy

Companies say state plan they once extolled as a way to exact fairer pricing doesn't work.

A Pittsburgh metals company with 3,500 employees in western Pennsylvania is trying to decide whether to make a major expansion here or in another state with better electricity rates.

As Allegheny Technologies weighs its options, company officials have been up front about what they consider to be the biggest strike against Pennsylvania: electricity deregulation.

It wasn't supposed to be this way. In the 1990s, industrial energy customers such as Allegheny Technologies were among the first and most forceful advocates of ending the state's traditional regulatory control over the electric industry. They wanted prices to be determined by market forces.

More than a decade later, that radical transformation is nearing completion. But now the industrial customers are among its most vocal critics.

"We're asking for a competitive market that's truly competitive not on a fictitious market," said David Kleppinger, a Harrisburg lawyer whose clients include the Industrial Energy Consumers of Pennsylvania.

Former Public Utility Commissioner Terry Fitzpatrick, who as a legislative aide was at the table when the state's deregulation plan was drafted, characterized industrial customers' dramatic shift as "one of the great ironies of this whole thing."

What drove deregulation's biggest proponents to the other side of the debate? The answer, of course, depends on whom you ask.

Energy companies and other supporters of deregulation say industrial customers, and just about everybody else, are having trouble getting used to the idea of paying market rates for a commodity whose price has been virtually frozen since 1997.

For example, PPL Electric Utilities, a subsidiary of Allentown energy company PPL Corp., is expected to raise the price of electricity about 30 percent on Jan. 1, 2010, when a cap on what it can charge retail customers for electricity expires. (The cap was intended to shield homeowners and businesses from price surges caused by the transition from regulation to market-based pricing.)

PPL says the looming hike is largely a reflection of higher fuel costs. The prices of the coal, uranium, oil and natural gas on which power plants run have risen sharply in recent years.

"Naturally [industrial customers] don't like those prices," said PPL spokesman Dan McCarthy. "They've been shielded from those prices for a long time."

The industrial customers, however, argue fuel costs do not fully explain the rise in electricity prices. They say the real problem is the electricity market itself -- in particular, a feature of the market called marginal pricing.

The control room

In an underground room of an unmarked building at a nondescript industrial park in Valley Forge, Chester County, an illuminated power-grid map stretches across a wall 30 yards long and 10 feet high. Below, about 10 people quietly work at their computer terminals.

This is the control room of PJM Interconnection, a nonprofit organization that manages the electricity market. PJM likens its role to that of air traffic controller: Air traffic controllers don't own planes, they just tell them where to go. Similarly, PJM directs the electricity generated at 1,200 power plants to utilities and other wholesale customers in parts of 13 states and the District of Columbia.

Before deregulation, electricity under PJM's control sold for a slight mark-up over production costs. In Pennsylvania, the mark-up was determined by the state Public Utility Commission.

Now, under marginal pricing, electricity generated from cheap coal or nuclear fuel sometimes sells at the same price as electricity from expensive natural gas: A megawatt-hour of electricity that costs $35 to make at a coal-fired power plant or $25 at a nuclear plant might sell for $70 -- the going price of a megawatt from a natural gas plant.

When this happens, it makes for higher electricity prices -- and profit for energy companies. That, at least, is the immediate result.

But the long-term impact of marginal pricing is quite different, according to economists who support it. They say it encourages power plants to run as efficiently as possible; if plants don't, they might not find a buyer for their higher-cost electricity when demand is low.

That's because, in times of low demand, the plants that cost more to run won't even be asked to come on line. And this means the plants that cost less to run set the market price.

Academic explanations, however, have done little to persuade industrial customers. Their attention is focused on energy companies' skyrocketing profits.

This summer, PPL, which serves 1.4 million Pennsylvania customers, reported its biggest-ever quarterly earnings, $345 million. The sale of an El Salvadoran subsidiary contributed to the record. But second-quarter earnings from operations, which exclude such gains, also were exceptionally strong.

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