Institute of Economic Affairs Beesley Lecture series. Does the UK's electricity market design and regulation foster anti-competitive incumbent vertical market power that slows innovation and experimentation?

1. Can
ver(cal
disintegra(on,
deregula(on,
and
innova(on
be
a
win-­‐win-­‐win
for
electricity
markets?
Lynne
Kiesling
Department
of
Economics
Northwestern
University
lynne@knowledgeproblem.com
Beesley
Lecture
November
2014

2. • Investor-­‐owned
u(lity
• Incumbent
distribu(on
u(lity
• Restructured
state
with
“full
retail
compe((on”
since
2006
• Default
service
provider
• By
2012,
miniscule
residen(al
entry
and
<1%
customer
switching
• Remains
the
dominant
firm
in
the
residen(al
retail
market,
by
a
long
shot
Incumbent
ver,cal
market
power
in
a
“compe,,ve”
retail
market

3. Ques(ons
I’ll
pose
tonight
• What
role
does
incumbent
ver(cal
market
power
play
in
reducing
innova(on
and
dynamism?
• To
what
extent
is
incumbent
ver(cal
market
power
a
result
of
regulatory
design?
• How
does
regulatory
design
affect
the
emergence
of
new
innova(ons,
services,
and
markets,
such
as
the
residen(al
solar
market
in
the
US?
• Is
there
a
more
useful
theory
of
compe((on
in
which
we
can
ground
regulatory
prac(ce?
• What
does
an
experimenta(on-­‐based
theory
of
compe((on
imply
for
innova(on
and
for
regulatory
ins(tu(onal
design?

4. Punch
line:
Retail
compe((on
+
Technology-­‐agnos(c,
performance-­‐
based
environmental
policy

6. Incumbent
ver(cal
market
power,
ownership,
&
regulatory
structure
UK
Retail
Heavy
oval:
economic
regula(on
Thin
oval:
compe((on
Do^ed
red
line:
market
rules
allow
for
ver(cal
downstream
par(cipa(on
Yellow
line:
market
rules
allow
for
ver(cal
downstream
ownership

8. Incumbent
ver(cal
market
power
&
regulatory
design
US
tradi*onal:
35
states
Retail

9. Incumbent
ver(cal
market
power
&
regulatory
design
US
deregulated:
Texas
US
restructured:
14
states
+
DC
Retail
Retail
Furthermore:
• Customers
own
their
data
• Only
retailers
can
provide
CPE

11. Persistent
regulatory
entry
barriers
Beloit
mee(ng
11

12. Case
study:
Electricity
incumbent
default
service
&
the
Bell
Doctrine
12
Cita*on:
L.
Lynne
Kiesling,
“Incumbent
Ver(cal
Market
Power,
Experimenta(on,
and
Ins(tu(onal
Design
in
the
Deregula(ng
Electricity
Industry,”
Independent
Review
19:2
(Fall
2014)

13. Quaran(ne
the
monopoly
13

14. Persistent
regulatory
entry
barrier:
incumbent
default
service
• Incumbent
serves
all
residen(al
customers
who
“choose
not
to
choose”
• Meant
as
a
transi(on
mechanism,
but
s(ll
in
place
• Implemented
in
all
restructured
states
except
for
Texas
– Incumbent
prevented
from
providing
retail
service
in
na(ve
service
territory
– Regulated
wires
u(li(es
prevented
from
providing
retail
service
except
through
AREPs
• Natural
experiment
in
progress:
more
robust
retail
compe((on
in
Texas?

15. Switching
data
suggest
incumbent
default
service
is
an
entry
barrier

16. Barrier
to
what?
Digital
innova(on
at
the
edge
of
the
network

17. Financial
and
technological
innova(on
in
solar

18. California
residen(al
solar
installa(ons
without
state
incen(ves
Source:
GTM
Research,
h^p://www.greentechmedia.com/ar(cles/read/the-­‐legacy-­‐of-­‐the-­‐california-­‐solar-­‐ini(a(ve

19. The
“u(lity
death
spiral”
Source:
William
Pentland,
“Why
the
‘U(lity
Death
Spiral’
is
Dead
Wrong,”
Forbes,
6
April
2014

20. Price
Quantity
A monopoly with large economies of scale can
have a lower price than competitive firms
Qmonopoly
Pm
Market Demand
Marginal Revenue
MC of monopoly
AC of monopoly
Qcompetitive
Pc
Qoptimal
Average costs for small
firms
Sta(c
model
underlies
regulatory
theory,
prac(ce,
ins(tu(ons

21. Is
this
s(ll
a
useful
model
in
a
dynamic
economy?
• Theory
is
sta(c
and
ins(tu(ons/prac(ce
are
built
upon
sta(c
theory
– Schumpeter:
entrepreneurship,
innova(on,
product
differen(a(on,
and
economic
growth,
crea(ve
destruc(on
– Market
processes
do
not
create
long-­‐run
value
by
gelng
to
P=MC;
they
do
so
through
experimenta(on
and
learning
through
trial
and
error
– Poli(cal
economy
cri(que,
VHV:
“…
a
serious
deficiency
of
regula(on
seems
to
be
that
it
oqen
fails
to
‘disappear’
when
the
natural
monopoly
does.”
• Epistemic
cri(que
–
the
knowledge
problem
– Hayek
(1945):
market
processes
aggregate
diffuse
private
knowledge,
and
centralized
processes
cannot
replicate
those
processes
or
outcomes
– A
price
is
a
signal
wrapped
in
an
incen(ve,
and
it
emerges
from
market
processes,
not
from
administered
cost
recovery

22. Is
regulatory
theory
and
prac(ce
suitable
to
evolving
policy
issues?
Sources:
h^p://ingrimayne.com/econ/Efficiency/Nutshell.html;
David
Suzuki
Founda(on
Economic
efficiency
Environmental
quality

24. Source:
Daily
Mail,
6
November
2012

25. What
regulatory
ins(tu(ons
are
compa(ble
with
this
complexity
and
with
evolving
policy
objec(ves?

26. Hypothesis:
policies
enabling
experimenta(on
fit
a
dynamic
economy
Beloit
mee(ng
26

27. Why?
Experimenta(on
• Is
part
of
the
process
of
value
crea(on
through
crea(ve
destruc(on
– Product
differen(a(on,
bundling,
change
market
boundaries,
rivalry
among
differen(ated
bundles
– New
entrants
are
most
likely
to
risk
their
resources
doing
so
– Schumpeterian
disrup(ve
entrepreneur
• Is
essen(al
to
entrepreneurial
discovery
of
new
knowledge,
leading
to
value
crea(on
when
innova(on
does
not
rely
on
regulatory
permission
– Kirznerian
equilibra(ng
entrepreneur
(with
a
dash
of
Hayek)
• Epistemic
context:
the
knowledge
relevant
to
coordina(on
across
individuals
and
across
economic
and
environmental
objec(ves
is
dispersed,
private,
oqen
tacit,
so
regulatory
mandates
cannot
replicate
it

28. Source:
EPRI
(2011)
A
plaworm
business
model:
Permissionless
innova(on
in
electricity?

29. Proposal:
Physical
+
digital
plaworm
business
model
• Technology
plaworm
– Common
core,
heterogeneous
periphery
– Open
interface
standards
– Loosely-­‐coupled
interoperable
system
of
systems
– Distributed
digital
sensing
and
communica(on
• Economic
plaworm
– Facilitate
mutually
beneficial
connec(on
– Heterogeneous
agents
with
distributed
knowledge
&
intelligence
at
the
edge
of
the
plaworm
• Organiza(onal
structure
– Firm
– Industry
• Compa(ble
&
enabling
regulatory
ins(tu(ons
– Compe((on
around
the
plaworm
– Open
interoperable
standards

30. New
York
Reforming
the
Energy
Vision
(REV)
proposal
• Staff
proposal
from
NY
Public
Service
Commission
• Policy
objec(ves
include
consumer-­‐centric
approach,
markets,
climate,
alongside
reliability
and
cost-­‐effec(veness
• Proposal:
Incumbent
u(lity
as
a
Distributed
System
Plaworm
(DSP)
– Enable
heterogeneous
agents
to
connect
– Involves
u(lity
ownership
of
genera(on
and
storage
technologies
for
reliability
and
market
liquidity
purposes
• Interoperability,
non-­‐discrimina(on,
ac(on
orienta(on

31. Ins(tu(onal
design:
Gardener,
not
engineer
“If
man
is
not
to
do
more
harm
than
good
in
his
efforts
to
improve
the
social
order,
he
will
have
to
learn
that
in
this,
as
in
all
other
fields
where
essen(al
complexity
of
an
organized
kind
prevails,
he
cannot
acquire
the
full
knowledge
which
would
make
mastery
of
the
events
possible.
He
will
therefore
have
to
use
what
knowledge
he
can
achieve,
not
to
shape
the
results
as
the
craqsman
shapes
his
handiwork,
but
rather
to
cul(vate
a
growth
by
providing
the
appropriate
environment,
in
the
manner
in
which
the
gardener
does
this
for
his
plants.”
-­‐F.A.
Hayek,
Nobel
address,
December
1974

32. Conclusions
• Persistent
incumbent
ver(cal
market
power
in
retail
markets
is
a
regulatory
choice
that
s(fles
producer
and
consumer
experimenta(on
• Experimenta(on
is
essen(al
to
the
dynamic
market
process,
but
absent
from
regula(on’s
theory
of
compe((on
regula(on
• The
Bell
Doctrine
suggests
to
quaran(ne
the
monopoly;
among
the
16
restructured
states,
only
Texas
has
done
so
• The
future
u(lity
business
model
as
a
physical
+
digital
plaworm
with
permissionless
innova(on
may
yield
other
revenue
streams
as
the
value
of
the
wires
network
diminishes
over
(me
• The
regulator’s
role
should
be
as
a
gardener,
not
as
an
engineer
–
retail
compe((on,
tech-­‐agnos(c
renewables

33. Parking
lot

34. Source:
SEIA
Solar
Market
Insight
2013:
Year
in
Review
Barrier
to
what?
Solar
technology
and
financial/
business
model
innova(on

35. 0
5000
10000
15000
20000
25000
30000
35000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
Total
new
≤
10kW
solar
installa*ons
in
9
states,
annual
Source:
Tracking
the
Sun
VII
(2014),
Lawrence
Berkeley
Laboratory
Why?
• Innova(on
• Technological
• Financial
• Decreasing
PV
costs
• Policies
• Very
complicated
policy
environment
• Tax
credits
(declining
over
(me)
• Net
metering
• RPS
• SREC
market
• Solar
carve-­‐outs
• Vary
in
flexibility

36. 0
5000
10000
15000
20000
25000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
Number
of
new
≤
10kW
solar
installa*ons,
annual,
selected
states
AZ
CA
IL
NC
NJ
NY
OH
TX
WI
Source:
Tracking
the
Sun
VII
(2014),
Lawrence
Berkeley
Laboratory

37. 0
1
2
3
4
5
6
7
8
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
Median
size
of
new
≤
10kW
installa*ons,
selected
states
AZ
CA
IL
NC
NJ
NY
OH
TX
WI
0.0
1.0
2.0
3.0
4.0
5.0
6.0
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
Median
size,
average
across
selected
states
Source:
Tracking
the
Sun
VII
(2014),
Lawrence
Berkeley
Laboratory

38. 0
2
4
6
8
10
12
14
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
Axis
Title
Median
installed
cost
($/W),
selected
states
AZ
CA
IL
NC
NJ
NY
OH
TX
WI
0
1
2
3
4
5
6
7
8
9
10
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
Median
installed
cost
($/W),
average
across
selected
states
Source:
Tracking
the
Sun
VII
(2014),
Lawrence
Berkeley
Laboratory