The Economic Basis for Competition in Electricity Generation

Today, in Louisiana, there are two parallel systems of electric generation. One system, representing one fifth of the state's generation, is owned and operated by industrial NUGs. The other system, representing four fifths of the state's generation, is owned and operated by the regulated electric utilities. The industrial NUG system, which grew in a competitive environment, can produce electricity at less than 4 cents per KWH. The electric utility system, which grew limited by a regulatory environment, produces electricity at an average of 5.7 cents per KWH. Similar situations exist in other states. Reasons for how and why these systems exist simultaneously are discussed in Appendix A.

These price data suggest that electricity prices for all consumers could be reduced by the introduction of competition into the electricity market. This concept has created a move to deregulate the electricity generation system and provide all future electricity generators, NUG or utility, with equal access to electric transmission systems.

Reaping the benefits of such competition, however, will not be without cost. Non utility generators through use of newer, more efficient generation technology have the capacity in a competitive generation market to capture substantial market share from the utilities. The resulting financial risk to the electric utilities is now well recognized. The terminology used to describe this risk is "stranded cost." This term represents the value of utility invested capital at risk of being lost as a result of competition or in other terms, non-competitive capital. Suggested total values for this capital at risk across the U.S. often exceed $200 billion.

The Regulatory Basis for the Introduction of Competition in Electricity Markets

The federal Energy Policy Act (EPACT) of 1992 has as its intent, not only the conservation of energy, but also the encouragement of competition in the marketplace for electricity. In response to EPACT, on April 24, 1996, the Federal Energy Regulatory Commission (FERC) issued Final Rules, Orders No. 888 and 889, designed to promote real competition in the generation and sale of electricity.

The first order, Rule 888, orders the electric utility owners of the electric transmission grid to provide non-discriminatory open access to others. This is intended to make the same transmission services available to electric utilities available to NUGs as well. The second order, Rule 889, mandates the creation of a real-time information system to assure that transmission owners or their affiliates do not have an unfair competitive advantage in using transmission to sell electric power. The overall effect of these Rules is intended to be the "unbundling" or separation of electric power generation and transmission and the potential creation of genuine competition in the generation sector of the electricity industry.

Operational Factors Affecting the Onset Timing and Effectiveness of Competition in Electricity Markets

This deregulation of electric generation and open access to transmission will have significant effects on the electric utilities, the NUGs, all electricity consumers, and the natural gas industry as well. NUG ability to compete with significant success seems assured. They have the ability to introduce generation technology which is more efficient, less capital costly, and more environmentally friendly than the vast majority of the electric utility generation capacity inventory.

However, the degree to which such competition is invariably effective in an operational sense is based on a kaleidoscope of factors, many of which are still controlled by governmental and regulatory processes. The equally critical factor of time to actual institution of real competition is similarly controlled. Some (but certainly not all) major factors affecting the degree and timing of real electricity market competition are:

• FERC's Rule 888 explicitly includes decision making by the state electric regulatory commissions. This is certainly appropriate. However, it will almost certainly create a system which, operationally, will vary form state to state, thus being more fragmented, less simple, and, in some cases, more protectionist of the status quo.
• The electric utilities are faced with the loss of income on investment, known as "stranded cost," amounting to $200 billion dollars or more. These utilities have millions of stockholders. Electric utility stock occupies a prominent position in the portfolio of almost every pension fund in the nation. This presents a powerful political constituency favoring and lobbying for a "go slow and limit utility economic effects" process in any transition to competition.
• Other interest groups who are financially dependent on the operation of electric utilities under the "status quo" will add further weight to the pressure and lobbying described above. This includes producers of fuels which may be adversely affected as well as legislative and regulatory delegations from energy producing states in which such fuels are produced.

Even if all other factors, technical or economic, are excluded from consideration, those listed above are likely to present a formidable obstacle to quick or one sided decisions regarding competition in the electricity market. Many hybrid systems of operation have been proposed. The final degree to which competition will exist is not and cannot be known at this time. Predicting the timing of the onset of any competition is equally impossible.

In the competitive circumstances in which new NUGs would enter such an electricity market, degree of competition and timing of onset are critical financial factors. Any NUG attempting early entry into such a market takes a serious risk. Failure to accurately predict either the competitive situation or the moment of its arrival could create fatal financial consequences.

Potential Effects of the New Electricity Market on the Natural Gas Industry

Combined cycle generation is the likely tool of any NUG entering the proposed new competitive electricity market. Natural gas is the fuel of choice for such generating plants. It is important, then, to understand which electric utility plants are at risk from combined cycle operations and how they are fueled.

To place this in perspective, the replacement values for various utility steam turbine fuels are considered in terms of natural gas potentially burned in combined cycle operations at 6.25 ft³ per KWH of electricity generated. The resulting values are an upper limit since they assume full and unlimited competition. The following values are calculated with 1995 data:

• Nuclear generation in Louisiana was 15.686 billion KWH. If replaced by combined cycle generation, this represents a potential increase in natural gas consumption of 98 billion ft³ / year.
• Coal fired generation in Louisiana was 18.954 billion KWH. If replaced by combined cycle generation, this represents a potential increase in natural gas consumption of 118.5 billion ft³ / year.
• Natural gas fired steam turbine generation in Louisiana was 30.132 billion KWH and used 313.4 billion ft³ of natural gas. If replaced by combined cycle generation, this represents a potential loss in natural gas consumption of 125.1 billion ft³ / year because of the higher thermal efficiency of combined cycle plants (See discussion in appendix A, Part I).
• Nuclear generation in the U.S. was 673.4 billion KWH. If 20% can be replaced by combined cycle generation, this represents a potential increase in natural gas consumption of 841.8 billion ft³ / year.
• Coal fired generation in the U.S. was 1,652.9 billion KWH. If 20% can be replaced by combined cycle generation, this represents a potential increase in natural gas consumption of 2,066.2 billion ft³ / year.
• Natural gas fired steam turbine generation in the U.S. was 267.7 billion KWH and used 2,772.9 billion ft³ of natural gas. If completely replaced by combined cycle generation, this represents a potential decrease in natural gas consumption of 1,100 billion ft³ due to the higher thermal efficiency of combined cycle generation.

The threshold limit which will be used for comparing combined cycle operations with electric utility units is the total cost to install and operate such a plant as well as an amount needed for profit. Under total competition, successful competition against an electric utility plant means that plant is shut down. The threshold number against which electric utility plants may be measured is the sum of total operations and maintenance (O&M) costs plus any percentage of "fixed overhead" which disappear with the closing of the plant. Any electric utility plant for which this number is significantly above the threshold number for a nearby combined cycle plant is at risk.

An important key to measuring potential effects of natural gas fired combined cycle plants against electric utility plants is having threshold numbers calculated for both. Such data are not currently available. Every attempt will be made to calculate these numbers, on a plant by plant basis, before the next release in this series on non utility generation.

Go To Appendix A

Return to Technology Assessment Division Reports Menu

Go to Technology Assessment Division Main Menu

Comments or questions to: techasmt@dnr.state.la.us

These web pages were designed under contract to the Department of Natural Resources and are maintained by employees of the Department of Natural Resources.

This page updated June 18, 2008