The Line in the Sand

Power UK
19 October 2007

NERA Economic Consulting is one of the most respected consultancies working in the field of utilities and regulation. Its expertise usually does not come cheap -- utilities, government and regulators will pay considerable fees to tap into NERA's excellent knowledge pool.

However, the company has just published a book which shows off its thinking on a broad range of issues -- at a price that even hard-up undergraduate economics students can afford.

In "The Line in the Sand", 30 of NERA's expert economists analyze shifts in the boundary between those industry segments that are subject to regulation and those facing market forces, the impact those shifts are having today, and the implications of these trends for future developments in network industries, especially electricity.

The book is broken down into five sections:
  • Section one contains essays on seven aspects of regulation that have evolved in the electricity sector. NERA's Graham Shuttleworth and Sarah Potts Voll provide an excellent first chapter on the economic principles of regulation -- offering a pithy take on the differences between rate of return and price cap regulation. In chapter four Shuttleworth goes on to offer his views on the practicalities of price cap regulation -- drawing heavily from the UK experiences in both the electricity and gas sectors. Other chapters in the section cover regulatory issues concerning mergers and competitive market theory. There is also a short, but thought provoking, chapter called "Why planning a nuclear plant is a good idea even if building one turns out to be a bad idea" -- which argues that phased development of nuclear power makes sense given the uncertainties about such factors as coal plant costs and the cost of greenhouse gases.
  • Section two covers the design of public policies to prevent or remedy market failures. Financial incentives under the US Energy Policy Act of 2005 for new nuclear plant construction and operation are reviewed and the question whether they will be enough to support new build is posed. The answer -- nearly but not quite. Other chapters cover the use of new mechanisms to implement public policies as well as the use of trading mechanisms to deal with air emissions in the US and Europe.
  • Section three examines the global issue of market power -- specifically differing approaches in Australia, Europe and the US.
  • Section four looks at security of supply and contains chapters looking at the conditions necessary for investment, capacity mechanisms and demand response.
  • Section five explores strategies for procuring competitive generation services by regulated distribution companies -- with a heavy emphasis on experiences in America.

Although this book offers a global perspective on a wide range of issues, it does have a strong bias towards the UK and US and should be in the library of any regulatory department worth its salt. The book is clearly written -- with a sparse use of academic jargon and formula -- and would be a vital resource to bring readers up to speed quickly on a wide range of issues (although a few of those covered may not be as relevant as they were a year or two ago).

The book also contains an excellent foreword by the famous and well-respected economist Dr Alfred Kahn, one of NERA's special consultants, who offers his perspective on 40 years of liberalization in the utility sector. Intriguingly, one of the things that Kahn most laments seems to be the lack of the development of demand side response in the electricity market -- something that he sees as partly to blame for the Californian power market "meltdown".

He says: "It is the comparative rarity of real-time pricing and metering, precluding an efficient demand-side response to shortages and sky-rocketing energy prices that makes these markets dysfunctional, subjecting policy makers to the Hobson's choice between caps on prices, to protect defenseless customers, and permitting prices on peak periodically to rise to the politically unacceptable levels necessary if capital costs are to be recovered over time and efficient entry encouraged...if markets were free to fluctuate with the changing balance of supply and demand and a sufficient portion of large customers were so metered as to be able to respond by changing their electricity using practices -- the very policy...that was the focus of my efforts at the New York Public Service Commission thirty years ago -- such capacity requirements would be unnecessary and genuine deregulation of generation and marketing would be feasible."

Excellent food for thought and this book is crammed full of such insights. Highly recommended.

"The line in the sand: the shifting boundary between markets and regulation in network industries" -- edited by Dr Sarah Voll and Mike King, ISBN 978-0-9748788-4-3, costs $39.95.