A watchful eye

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Enron’s swift slide to bankruptcy poses important questions on the regulation of electricity markets

Ask why? was the slogan of Enron’s high profile television advertising campaign against regulation. Regulators around the world are now working to deal with the consequences of Enron’s collapse. Ask why?

The failure of the world’s largest trader in electricity is the third major disaster of deregulation. It is also the least significant. The lights will stay on. The regulatory issues that arise will probably have more to do with financial services and accounting standards than power generation. But in the two previous failures – in California and New Zealand – the lights went out. Ask why?

Magicians have always attributed failures of their magic to the inadequacy of their clients’ belief. People who think that that market failures are generally to be laid at the door of government generally take the same line. If deregulation fails, it is because we have not deregulated enough.

There is some justice in this claim. Ask why the Californian power system could not meet the needs of its customers? The problem was mismanaged deregulation rather than deregulation itself. Californian voters had decided they wanted to stop the construction of new power plants. Their concern for the environment was admirable. But they also wanted to consume much more electricity and pay less for it.

In a democratic political system such as the United States, there is nothing to stop the electorate demanding incompatible things. Nor is there anything to stop local politicians from cheering voters’ demands and blaming the failures on profiteers from outside the state. It was not, perhaps, the most propitious environment in which to deregulate California’s electric power industry. Nor, perhaps, was it the most propitious environment in which to be regulating it.

The trouble is that government cannot stay out of the electricity business. Most households, offices and factories want a continuous supply of electricity. There may be those who murmur ‘you can’t buck the market’ as the lights flicker, and wait for market forces to sort things out. But even in libertarian circles, there are quite a few who will complain to their congressman as they sit in the dark. No economist has ever claimed that the price mechanism could ensure that supply equals demand, twenty-four hours a day, three hundred and sixty-five days a year. But that is what we expect from our electricity suppliers.

The most radical experiment ever in electricity deregulation failed to deliver this to the businesses and residents of Auckland. The successive failures of all four cables supplying the city’s Central Business District cut off power supplies for several weeks in the warm New Zealand summer of 1998.

When I mentioned this unhappy story in a previous article, I received two groups of e-mails. One group blamed the failure on privatisation. The other blamed the failure on the absence of privatisation. Just as some people blame California’s problems on regulation and others blame it on deregulation.

Both points of view have some merit. The structure of Mercury Energy – the business responsible for electricity distribution in Auckland – was so convoluted that it is still quite hard to decide whether it had been privatised or not.

When the New Zealand government restructured the state-owned electricity industry, it was determined above all to remove any political influence or control. There was to be no regulation. But even the most hard nosed of free marketers realised that creating of a private profit-making company with a monopoly of electricity supply would not win much public support. Mercury Energy was established with a structure in which its customers, through the Auckland Electricity Consumers Trust owned most of the shares, but not the votes.

Most of the board was appointed by independent trustees. The trustees were obliged to act on the instructions of Mercury Energy. This was intended as an interim solution, but the structure suited the management of Mercury Energy rather well, so no urgency was attached to the search.

It is not possible to attribute the failure of Auckland power supplies directly to the peculiar governance of Mercury Energy. But an official inquiry revealed a saga of management arrogance and incompetence in Mercury Energy which cannot be separated from the structure of the organisation. And the large reductions in manpower which the company implemented must have destroyed tacit knowledge within the organisation.

Ask why? We should question any system of regulation. The history of government involvement in electricity is a history of overmanned power stations, grotesque cost overruns, and insensitivity to the needs of consumers. But complete deregulation of the electricity business is impossible. What is needed is regulation that tackles public concerns – costs, prices and investment in the natural monopolies of the transmission and distribution system, and the capacity of the industry as a whole to guarantee security of supply – and leaves as much of the rest as possible to competitive markets. Do ask why. But the answers are too complex to be addressed within a thirty second television commercial.

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