January 2002

Electricity Goes to Market

Building intelligence into the power grid would make electricity cheaper and more reliable. The technology-from self-monitoring power lines to giant transistors-is ready to go. But no one has an incentive to foot the bill.

By Robert Pool

Economists aren't generally known for consensus of opinion, but there's one point on which almost all of them agree: regulated markets are less efficient and end up costing consumers more than unregulated markets. It is this conviction that has driven the deregulation of the electric utility industry over the past decade. In a free electricity marketplace, the theory goes, the forces of supply and demand would drive the industry to become more efficient and reliable. Electricity prices would drop, supplies would increase and companies would make rational investment decisions based on expected returns. Because one unit of power is indistinguishable from any other, electricity would ultimately become a commodity, bought and sold on the basis of price with no concern over whether it was produced a few kilometers away or halfway across the country.

Time has shown, however, that the road to commoditization will not be without its bumps. As the California energy crisis of 2000 has demonstrated, partial deregulation-in this case, letting wholesale electricity prices float while keeping the retail price capped-can make matters worse. And as long as public opposition to new generating plants remains high, the supply of electric power will have difficulty keeping up with demand, no matter how enlightened the deregulatory policies.

But as those who study the electric industry point out, there's an even more fundamental obstacle to realizing the promise of deregulation: the technology itself. Nearly everything in the current power system-from the generating plants and the transmission grid that distributes electricity throughout the country to the devices that run on that power and the meters that keep track of power usage-is designed for use in a centralized system of regulated, monopolistic utilities that produce power at a few locations and ship it out to local customers at a fixed price. While the regulatory policies have begun to change, the technology, for the most part, has not kept up.

Take the power grid, for example. Utilities began building this network of transmission lines over 100 years ago to bring power from their generating plants straight to their customers. In the early 20th century, they began to interconnect their transmission systems so that a utility that needed extra power might buy it from a nearby firm; but these uses remained a small part of the grid's traffic. Thomas Edison himself-who came up with the grid's original hub-and-spoke design-would likely have no difficulty recognizing today's transmission system. But while Edison's design has sufficed for a century, it doesn't offer the flexibility required to turn electricity into a commodity.

"People are trying to operate the grid in a way it wasn't designed for," says Thomas Overbye, a power systems expert at the University of Illinois at Urbana-Champaign. "When you try to treat electricity as a commodity, you change the whole flow pattern." A customer in Pennsylvania, for example, might now contract for power from a supplier in Illinois, through an electricity reseller who would pay for transmission rights on the lines between the two places. As a result, the electricity may be traveling a thousand kilometers instead of a few hundred, and because electrons follow the path of least resistance, the current will distribute itself over a variety of routes between source and destination, not just the single transmission path that has been paid for. As more and more customers-mainly large industrial concerns and utilities themselves-have gone further afield to find the least expensive power, traffic on transmission lines has increased to the point that a growing number of them are bumping up against their maximum capacity. It will only get worse in the future, as competition and choices increase, prompting more users to look beyond local utilities.

Help could be on the way. A new generation of technologies, some already in existence and some under development, could allow the power system to operate with unprecedented flexibility, efficiency and stability. Consumers could control the timing of their electricity purchases, in order to get the best prices. Homeowners and companies could operate their own generators, selling excess power back to the grid and helping to drive prices down further (see "Power to the People," TR May 2001). Electricity would finally become a true commodity, freely traded in an open market. One caveat: many of the systems that would enable such practices are still hypothetical, and realizing them could require a fundamental rethinking of how the grid is owned and operated.