Q1Restructured Power System

Deregulation (restructuring) of the traditional vertically-integrated electric power industry — in which a single utility historically owned and controlled generation, transmission, distribution and retail supply within its service territory — arose from a combination of economic, technological and political factors, aiming to replace administratively-set, cost-of-service regulated pricing with competitive market mechanisms wherever genuine competition is feasible.

Reasons for Deregulation

Inefficiencies of the vertically-integrated monopoly model: under traditional cost-of-service regulation, utilities were guaranteed a regulated rate of return on their capital investment (rate base), which created an incentive to over-invest in capital assets (the 'Averch-Johnson effect') rather than to minimize costs, since higher capital investment directly translated into higher allowed profit, regardless of whether that investment represented the most cost-efficient way to meet demand.

Technological changes reducing generation-scale economies: the historical justification for vertically-integrated monopoly was that large-scale, centralized generation exhibited strong economies of scale, making a single integrated utility the most efficient supplier; however, technological advances (efficient combined-cycle gas turbines, later renewable technologies) reduced the minimum efficient scale of new generation capacity, making it technically and economically feasible for multiple independent generators to compete, undermining the natural-monopoly justification specifically for the generation segment (though transmission and distribution wires retain strong natural-monopoly characteristics even today).

Desire to attract private investment: many developing and transition economies pursued power sector reform specifically to attract private capital investment into generation capacity expansion, since state-owned, vertically-integrated utilities often lacked sufficient capital or operational efficiency to meet rapidly growing electricity demand, and unbundling generation into a competitive segment made private investment in generation both more attractive (clear commercial rules, ability to sell output competitively) and more readily financeable.

International policy influence and precedent: the successful early restructuring experiences of countries such as Chile, the UK, and several US states in the 1980s-1990s provided influential precedents and, in many cases, direct policy pressure (including from international financial institutions) for other countries to pursue similar market-oriented reforms of their power sectors.

Objectives of Deregulation

Improved economic efficiency: introducing competition among generators is intended to drive down generation costs through competitive pressure, more accurately reflecting the true marginal cost of electricity in market prices rather than administratively-determined, average-cost-based regulated tariffs.

Consumer choice and lower prices: in markets extending competition to retail supply, consumers gain the ability to choose their electricity supplier based on price and service offerings, intended to place competitive downward pressure on retail prices over time.

Encouraging innovation and new entry: a competitive generation market is intended to encourage technological innovation, new entrant competition, and diversification of the generation mix (including renewable energy sources), rather than relying on a single incumbent utility's investment choices.

Efficient price signals for investment: market-based (particularly locational marginal) pricing is intended to send accurate economic signals indicating where new generation or transmission investment is most needed, guiding private capital toward economically efficient locations and technologies rather than requiring centralized utility planning to make these decisions administratively.

Separating regulated (natural monopoly) and competitive segments: by clearly unbundling the naturally-monopolistic transmission and distribution 'wires' businesses (which continue to require price regulation, since duplicate competing networks would be wasteful) from the potentially competitive generation and retail-supply segments, deregulation aims to apply the most appropriate governance mechanism (competition vs regulation) to each distinct segment of the industry, rather than applying a single, one-size-fits-all regulatory approach across the entire vertically-integrated value chain as in the traditional utility model.