Nevada Ballot Question 3

Nevadans will be voting for four ballot measures during this year’s election.

One of them is about energy choice. Ballot question 3 asks voters if they vote yes or no for the “establishment of an open, competitive retail electric energy market that prohibits the granting of monopolies and exclusive franchises for the generation of electricity.”

The text of the question mentions the existence of a monopoly. But how did we even end up with a monopoly utility in the first place?

The answer lies in simple economics. Electricity industry is a canonical textbook example of natural monopoly. It is because we only need one set of transmission lines and one set of distribution lines. Also, a single large power plant tends cost less per kWh than multiple small plants do. So it is cheaper for one company to generate 100 kWh then hundred companies to generate 1 kWh each.

The regulators pretty much strike a deal with the power company with the following terms:

The utility company will have the monopoly status and they will be allowed to cover all their costs from the ratepayers.

In exchange for this, the utility promises to invest in generation, distribution, and transmission capacity to serve everybody in the constituency. They also have to have reliable service where we don’t end up with annoying blackouts and the voltage shouldn’t fluctuate enough to break our appliances. The utility is also required to serve every single customer who wants service regardless of how profitable they are. Additionally, the utility needs to file detailed rate cases where they substantiate their claims of cost increases if they want to increase the rates. Once the rates are locked in, they can’t change it for certain number of years. Last but definitely not least, the utility needs to comply with renewable portfolio standards where a certain percentage of the generation needs to come from renewables sources.

An obvious question would be if we have such a hunky dory setting here why on earth we consider changing it? The answer is again simple economics. The cost of generating electricity at small scale has come down significantly in the past decade. Now for many large electricity consumers it is more economical to generate their own electricity (or buy it from independent power providers) rather than purchasing it from the utility. Because remember, the utility is charging for the stranded costs from older and more expensive technologies.

An important thing to keep in mind is that the utility makes all the infrastructure investment (generation, transmission, distribution systems) even before they can start selling the electrons and billing people. We are talking about really large amounts of cash here. For obvious reasons, in economics lingo all these capital investments are called “stranded costs”.

Here is where it gets all hairy. The stranded costs make up the major portion of doing business in electricity industry. If a large customer wants to leave the utility, it is true that the utility will no longer have to buy fuel to serve that customer. However, the stranded costs will not go anywhere. The utility, per the agreement with the regulator, already planned out the consumption and made the necessary capital investments to serve that customer. The decline in the utility’s cost by not serving this customer is not commensurate with the customer’s consumption. Since the state law and the federal law give the utility the right to charge the remaining customers to cover for all the costs, there can be potentially substantial rate increases to the remaining customers associated with massive exits.

Currently, commercial and industrial customers can leave the utility if they want to by paying what is called the “impact fee”. It is designed precisely to cover for the stranded costs that the utility incurred for each customer.

What this ballot measure wants to do is to make the rule ubiquitous so that anybody who wants to leave can do so.

The major problem is that it does not say anything about how the stranded costs will be recovered.

Who is going to pay for them?

Will the rest of the ratepayers who chose to stay with the incumbent (utility) be stuck with them?

If not, will the utility go bankrupt as a result?

That certainly wouldn’t be good for anyone…

I also didn’t see anything regarding the environmental impact. I assume and certainly hope if anybody is buying electricity from a third party, they should make sure a certain percent comes from renewable sources to comply with the renewable portfolio standard. Otherwise it wouldn’t be fair to the utility.

Not to mention this may add additional administrative costs associated with monitoring compliance. The regulator will have to monitor the compliance of many sellers as opposed to just one.

Opening the electricity market can potentially lower the costs for those who are able to exit economically. But the overall success is not guaranteed. Designing a well functioning market is not cheap and definitely for not the faint of heart. Texas was able to make it work only after putting thousands of hours of legislature time into planning their move. However, many people still stayed with the utility due to inertia (i.e. being too lazy to look for bargains).

Voter, beware!