Blog Post

Why We Get the Electricity Reliability We're Willing to Pay For

Jul 18, 2012 | Timothy J. Brennan

Everybody’s talking about power outages—is there anything we should do about them?

That’s been the local hot topic since the June 29 derecho blew through the DC area, causing many to lose power for as much as a week, throw out food, seek out hotels, and start shopping for generators.

We can be sure of a few things. First, whether it’s burying lines, trimming trees, keeping more crews on hand, or bringing in crews from elsewhere, added costs of prevention or restoration will be paid by the customers. Utilities have the right to getting their costs covered, so if those costs rise, rates follow.

Second, even the best remedy won’t eliminate all outages. The costs of “getting to never” likely exceed what most people would pay to get there. We still might see some people (often but not always wealthy) purchasing stand-by generators rather than accept the less-than-perfect reliability that most would pay for.

Third, despite outage outrage, we have no way of knowing whether pre-storm planning and reliability investments and the post-storm restoration efforts were right. Because perfection isn’t in the cards, it’s difficult to tell whether local utilities were incompetent or were doing the best they could.

So what, if anything, can be done?

Some suggest having the government take utilities over. If “a conservative is a liberal who’s been mugged,” perhaps a liberal is a conservative whose power was out for a week. Tempting as that may be, one should remember similar complaints when governments don’t remove snow fast enough or public mass transit breaks down.

A less radical solution would be penalties, but they bring complications.

A first is determining the costs of an outage. Ideally, one would want a dollar value based on how much each affected customer would pay to avoid or shorten an outage. Ascertaining that won’t be easy.

Since the point of the penalty is to get the utility to invest more in mitigating outages, electricity rates will rise. Perhaps we could have premium rates to areas that get premium service, e.g., buried lines.

Additionally, the expected costs of outage compensation will be factored into electricity prices. In effect, penalties for all outage-related costs create insurance against outages, where the customer pays a premium in higher electricity rates to cover the outage related costs if they happen. We might want to leave that to the insurance companies.

Insurance also invites moral hazard. Believing they will be compensated for outage-related costs, people may not take into account outage risk. They can and should take actions to reduce (but, to be sure, not eliminate) the damage or extent of an outage, e.g., trimming trees or delaying restocking the freezer until a storm threat passes.

These insurance-related problems can be avoided by applying penalties only if the utility fails to exercise the appropriate amount of effort to avoid an outage or restore power. Unfortunately, that brings us back to exactly the arguments about whether utilities did the right thing, which a penalty system would help avoid.

As to whether utilities lacked incentive to restore power, I can offer only a couple of speculations. First, policies to encourage utilities to support energy conservation by divorcing revenues from the amount of electricity delivered could attenuate incentives to restore power. This came up after the derecho. My understanding is that after blizzards in 2011, the utilities would be compensated for unsold electricity within only the first 24 hours of an outage, and some have called for eliminating that 24 hour recovery window.

The second speculation may, if true, be more important. In 2006, following removal of rate caps imposed when Maryland elected to open electricity markets, electricity rates notoriously skyrocketed. Had other energy sources been similarly capped, gasoline for example, we would have noticed seen similar if not worse price hikes. Because state officials and regulators no longer control the price of the electricity itself, the only way they can force rates down is to hold down what utilities charge to distribute electricity. But holding down the price means spending less on the distribution system, which could lead to low maintenance, staff reductions, and the like.

Maybe utilities really are incompetent. But the bottom line with what we’ve experienced, and what to do about it, is that but, by and large, we get the electricity reliability that we’re willing to pay for.