EBF 483
Introduction to Electricity Markets

6.0 Introduction


6.0 Introduction

The electric utility industry has been one of the most stable in the world over the last century. Yet, beginning in the 1970s dissatisfaction with the industrial and regulatory model for providing electric power - in which a single highly regulated company generated electricity and sold that electricity to customers of all sizes - began to grow rapidly. The United States and other countries began to experiment with various reforms to the electricity industry model. We sometimes call this process "deregulation," and indeed these reforms did involve some degree of loosening or elimination of some kinds of price regulation. But what has really happened is an industrial transformation that we are still working through today. So maybe a better word for this process would be "restructuring."

In the United States there have really been a few watershed moments in the process of regulatory reform:

  • In 1978 the Public Utilities Regulatory Policies Act (PURPA) permitted companies other than electric utilities to own and operate power plants, selling that power to electric utilities. Many utilities were required by their regulators to buy power from these new "independent power producers."
  • Following the passage of PURPA, a number of utilities in the Western U.S. began to experiment with an informal market for trading surplus electricity. The Western Systems Power Pool (WSPP) was the first organization that allowed the purchase and sale of electricity at whatever price the market would bear. Only electric utilities and independent power producers, however, were allowed to participate in the WSPP market.
  • The Energy Policy Act of 1992 allowed purely financial entities, who did not own any physical assets like power plants or transmission lines, to buy and sell electricity. A new breed of commodities trade thus emerged, with electricity contracts traded on over-the-counter exchanges just in the way that crude oil, natural gas or hog bellies were traded.
  • In 1998, California and Pennsylvania began bold experiments with full price deregulation for their electric utilities. California's experiment ended particularly badly, as we will see later in this lesson.
  • In 2000, The Federal Energy Regulatory Commission issued a series of orders requiring electric transmission companies to offer "non-discriminatory access" to their grids by both utility-owned power plants and independent power producers. This meant that electric utilities no longer had a monopoly on power generation - new firms could come in and compete with them on regional markets. One of the earliest of these regional markets - the PJM Interconnection - is one that we'll study a lot in the second half of this course.
  • The Energy Policy Act of 2005 repealed an old law called the Public Utilities Holding Company Act (PUHCA), which was passed in the wake of the Great Depression. PUHCA had prevented electric utilities from growing too large. The repeal of PUHCA has meant a tremendous amount of merger and acquisition activity in the electricity sector.

Before we get to how modern electricity markets work, we'll discuss why we felt the need to restructure or deregulate electric power in the first place.

There are a couple of external readings for this lesson, available on Canvas::

  • Notes on regulation and restructuring, which describe more fully some of the problems with the rate of return regulation.
  • "Price and Revenue Cap Regulation" by Mark Jamison explains some ways that regulators tried to improve regulation after the 1970s.
  • "Measuring the Benefits and Costs of Regional Electric Grid Integration," by Seth Blumsack, Energy Law Journal, 2007. The beginning of this piece has a nice explanation of what we mean by "restructuring."

Learning Outcomes

By the end of this lesson, you should be able to:

  • Explain the incentive problems with the rate of return regulation.
  • Explain the Averch-Johnson effect and what it means for electric ratepayers.
  • Describe price and revenue cap regulation.
  • Identify similarities and differences between Regional Transmission Organizations and electric utilities.

Lesson Roadmap

Lesson 6 Roadmap
To Read

Online course material

Additional Readings

  • Notes on regulation and restructuring
  • Jamison: Price and Revenue Cap Regulation
  • Blumsack: Regional Electric Grid Integration
To Do Homework Assignment 6

Exam 2


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