1 00:00:00,000 --> 00:00:02,520 The following content is provided under a Creative 2 00:00:02,520 --> 00:00:03,970 Commons license. 3 00:00:03,970 --> 00:00:06,360 Your support will help MIT OpenCourseWare 4 00:00:06,360 --> 00:00:10,660 continue to offer high quality educational resources for free. 5 00:00:10,660 --> 00:00:13,320 To make a donation or view additional materials 6 00:00:13,320 --> 00:00:17,160 from hundreds of MIT courses, visit MIT OpenCourseWare 7 00:00:17,160 --> 00:00:18,450 at ocw.mit.edu. 8 00:00:25,315 --> 00:00:26,690 RICHARD SCHMALENSEE: Today, we're 9 00:00:26,690 --> 00:00:30,900 doing electric power systems, sort of as they are, 10 00:00:30,900 --> 00:00:32,060 and as they have been. 11 00:00:32,060 --> 00:00:36,290 In 2010, electric power systems were about 40%-- 12 00:00:36,290 --> 00:00:38,540 I'm going to have to stand here and use the keyboard-- 13 00:00:38,540 --> 00:00:45,860 about 40% of primary energy, and 40% of CO2 emissions, roughly. 14 00:00:45,860 --> 00:00:48,650 Most electricity goes to residential and commercial 15 00:00:48,650 --> 00:00:54,890 sectors and supplies about 46% of the energy they use. 16 00:00:54,890 --> 00:00:56,990 What I want to do today is to talk 17 00:00:56,990 --> 00:00:59,120 about the essential features of these systems. 18 00:00:59,120 --> 00:01:02,720 I'm guessing most of you haven't had a course in power systems 19 00:01:02,720 --> 00:01:05,690 since MIT doesn't teach a course in power systems, 20 00:01:05,690 --> 00:01:11,810 really, and talk a little bit about the regulatory regime. 21 00:01:11,810 --> 00:01:13,880 Monday we'll look forward, what are 22 00:01:13,880 --> 00:01:16,970 some of the challenges, what are some of the opportunities, what 23 00:01:16,970 --> 00:01:19,080 are some of the policy issues? 24 00:01:19,080 --> 00:01:22,290 So let's talk about the power system. 25 00:01:22,290 --> 00:01:24,800 The one thing you really do have to keep in mind 26 00:01:24,800 --> 00:01:27,290 is despite all of the interest in storage, 27 00:01:27,290 --> 00:01:30,410 and everybody talks about storage of electricity. 28 00:01:30,410 --> 00:01:32,240 As a practical matter, you simply 29 00:01:32,240 --> 00:01:37,760 can't store electricity in bulk at a reasonable cost. 30 00:01:37,760 --> 00:01:41,450 You can pump water uphill and use pumped hydro, and that's 31 00:01:41,450 --> 00:01:43,440 pretty good, that's pretty efficient, 32 00:01:43,440 --> 00:01:48,260 it's very hard to build new pump hydro sites. 33 00:01:48,260 --> 00:01:49,640 There's one in New England. 34 00:01:49,640 --> 00:01:51,600 There are no plans for any others. 35 00:01:51,600 --> 00:01:54,080 And as we'll see next time, the value of storage 36 00:01:54,080 --> 00:01:56,250 goes up over time. 37 00:01:56,250 --> 00:01:58,880 You can also pump air underground. 38 00:01:58,880 --> 00:02:02,610 And there are like two of those in the world. 39 00:02:02,610 --> 00:02:04,640 And there's a lot of research into batteries, 40 00:02:04,640 --> 00:02:06,980 but so far nothing looks cheap. 41 00:02:06,980 --> 00:02:11,840 So at the moment, the system operates effectively 42 00:02:11,840 --> 00:02:14,540 without storage. 43 00:02:14,540 --> 00:02:16,850 And this matters because demand varies 44 00:02:16,850 --> 00:02:20,430 over time in ways that are perfectly predictable. 45 00:02:20,430 --> 00:02:23,190 Here's some seasonal variation. 46 00:02:23,190 --> 00:02:28,640 This is a forecast for New England. 47 00:02:28,640 --> 00:02:33,770 And you'll see that as it says, their week 8 is late July. 48 00:02:33,770 --> 00:02:36,420 Week 8 was forecast to be the peak. 49 00:02:36,420 --> 00:02:39,530 And week 32, which is that sort of secondary peak 50 00:02:39,530 --> 00:02:41,390 is early January. 51 00:02:41,390 --> 00:02:44,000 Most American systems now look like that. 52 00:02:44,000 --> 00:02:47,390 They peak in the summertime, that's air conditioning. 53 00:02:47,390 --> 00:02:49,260 There's also a good deal of variation. 54 00:02:49,260 --> 00:02:50,660 So you have to follow that load. 55 00:02:50,660 --> 00:02:54,320 You have to follow that variation in demand. 56 00:02:54,320 --> 00:02:57,620 But hour-by-hour, there's a lot of variation. 57 00:03:01,490 --> 00:03:02,720 Does the laser work? 58 00:03:02,720 --> 00:03:03,260 No. 59 00:03:03,260 --> 00:03:06,410 OK, how long are my arms? 60 00:03:06,410 --> 00:03:09,260 That sort of an interesting-- that's what? 61 00:03:09,260 --> 00:03:12,890 Last week for New England. 62 00:03:12,890 --> 00:03:18,620 And you'll see first of all that the load in this relatively 63 00:03:18,620 --> 00:03:24,140 uneventful April week varied within a day between 9,000 64 00:03:24,140 --> 00:03:28,200 and just about 16,000 megawatts. 65 00:03:28,200 --> 00:03:31,500 That's fairly substantial. 66 00:03:31,500 --> 00:03:35,490 You see April 2nd was a Monday. 67 00:03:35,490 --> 00:03:37,650 So you can see demand is higher during the week 68 00:03:37,650 --> 00:03:41,120 than the last two which are the weekends. 69 00:03:41,120 --> 00:03:43,820 You'll also see the distinctive feature. 70 00:03:43,820 --> 00:03:47,480 There's sort of a morning peak and an evening peak most days. 71 00:03:47,480 --> 00:03:52,340 The evening peak, again focus on the actual load, the blue. 72 00:03:52,340 --> 00:03:55,370 The evening peak is the higher. 73 00:03:55,370 --> 00:03:58,100 And the minimum occurs in the middle of the night, 74 00:03:58,100 --> 00:03:59,660 not too surprisingly. 75 00:03:59,660 --> 00:04:02,450 But the system has to track that. 76 00:04:02,450 --> 00:04:04,400 The system has to track that. 77 00:04:04,400 --> 00:04:08,690 The other thing you will see in terms of predictability, 78 00:04:08,690 --> 00:04:13,190 forecast load, I'm not sure how far ahead that forecast is. 79 00:04:13,190 --> 00:04:16,040 But DA is Day Ahead. 80 00:04:16,040 --> 00:04:19,010 So the New England system operates with a market. 81 00:04:19,010 --> 00:04:20,570 And there's a real time clearing, 82 00:04:20,570 --> 00:04:22,153 which there has to be because you have 83 00:04:22,153 --> 00:04:23,600 to follow it second-to-second. 84 00:04:23,600 --> 00:04:26,190 But there's also a day ahead market. 85 00:04:26,190 --> 00:04:33,140 So the DA gives you in effect the day ahead forecast. 86 00:04:33,140 --> 00:04:35,420 And you will see the difference between the green 87 00:04:35,420 --> 00:04:41,900 and the blue is usually small but not trivial, not 0. 88 00:04:41,900 --> 00:04:43,070 What else to say? 89 00:04:43,070 --> 00:04:46,310 Any comments or questions so far on this. 90 00:04:46,310 --> 00:04:47,230 Yeah, Jacob. 91 00:04:47,230 --> 00:04:55,547 AUDIENCE: [INAUDIBLE] 92 00:04:55,547 --> 00:04:57,630 RICHARD SCHMALENSEE: Well, it's got to be made up. 93 00:04:57,630 --> 00:05:01,950 The question is, that's a day ahead. 94 00:05:01,950 --> 00:05:03,840 Some of this is going to be-- 95 00:05:03,840 --> 00:05:08,250 the actual load tended to be above the day 96 00:05:08,250 --> 00:05:09,750 ahead which suggests-- 97 00:05:12,490 --> 00:05:14,980 well, if this were the summertime, 98 00:05:14,980 --> 00:05:17,680 I'd say this suggests warmer than expected, which is 99 00:05:17,680 --> 00:05:19,840 sort of what it was that week. 100 00:05:19,840 --> 00:05:23,110 You get better at forecasting the weather as you get closer. 101 00:05:23,110 --> 00:05:25,330 So an hour or two ahead. 102 00:05:25,330 --> 00:05:28,390 It's not like, oh, my God, right now we've got to make a change. 103 00:05:28,390 --> 00:05:31,540 But you may have a few hours warning that it's warmer 104 00:05:31,540 --> 00:05:32,250 than we thought. 105 00:05:32,250 --> 00:05:34,010 So we really have to ramp stuff up. 106 00:05:34,010 --> 00:05:36,250 But yeah, something has to follow that load. 107 00:05:36,250 --> 00:05:37,735 It could be hydro. 108 00:05:37,735 --> 00:05:40,120 It could be gas turbines. 109 00:05:40,120 --> 00:05:42,430 It's not going to be big coal plants 110 00:05:42,430 --> 00:05:45,370 because as I'll come to in a minute, 111 00:05:45,370 --> 00:05:47,732 following load with big coal plants is very expensive. 112 00:05:47,732 --> 00:05:49,190 There's a lot of stuff you get hot. 113 00:05:49,190 --> 00:05:50,800 There's a lot of stuff spinning. 114 00:05:50,800 --> 00:05:54,010 And to let that cool off and/or slow down 115 00:05:54,010 --> 00:05:57,440 and then bring it back wastes a lot of energy. 116 00:05:57,440 --> 00:05:59,770 So you want things that are quick that don't 117 00:05:59,770 --> 00:06:03,460 have a lot of rotating mass. 118 00:06:03,460 --> 00:06:06,310 And that don't have a lot of stuff 119 00:06:06,310 --> 00:06:10,960 that you have to heat and cool, I have to heat and then reheat. 120 00:06:10,960 --> 00:06:11,710 Anything else? 121 00:06:11,710 --> 00:06:12,608 [INAUDIBLE] 122 00:06:12,608 --> 00:06:18,993 AUDIENCE: [INAUDIBLE] 123 00:06:18,993 --> 00:06:20,910 RICHARD SCHMALENSEE: Why is there 10,000 what? 124 00:06:20,910 --> 00:06:27,290 AUDIENCE: Megawatts [INAUDIBLE] 125 00:06:27,290 --> 00:06:30,773 RICHARD SCHMALENSEE: Well, it could. 126 00:06:30,773 --> 00:06:31,940 What are these people doing? 127 00:06:31,940 --> 00:06:32,600 I don't know. 128 00:06:32,600 --> 00:06:34,520 This is you guys working late, I guess. 129 00:06:38,560 --> 00:06:39,310 You've got me. 130 00:06:39,310 --> 00:06:43,150 Some of that traditionally would be industrial load, 131 00:06:43,150 --> 00:06:45,670 like if you're running a factory three shifts. 132 00:06:45,670 --> 00:06:48,500 There's not that much of that in New England. 133 00:06:48,500 --> 00:06:55,310 Some of it may be HVAC in some buildings consuming 134 00:06:55,310 --> 00:07:03,040 electricity, fans running, various kinds of machinery. 135 00:07:03,040 --> 00:07:05,260 There are also these vampire load devices, 136 00:07:05,260 --> 00:07:07,510 when you have almost anything plugged in, even if it's 137 00:07:07,510 --> 00:07:09,190 turned off, it sucks power. 138 00:07:09,190 --> 00:07:11,770 So those loads have gone up. 139 00:07:11,770 --> 00:07:16,600 I have never really seen an analysis of 3:00 AM load. 140 00:07:16,600 --> 00:07:18,910 But you're right. 141 00:07:18,910 --> 00:07:22,660 Your consumption probably goes a lot lower. 142 00:07:22,660 --> 00:07:27,483 You're within day variation is probably greater than that. 143 00:07:27,483 --> 00:07:29,650 And I'm trying to think about the apartment building 144 00:07:29,650 --> 00:07:32,380 where I live and what goes on at 3:00 in the morning. 145 00:07:32,380 --> 00:07:37,450 And about all that's going on is in a warm period 146 00:07:37,450 --> 00:07:41,740 like this there may be some AC usage, although ours wasn't on. 147 00:07:41,740 --> 00:07:42,950 So I don't know. 148 00:07:42,950 --> 00:07:44,440 And you know, you've got appliances 149 00:07:44,440 --> 00:07:47,570 running all night long, refrigerators and such. 150 00:07:47,570 --> 00:07:49,440 But I don't know. 151 00:07:49,440 --> 00:07:51,090 Anything else? 152 00:07:51,090 --> 00:07:51,960 Yeah, Jacqueline. 153 00:07:51,960 --> 00:07:54,058 AUDIENCE: [INAUDIBLE] 154 00:07:54,058 --> 00:07:56,100 RICHARD SCHMALENSEE: The forecast is presumably-- 155 00:07:56,100 --> 00:07:58,140 and I should have checked before I put this up. 156 00:07:58,140 --> 00:08:01,350 The forecast is presumably farther back in time than day 157 00:08:01,350 --> 00:08:02,010 ahead. 158 00:08:02,010 --> 00:08:03,820 The forecast is a forecast. 159 00:08:03,820 --> 00:08:05,970 This would be the regional authority. 160 00:08:05,970 --> 00:08:07,740 And I'll talk about them a bit later. 161 00:08:07,740 --> 00:08:10,500 The regional authorities guess maybe a week ahead 162 00:08:10,500 --> 00:08:11,670 or two weeks ahead. 163 00:08:11,670 --> 00:08:14,960 Day ahead clear demand, that's a market. 164 00:08:14,960 --> 00:08:17,570 People bid to supply. 165 00:08:17,570 --> 00:08:18,320 There's demand. 166 00:08:21,590 --> 00:08:22,880 Well, it clears at a price. 167 00:08:22,880 --> 00:08:24,450 We'll come to price later. 168 00:08:24,450 --> 00:08:27,110 But that is a market. 169 00:08:27,110 --> 00:08:28,220 That's a market outcome. 170 00:08:30,860 --> 00:08:33,112 That's a forecast outcome. 171 00:08:33,112 --> 00:08:34,820 And I just don't know how far in advance. 172 00:08:34,820 --> 00:08:38,270 But it's clearly by the regional authority that runs the system. 173 00:08:38,270 --> 00:08:41,450 An actual load is what actually happened when you 174 00:08:41,450 --> 00:08:44,840 turned on your computer, so OK. 175 00:08:48,910 --> 00:08:59,010 Short term variation, minute to minute, the frequency, right? 176 00:08:59,010 --> 00:09:04,080 Everything assumes, all your equipment assumes, 177 00:09:04,080 --> 00:09:06,120 your appliances assume that you'll 178 00:09:06,120 --> 00:09:10,980 be getting electricity that vary 60 cycles a second. 179 00:09:10,980 --> 00:09:13,530 That frequency has to be maintained. 180 00:09:13,530 --> 00:09:17,070 And it's mainly maintained by sort of automatic control 181 00:09:17,070 --> 00:09:18,430 at designated units. 182 00:09:18,430 --> 00:09:20,790 But when you get big changes like that, 183 00:09:20,790 --> 00:09:22,710 governors aren't going to do it. 184 00:09:22,710 --> 00:09:26,160 And you will need to bring units on and off. 185 00:09:26,160 --> 00:09:32,040 So let me talk about technology mix. 186 00:09:32,040 --> 00:09:37,730 So we mentioned a little earlier that you have fast 187 00:09:37,730 --> 00:09:42,620 responding generating units, turbines say, 188 00:09:42,620 --> 00:09:47,210 or diesels to respond to short term variations in load. 189 00:09:47,210 --> 00:09:51,110 But even if you could forecast the load, 190 00:09:51,110 --> 00:09:54,190 you would want units like that. 191 00:09:54,190 --> 00:10:02,940 And as I mentioned, it's expensive to vary the output 192 00:10:02,940 --> 00:10:05,340 from what are called base load units, nuclear power 193 00:10:05,340 --> 00:10:08,320 plants, big coal plants. 194 00:10:08,320 --> 00:10:11,620 But not only that, when you run them flat out, 195 00:10:11,620 --> 00:10:16,030 they have very low running cost, nuclear virtually 0, 196 00:10:16,030 --> 00:10:19,090 coal pretty low. 197 00:10:19,090 --> 00:10:22,670 You can buy turbines or diesels. 198 00:10:22,670 --> 00:10:25,400 But they're very expensive to build these big units. 199 00:10:25,400 --> 00:10:28,880 The little units, peaking units or intermediate units, 200 00:10:28,880 --> 00:10:30,680 but let me just assume two kinds, 201 00:10:30,680 --> 00:10:33,500 think coal plants and gas turbines, 202 00:10:33,500 --> 00:10:35,960 they're cheap to build, but they're 203 00:10:35,960 --> 00:10:40,340 expensive to run, relatively on today's prices. 204 00:10:40,340 --> 00:10:45,560 So you would want since load varies, 205 00:10:45,560 --> 00:10:48,330 you're not going to run your whole fleet all the time, 206 00:10:48,330 --> 00:10:48,830 right? 207 00:10:48,830 --> 00:10:50,900 If we didn't have those variations, 208 00:10:50,900 --> 00:10:54,230 if demand were constant, you just build, 209 00:10:54,230 --> 00:10:56,180 well, but for environmental issues 210 00:10:56,180 --> 00:10:58,070 you just build cheap coal plants, 211 00:10:58,070 --> 00:11:01,970 cheap nuclear plants if you could find one, combined cycle 212 00:11:01,970 --> 00:11:04,380 plants and run them all the time. 213 00:11:04,380 --> 00:11:06,170 But since the load varies, you know 214 00:11:06,170 --> 00:11:09,330 that you're not going to run your plants all the time. 215 00:11:09,330 --> 00:11:10,640 So what do you do? 216 00:11:10,640 --> 00:11:17,120 If you look, Imagine two plants of the same capacity. 217 00:11:17,120 --> 00:11:21,830 One is, I call it a peaker, but let it be a gas turbine. 218 00:11:21,830 --> 00:11:26,057 And the other is a baseload, let it be a coal plant. 219 00:11:26,057 --> 00:11:27,890 They don't tend to have the same capacities, 220 00:11:27,890 --> 00:11:32,210 but for the sake of argument, suppose they do. 221 00:11:32,210 --> 00:11:34,790 You ask, what's the total cost of this plant? 222 00:11:38,341 --> 00:11:41,750 The more hours you run it, the larger 223 00:11:41,750 --> 00:11:45,410 will be the fuel cost as a component of total cost, right? 224 00:11:45,410 --> 00:11:48,020 So the total cost consists of the cost 225 00:11:48,020 --> 00:11:51,800 of building the thing, basically taken down 226 00:11:51,800 --> 00:11:54,920 to say a per day cost or a per year cost. 227 00:11:54,920 --> 00:11:58,590 And then the slope is the marginal cost of running it. 228 00:11:58,590 --> 00:12:01,340 So the height gives you the total cost. 229 00:12:01,340 --> 00:12:04,520 If you're going to run all year long, 230 00:12:04,520 --> 00:12:08,680 then the base load plant is the plant to build. 231 00:12:08,680 --> 00:12:14,440 Because way out here, the fact that the fuel is cheap 232 00:12:14,440 --> 00:12:17,260 makes up for the capital cost. 233 00:12:17,260 --> 00:12:19,240 But if you're only going to run it a little bit 234 00:12:19,240 --> 00:12:20,980 but you have to have it, then you 235 00:12:20,980 --> 00:12:24,910 want to build a peaker, right? 236 00:12:24,910 --> 00:12:26,790 Is that notion clear? 237 00:12:26,790 --> 00:12:28,680 The fact that there's output variation 238 00:12:28,680 --> 00:12:31,470 means you want to have plants of multiple types. 239 00:12:31,470 --> 00:12:33,840 If you can get a base load plant to run 240 00:12:33,840 --> 00:12:38,790 almost all the time, or all the time, then 241 00:12:38,790 --> 00:12:40,000 you're in great shape. 242 00:12:40,000 --> 00:12:41,730 But if you have to have plants that 243 00:12:41,730 --> 00:12:45,780 run only a little bit, only a few hours per year, 244 00:12:45,780 --> 00:12:48,090 then you've got to have some of these. 245 00:12:48,090 --> 00:12:50,590 And you've always got that mix. 246 00:12:50,590 --> 00:12:53,610 We're going to talk about wind and solar next time. 247 00:12:53,610 --> 00:12:55,830 They don't quite fit either of these categories, 248 00:12:55,830 --> 00:12:59,340 if you think about it for a minute. 249 00:12:59,340 --> 00:13:03,676 But if that's clear, then let's look at this. 250 00:13:07,148 --> 00:13:11,430 The red curve is what's called a low duration curve. 251 00:13:11,430 --> 00:13:14,760 And it's the actual curve, because I happen to find it. 252 00:13:14,760 --> 00:13:17,400 It's the actual curve for-- 253 00:13:17,400 --> 00:13:18,750 it's probably England and Wales. 254 00:13:18,750 --> 00:13:22,980 It says Great Britain, for 2007. 255 00:13:22,980 --> 00:13:25,170 What a low duration curve is, you 256 00:13:25,170 --> 00:13:30,810 look at how much electricity was consumed hour-by-hour. 257 00:13:30,810 --> 00:13:35,490 And you basically convert those to a graph putting the hour 258 00:13:35,490 --> 00:13:37,650 with the highest consumption here, then 259 00:13:37,650 --> 00:13:39,060 the second highest there. 260 00:13:39,060 --> 00:13:41,700 You basically stack it up. 261 00:13:41,700 --> 00:13:47,340 So out here at 100%, you have the consumption, the demand, 262 00:13:47,340 --> 00:13:49,260 and it's expressed as a percentage of peak 263 00:13:49,260 --> 00:13:56,310 to keep life simple, the percentage of peak demand 264 00:13:56,310 --> 00:14:00,840 at the lowest hour of the year, presumably at 3 o'clock 265 00:14:00,840 --> 00:14:02,670 in the morning on some day that was 266 00:14:02,670 --> 00:14:04,770 neither hot nor cold so nobody needed 267 00:14:04,770 --> 00:14:07,290 to run anything, any HVAC. 268 00:14:07,290 --> 00:14:10,710 And it was a holiday, so there was no industrial work going 269 00:14:10,710 --> 00:14:12,910 on, or whatever. 270 00:14:12,910 --> 00:14:17,790 So if you go back to this picture, this picture says, 271 00:14:17,790 --> 00:14:22,582 if you're going to run a plant fewer than H star hours a year, 272 00:14:22,582 --> 00:14:23,790 you're going to want to peak. 273 00:14:23,790 --> 00:14:25,560 It's going to have to be a peak. 274 00:14:25,560 --> 00:14:28,065 It should be a peaker rather than a baseload. 275 00:14:31,200 --> 00:14:35,070 Come to this picture, and you say, OK, let's suppose-- 276 00:14:35,070 --> 00:14:37,170 just because it fits the picture-- 277 00:14:37,170 --> 00:14:41,110 that if there are 8,760 hours in a year, 278 00:14:41,110 --> 00:14:42,810 this is like 42 gallons in a barrel, 279 00:14:42,810 --> 00:14:44,910 another one of those numbers you have to have. 280 00:14:44,910 --> 00:14:54,970 8,760 hours in a year, let's see if I can do this. 281 00:14:54,970 --> 00:15:00,250 If you build baseload capacity up to this line, 282 00:15:00,250 --> 00:15:04,810 you know that it will be running at least that fraction 283 00:15:04,810 --> 00:15:05,770 of hours. 284 00:15:05,770 --> 00:15:07,930 You'll have to cut it down somewhat 285 00:15:07,930 --> 00:15:11,680 in the really low hours. 286 00:15:11,680 --> 00:15:15,670 But if you build that much baseload capacity, 287 00:15:15,670 --> 00:15:19,300 it will run for at least this many hours. 288 00:15:19,300 --> 00:15:23,710 Because demand exceeds that capacity for that fraction 289 00:15:23,710 --> 00:15:25,740 of the year, right? 290 00:15:25,740 --> 00:15:32,110 So we're asking, you decide what you 291 00:15:32,110 --> 00:15:34,780 want to build in terms of baseload capacity 292 00:15:34,780 --> 00:15:36,580 as a fraction of the peak. 293 00:15:36,580 --> 00:15:39,790 Read across to the curve and come down 294 00:15:39,790 --> 00:15:43,240 and you get the fraction of hours of the year when demand 295 00:15:43,240 --> 00:15:47,950 is at least that high, right? 296 00:15:47,950 --> 00:15:51,270 So we've normalized the low duration curve 297 00:15:51,270 --> 00:15:52,840 so the peak is 100. 298 00:15:52,840 --> 00:15:55,870 We also normalized time, which is kind of awkward 299 00:15:55,870 --> 00:16:00,590 so that 8,760 hours equals 100. 300 00:16:00,590 --> 00:16:04,100 So we can do percentages. 301 00:16:04,100 --> 00:16:07,300 So again, this is just stylized. 302 00:16:07,300 --> 00:16:11,620 But if H star over 8,760 is here, 303 00:16:11,620 --> 00:16:15,440 then that says you build half baseload capacity and half 304 00:16:15,440 --> 00:16:17,650 peaker capacity, right? 305 00:16:17,650 --> 00:16:22,000 The peakers are only going to come into play 306 00:16:22,000 --> 00:16:24,890 when demand is above-- 307 00:16:24,890 --> 00:16:26,410 and this is where I need the laser-- 308 00:16:26,410 --> 00:16:29,050 is above that 50% point. 309 00:16:29,050 --> 00:16:32,560 That's an artifact. 310 00:16:32,560 --> 00:16:33,880 This is stylized 50%. 311 00:16:33,880 --> 00:16:37,300 It has no particular significance in life. 312 00:16:37,300 --> 00:16:39,530 It just works out in this picture. 313 00:16:39,530 --> 00:16:43,190 So you'd build 1/2 peaker capacity and 1/2 base load. 314 00:16:43,190 --> 00:16:50,920 The peak units would be on for less than H star hours a year, 315 00:16:50,920 --> 00:16:55,392 or less than this fraction of hours per year. 316 00:16:55,392 --> 00:16:56,350 So it makes some sense. 317 00:16:59,450 --> 00:17:01,790 You see why you need the mix. 318 00:17:01,790 --> 00:17:04,760 And this is just mechanical to say, 319 00:17:04,760 --> 00:17:09,140 if I know where the breakpoint is, then I've got to say, 320 00:17:09,140 --> 00:17:10,385 what fraction of the year. 321 00:17:14,010 --> 00:17:15,770 I've got to use the low duration curve 322 00:17:15,770 --> 00:17:22,160 to go from the break point where I decide 323 00:17:22,160 --> 00:17:24,290 between the different technologies, the base 324 00:17:24,290 --> 00:17:27,560 load and the peaker in this case, 325 00:17:27,560 --> 00:17:31,800 and to get a capacity mix out of that, for what fraction 326 00:17:31,800 --> 00:17:34,770 of the year, blah, blah, blah. 327 00:17:34,770 --> 00:17:40,380 OK, I know I want to build baseload plants that will 328 00:17:40,380 --> 00:17:42,925 run at least this fraction. 329 00:17:45,780 --> 00:17:49,110 We'll run at least this fraction of the year. 330 00:17:49,110 --> 00:17:52,590 I want peakers that will run less. 331 00:17:52,590 --> 00:17:57,390 The load duration curve translates that into capacity, 332 00:17:57,390 --> 00:17:58,770 OK. 333 00:17:58,770 --> 00:18:02,670 Detail is not critical, concept pretty critical. 334 00:18:02,670 --> 00:18:03,300 Questions? 335 00:18:07,030 --> 00:18:08,362 Yeah. 336 00:18:08,362 --> 00:18:11,680 AUDIENCE: [INAUDIBLE] 337 00:18:11,680 --> 00:18:13,930 RICHARD SCHMALENSEE: I'd have to use them both, right? 338 00:18:13,930 --> 00:18:16,093 I'd have to go back and say, OK, what 339 00:18:16,093 --> 00:18:18,010 are the characteristics of these technologies? 340 00:18:18,010 --> 00:18:19,600 Where's the breakpoint? 341 00:18:19,600 --> 00:18:22,510 Where is the breakpoint? 342 00:18:22,510 --> 00:18:24,740 And then what I would do in fact, 343 00:18:24,740 --> 00:18:27,550 if I'm doing this, if I'm centrally planning 344 00:18:27,550 --> 00:18:32,380 and I'm not a market, if I'm centrally planning I would A, 345 00:18:32,380 --> 00:18:35,030 allow for reserve margin. 346 00:18:35,030 --> 00:18:38,050 So I wouldn't build just capacity. 347 00:18:38,050 --> 00:18:41,200 And I would allow for the fact that I don't know the load 348 00:18:41,200 --> 00:18:43,660 duration curve exactly. 349 00:18:43,660 --> 00:18:46,900 So I'd do a little stochastic work here. 350 00:18:46,900 --> 00:18:50,960 I'd say, if the curve varies up and down by 20%, 351 00:18:50,960 --> 00:18:52,720 what do I need to be sure? 352 00:18:52,720 --> 00:18:56,110 And I'd work out a somewhat more complicated problem. 353 00:18:56,110 --> 00:19:01,450 What I gave you was, well, if I've only got two technologies 354 00:19:01,450 --> 00:19:06,130 and the slate is clean, then I know 355 00:19:06,130 --> 00:19:11,320 how to choose based on how long the plant is going to run. 356 00:19:11,320 --> 00:19:16,540 And using this curve, I can go from how long the plant is 357 00:19:16,540 --> 00:19:20,550 going to run to how much of it I need, 358 00:19:20,550 --> 00:19:23,370 based on how many hours demand will 359 00:19:23,370 --> 00:19:26,940 be above and below certain levels, right? 360 00:19:26,940 --> 00:19:29,700 So yeah, that's exactly what this exercise in the very 361 00:19:29,700 --> 00:19:30,780 simple case would do. 362 00:19:30,780 --> 00:19:33,160 It would optimize the fleet. 363 00:19:33,160 --> 00:19:34,820 And you need both. 364 00:19:34,820 --> 00:19:38,590 Even if you don't have to worry about quick response, which 365 00:19:38,590 --> 00:19:45,310 is not present in this picture, you'd need both, OK. 366 00:19:51,430 --> 00:19:54,790 In fact, in real systems you have multiple technologies. 367 00:19:54,790 --> 00:19:59,770 And this is a very strange graph, but it makes that point. 368 00:19:59,770 --> 00:20:07,030 This shows in 2008 supposedly ranked vertically 369 00:20:07,030 --> 00:20:10,630 by marginal cost and horizontally 370 00:20:10,630 --> 00:20:17,320 by capacity, all the plants in the lower 48 states. 371 00:20:17,320 --> 00:20:22,420 And so it gives you sort of a supply curve. 372 00:20:22,420 --> 00:20:24,950 The lower 48 states are not a single market. 373 00:20:24,950 --> 00:20:27,190 So it's a funny kind of supply curve. 374 00:20:27,190 --> 00:20:29,050 But it gives you the sense. 375 00:20:29,050 --> 00:20:38,020 It shows hydro there in the far left, which essentially, it 376 00:20:38,020 --> 00:20:40,775 has only an opportunity cost of running, right? 377 00:20:40,775 --> 00:20:43,150 If you let the water out now, you don't have it tomorrow. 378 00:20:43,150 --> 00:20:45,108 So there's a little bit of an opportunity cost. 379 00:20:45,108 --> 00:20:46,930 But out of pocket is 0. 380 00:20:46,930 --> 00:20:50,860 And then you've got nukes, which have a very low running cost. 381 00:20:50,860 --> 00:20:55,670 And then you've got this mixture of coal and gas and others. 382 00:20:55,670 --> 00:21:00,520 And then finally, up here that vertical portion, 383 00:21:00,520 --> 00:21:03,640 that's the oh, my God, start the diesels portion. 384 00:21:03,640 --> 00:21:06,850 That's the very hot summer day when very inefficient, very 385 00:21:06,850 --> 00:21:08,450 dirty diesels that are kept around 386 00:21:08,450 --> 00:21:12,740 to run for only a few hours a year get fired up. 387 00:21:12,740 --> 00:21:14,650 So there are really expensive units 388 00:21:14,650 --> 00:21:17,640 that you keep on hand, even though they're 389 00:21:17,640 --> 00:21:20,280 expensive to run because you've got them. 390 00:21:20,280 --> 00:21:23,110 And on a hot summer day, you may need them. 391 00:21:23,110 --> 00:21:25,800 So in fact, that two technology picture 392 00:21:25,800 --> 00:21:30,540 that I gave you is too simple because you'd want to build 393 00:21:30,540 --> 00:21:32,730 a more complicated mixture. 394 00:21:32,730 --> 00:21:37,430 But you need a mixture, OK. 395 00:21:37,430 --> 00:21:40,170 Comments, yeah, Scott. 396 00:21:40,170 --> 00:21:42,170 AUDIENCE: So by capacity, does it mean 397 00:21:42,170 --> 00:21:44,160 what capacity you turn it on? 398 00:21:44,160 --> 00:21:47,310 RICHARD SCHMALENSEE: No, it means, this tells you 399 00:21:47,310 --> 00:21:48,720 the total hydro capacity. 400 00:21:48,720 --> 00:21:51,820 This is the total nuclear capacity, this distance. 401 00:21:51,820 --> 00:21:54,810 So it's giving you a sense of how much you can get 402 00:21:54,810 --> 00:21:56,820 at different marginal costs. 403 00:21:56,820 --> 00:22:00,030 So it is a supply curve in that sense 404 00:22:00,030 --> 00:22:03,230 if they were all in the same market dot, dot, dot, dot, 405 00:22:03,230 --> 00:22:07,090 yeah, OK. 406 00:22:10,870 --> 00:22:12,760 OK, what's the grid look like? 407 00:22:18,070 --> 00:22:19,870 You can have multiple generating plants 408 00:22:19,870 --> 00:22:22,180 in any particular region. 409 00:22:22,180 --> 00:22:25,330 But you really can't economically 410 00:22:25,330 --> 00:22:27,910 have multiple transmission systems 411 00:22:27,910 --> 00:22:30,400 and multiple distribution systems. 412 00:22:30,400 --> 00:22:35,950 They are typically considered natural monopolies. 413 00:22:35,950 --> 00:22:39,460 What a natural monopoly means is generally 414 00:22:39,460 --> 00:22:45,920 defined as having more than one of them would raise costs. 415 00:22:45,920 --> 00:22:51,820 So if you think of the X's in that subadditivity bullet 416 00:22:51,820 --> 00:22:56,890 as basically electricity supplied to houses, 417 00:22:56,890 --> 00:23:01,990 so each component is a house or a building, 418 00:23:01,990 --> 00:23:04,690 rather than total kilowatt hours, but a vector 419 00:23:04,690 --> 00:23:08,830 of locations, then subadditivity by that definition 420 00:23:08,830 --> 00:23:12,700 means it's cheaper to supply. 421 00:23:12,700 --> 00:23:18,400 You can't split the system without raising costs. 422 00:23:18,400 --> 00:23:20,440 The normal picture you get for this 423 00:23:20,440 --> 00:23:30,480 is, if the X's are scalars, then it's just economies of scale. 424 00:23:30,480 --> 00:23:36,420 So natural monopoly is present in electricity. 425 00:23:36,420 --> 00:23:42,100 It's present in other areas as well. 426 00:23:42,100 --> 00:23:45,303 Let's do a minute on why there's a problem when 427 00:23:45,303 --> 00:23:46,470 you have a natural monopoly. 428 00:23:46,470 --> 00:23:47,870 What's the policy problem? 429 00:23:54,140 --> 00:23:56,740 Why do we bother to talk about it? 430 00:23:56,740 --> 00:23:58,150 Alex, are you raising your hand? 431 00:23:58,150 --> 00:24:00,010 Or no, you were not raising your hand. 432 00:24:00,010 --> 00:24:01,840 You were thinking about raising your hand? 433 00:24:01,840 --> 00:24:02,710 No, not even that. 434 00:24:02,710 --> 00:24:10,260 OK, OK, we're back in 1401 or 001. 435 00:24:10,260 --> 00:24:11,710 Kierstan and then David. 436 00:24:11,710 --> 00:24:15,967 AUDIENCE: [INAUDIBLE] otherwise a natural monopoly 437 00:24:15,967 --> 00:24:20,500 would release them to just take as much as they could. 438 00:24:20,500 --> 00:24:22,000 RICHARD SCHMALENSEE: So what enables 439 00:24:22,000 --> 00:24:23,740 it to take as much as it could? 440 00:24:23,740 --> 00:24:25,000 AUDIENCE: No competition. 441 00:24:25,000 --> 00:24:26,375 RICHARD SCHMALENSEE: So you think 442 00:24:26,375 --> 00:24:37,260 there would be no competition and they'd make a lot of money. 443 00:24:37,260 --> 00:24:41,820 But we like making a lot of money, don't we? 444 00:24:41,820 --> 00:24:42,570 Consumers don't. 445 00:24:42,570 --> 00:24:45,090 So there'd be a welfare loss. 446 00:24:50,960 --> 00:24:52,820 David? 447 00:24:52,820 --> 00:24:55,220 AUDIENCE: I mean, yeah, they could just charge as much 448 00:24:55,220 --> 00:25:01,400 up to the point where it would be profitable for another firm 449 00:25:01,400 --> 00:25:02,690 to enter. 450 00:25:02,690 --> 00:25:04,982 RICHARD SCHMALENSEE: I mean, it's actually interesting. 451 00:25:04,982 --> 00:25:07,670 We always assume in these discussions 452 00:25:07,670 --> 00:25:08,960 that competition isn't viable. 453 00:25:11,470 --> 00:25:14,050 And cable television is a standard example 454 00:25:14,050 --> 00:25:16,702 of a natural monopoly, local cable television distribution. 455 00:25:16,702 --> 00:25:18,535 But there are a number of places where there 456 00:25:18,535 --> 00:25:21,250 are competing cable systems. 457 00:25:21,250 --> 00:25:25,180 And that's wasteful, but it may be less wasteful than having 458 00:25:25,180 --> 00:25:26,880 really high prices-- 459 00:25:26,880 --> 00:25:31,311 welfare loss because of high prices. 460 00:25:31,311 --> 00:25:32,907 AUDIENCE: They can also under supply. 461 00:25:32,907 --> 00:25:35,240 RICHARD SCHMALENSEE: Well, that's the same story, right? 462 00:25:35,240 --> 00:25:36,290 You raise the price. 463 00:25:36,290 --> 00:25:39,560 You supply less. 464 00:25:39,560 --> 00:25:40,400 I can't draw it. 465 00:25:40,400 --> 00:25:45,170 You might like to end up at some point like A, 466 00:25:45,170 --> 00:25:50,180 and in fact, what a monopoly in this situation might do 467 00:25:50,180 --> 00:25:53,420 is produce 1/2 that where the production would B, 468 00:25:53,420 --> 00:25:56,800 but the price would be notably higher than at A. 469 00:25:56,800 --> 00:25:58,550 AUDIENCE: That's good for the environment. 470 00:25:58,550 --> 00:25:58,880 RICHARD SCHMALENSEE: What? 471 00:25:58,880 --> 00:26:01,530 AUDIENCE: It's good for the environment [INAUDIBLE],, 472 00:26:01,530 --> 00:26:03,447 RICHARD SCHMALENSEE: Good for the environment. 473 00:26:03,447 --> 00:26:04,620 Good for the environment. 474 00:26:04,620 --> 00:26:06,930 So we should just deregulate electricity 475 00:26:06,930 --> 00:26:11,550 throughout because we'd spent a lot of money. 476 00:26:11,550 --> 00:26:12,892 Interesting point. 477 00:26:12,892 --> 00:26:14,850 Anybody else, anything else that could go wrong 478 00:26:14,850 --> 00:26:15,680 in this situation? 479 00:26:19,570 --> 00:26:22,590 OK, what about cost? 480 00:26:22,590 --> 00:26:26,100 Let's think about human beings running an organization. 481 00:26:26,100 --> 00:26:29,130 And you have no competition. 482 00:26:29,130 --> 00:26:32,470 And you're providing a necessity. 483 00:26:32,470 --> 00:26:36,520 And your brother-in-law asks for a job. 484 00:26:36,520 --> 00:26:39,340 You hire your brother-in-law, right? 485 00:26:39,340 --> 00:26:40,645 There's a cost problem. 486 00:26:45,060 --> 00:26:50,970 We always draw these curves like these come out of the sky. 487 00:26:50,970 --> 00:26:52,770 And we march down cost curves. 488 00:26:52,770 --> 00:26:56,730 In fact, these are determined by organizational decisions. 489 00:26:56,730 --> 00:27:01,230 And when you have a monopoly, the pressure to actually do 490 00:27:01,230 --> 00:27:05,850 unpleasant things like firing people or not 491 00:27:05,850 --> 00:27:11,130 hiring your brother-in-law, those pressures are gone. 492 00:27:11,130 --> 00:27:13,650 Not gone, they're diminished. 493 00:27:13,650 --> 00:27:14,610 They're diminished. 494 00:27:14,610 --> 00:27:15,705 So you expect high costs. 495 00:27:19,780 --> 00:27:22,540 There's another reason, and it's not 496 00:27:22,540 --> 00:27:25,100 true for all natural monopolies. 497 00:27:25,100 --> 00:27:29,050 But it's true for the ones that we're mostly concerned about, 498 00:27:29,050 --> 00:27:31,760 most of these things are called public utilities. 499 00:27:31,760 --> 00:27:36,110 Now, it's not true for cable television yet. 500 00:27:36,110 --> 00:27:38,200 Electricity used to be a luxury good. 501 00:27:38,200 --> 00:27:39,820 Telephones used to be a luxury good. 502 00:27:39,820 --> 00:27:41,650 They're not anymore. 503 00:27:41,650 --> 00:27:44,410 They're mostly considered necessities. 504 00:27:44,410 --> 00:27:47,680 And when you raise the price, as Kierstan wanted them to do, 505 00:27:47,680 --> 00:27:50,740 to raise the price to pay for necessities, 506 00:27:50,740 --> 00:27:53,620 you're basically taking money out of poor people's pockets 507 00:27:53,620 --> 00:27:56,600 and giving them to rich shareholders. 508 00:27:56,600 --> 00:28:02,290 So these are the problems that people mostly worry about. 509 00:28:02,290 --> 00:28:04,840 And that business about triangles and rectangles, 510 00:28:04,840 --> 00:28:05,890 let me just remind you. 511 00:28:13,230 --> 00:28:15,450 For some reason let this be marginal cost 512 00:28:15,450 --> 00:28:18,400 equals average cost. 513 00:28:18,400 --> 00:28:22,450 And this is the demand curve. 514 00:28:22,450 --> 00:28:26,273 And this is, of course, what you'd like, right? 515 00:28:26,273 --> 00:28:27,690 You'd like production at the point 516 00:28:27,690 --> 00:28:30,700 where price equals marginal cost. 517 00:28:30,700 --> 00:28:35,240 And this is the price axis, and this is the quantity axis. 518 00:28:35,240 --> 00:28:37,760 The classic thing that a monopoly might do 519 00:28:37,760 --> 00:28:43,010 is to produce say, QM, and charge PM. 520 00:28:46,170 --> 00:28:50,040 And then the deadweight loss, this triangle over here. 521 00:28:50,040 --> 00:28:52,440 I'm hoping, I'm reminding you, it's 522 00:28:52,440 --> 00:28:55,980 the difference between what people were willing to pay 523 00:28:55,980 --> 00:28:59,130 and what it would have cost to produce this output that's 524 00:28:59,130 --> 00:29:01,080 not produced. 525 00:29:01,080 --> 00:29:02,250 So that's a loss, right? 526 00:29:02,250 --> 00:29:07,980 If you reduce output from say Q star to QM, 527 00:29:07,980 --> 00:29:11,050 you lose that triangle. 528 00:29:11,050 --> 00:29:13,180 But suppose what in fact, happens 529 00:29:13,180 --> 00:29:22,090 is the monopolist is really lazy and costs go up to PM. 530 00:29:22,090 --> 00:29:26,830 Well, in that case, you lose the rectangle too. 531 00:29:26,830 --> 00:29:29,440 And in most reasonable cases, the rectangles 532 00:29:29,440 --> 00:29:32,090 are bigger than the triangles. 533 00:29:32,090 --> 00:29:34,600 So that if I can't resist hiring my brother-in-law, 534 00:29:34,600 --> 00:29:35,740 neither can anybody else. 535 00:29:35,740 --> 00:29:41,320 That could be much worse aside from the rich/poor issue, 536 00:29:41,320 --> 00:29:44,950 than the fact that I'm pricing high, OK. 537 00:29:44,950 --> 00:29:46,450 So these are things you worry about. 538 00:29:50,970 --> 00:29:53,840 What do you do about it? 539 00:29:53,840 --> 00:29:55,370 Water supply is like this. 540 00:29:55,370 --> 00:29:57,410 You could argue bus service is like this. 541 00:29:57,410 --> 00:29:59,360 Telephone distribution is like this. 542 00:29:59,360 --> 00:30:01,820 Electricity distribution is like this. 543 00:30:01,820 --> 00:30:03,738 Electricity transmission is like this. 544 00:30:03,738 --> 00:30:05,030 Now, we're mostly about energy. 545 00:30:05,030 --> 00:30:07,230 But it is a general problem. 546 00:30:07,230 --> 00:30:09,890 What are some of the solutions, right. 547 00:30:09,890 --> 00:30:15,490 This difficulty, a natural monopoly 548 00:30:15,490 --> 00:30:19,510 arises across time and space and industries. 549 00:30:19,510 --> 00:30:24,670 And a variety of mechanisms have been adopted. 550 00:30:24,670 --> 00:30:25,720 What might you do? 551 00:30:34,890 --> 00:30:43,910 So we could have a private firm, and we could regulate it, OK? 552 00:30:43,910 --> 00:30:46,090 Anything else, Brendan? 553 00:30:46,090 --> 00:30:51,598 AUDIENCE: [INAUDIBLE] 554 00:30:51,598 --> 00:30:53,390 RICHARD SCHMALENSEE: Well, that's not good. 555 00:30:53,390 --> 00:30:54,307 What am I going to do? 556 00:30:54,307 --> 00:30:57,170 If I can't have competition as an economic matter. 557 00:30:57,170 --> 00:30:58,520 I can split it. 558 00:30:58,520 --> 00:31:01,010 You're saying forced competition. 559 00:31:01,010 --> 00:31:04,220 Well, what if I split it and in fact, one of them 560 00:31:04,220 --> 00:31:06,010 goes out of business? 561 00:31:06,010 --> 00:31:12,290 See, the problem with this, if you go back to this picture, 562 00:31:12,290 --> 00:31:13,730 if I've got two firms and they're 563 00:31:13,730 --> 00:31:16,550 both on this cost curve, the larger one 564 00:31:16,550 --> 00:31:19,290 always has a cost advantage. 565 00:31:19,290 --> 00:31:23,600 So you can imagine competition working. 566 00:31:23,600 --> 00:31:26,330 But you could also imagine the larger firm drives the smaller 567 00:31:26,330 --> 00:31:28,770 firm out just competing. 568 00:31:28,770 --> 00:31:31,410 And nobody comes in because they have a big cost 569 00:31:31,410 --> 00:31:33,120 disadvantage if they come in. 570 00:31:33,120 --> 00:31:34,860 So that's a tough one. 571 00:31:34,860 --> 00:31:37,120 Most industries, that's what you want to do. 572 00:31:37,120 --> 00:31:38,490 And that's what's done. 573 00:31:38,490 --> 00:31:40,520 But that's tough here. 574 00:31:40,520 --> 00:31:41,720 Anything else? 575 00:31:41,720 --> 00:31:43,970 Yeah, Max. 576 00:31:43,970 --> 00:31:46,130 AUDIENCE: A government run enterprise. 577 00:31:46,130 --> 00:31:53,930 RICHARD SCHMALENSEE: You could have a government run 578 00:31:53,930 --> 00:31:54,620 enterprise. 579 00:32:00,600 --> 00:32:02,520 Let me drill down a little bit on regulation. 580 00:32:02,520 --> 00:32:06,260 How might you regulate? 581 00:32:06,260 --> 00:32:06,760 Max. 582 00:32:06,760 --> 00:32:08,153 AUDIENCE: Price floor. 583 00:32:08,153 --> 00:32:10,320 RICHARD SCHMALENSEE: Well, no, you actually probably 584 00:32:10,320 --> 00:32:12,557 don't want to price floor. 585 00:32:12,557 --> 00:32:13,390 Price ceiling maybe. 586 00:32:17,770 --> 00:32:21,420 Oh, you want them to raise prices to bring in entry? 587 00:32:21,420 --> 00:32:26,620 Yeah, ooh, ooh, that could be really expensive, right? 588 00:32:26,620 --> 00:32:31,390 Remember, if you split, you've raised costs. 589 00:32:31,390 --> 00:32:33,070 And now you're going to raise the price 590 00:32:33,070 --> 00:32:36,460 to make sure that you can survive with higher costs. 591 00:32:39,020 --> 00:32:40,340 You get more companies in. 592 00:32:43,390 --> 00:32:46,300 There actually have been examples of competing 593 00:32:46,300 --> 00:32:48,700 telephone systems historically. 594 00:32:48,700 --> 00:32:52,220 I don't know of any competing, I don't 595 00:32:52,220 --> 00:32:55,970 know offhand of any competing electric distribution systems. 596 00:32:55,970 --> 00:32:57,780 There are competing cable systems. 597 00:32:57,780 --> 00:32:59,120 It's expensive, right? 598 00:32:59,120 --> 00:33:00,500 I mean, you're duplicating. 599 00:33:00,500 --> 00:33:01,880 You're duplicating. 600 00:33:01,880 --> 00:33:04,370 So most people say, that's triangles versus rectangles. 601 00:33:04,370 --> 00:33:07,400 You're saying, I'll tolerate, I'll 602 00:33:07,400 --> 00:33:11,720 tolerate a higher cost as long as they're not 603 00:33:11,720 --> 00:33:13,620 making any money. 604 00:33:13,620 --> 00:33:17,190 Well, I don't want to pay a higher price, Max, I'm sorry. 605 00:33:17,190 --> 00:33:19,740 I'm happy that they're not making profits. 606 00:33:19,740 --> 00:33:22,993 But what you're managing to do is to raise the cost. 607 00:33:22,993 --> 00:33:24,660 And that's the natural monopoly problem. 608 00:33:24,660 --> 00:33:26,280 That's the core of it. 609 00:33:26,280 --> 00:33:30,190 If you get competition, then you will have it at a higher cost. 610 00:33:30,190 --> 00:33:35,130 And sometimes, if you think about ways 611 00:33:35,130 --> 00:33:40,470 that curve could look, sometimes in fact, if that curve is 612 00:33:40,470 --> 00:33:44,790 shallow enough, you'd be right. 613 00:33:44,790 --> 00:33:48,120 Let's have a little competition, the costs will go up, 614 00:33:48,120 --> 00:33:50,880 but the incentives will be stronger. 615 00:33:50,880 --> 00:33:53,740 They will not hire their brothers-in-law. 616 00:33:53,740 --> 00:33:57,360 And yeah, the costs will be up. 617 00:33:57,360 --> 00:34:00,240 But the pressure on prices will overwhelm it. 618 00:34:00,240 --> 00:34:02,940 Mostly that's not true. 619 00:34:02,940 --> 00:34:05,400 I mean, telephone it might be. 620 00:34:05,400 --> 00:34:07,660 Wireless, it surely is. 621 00:34:07,660 --> 00:34:09,989 That's why we can have competing wireless companies. 622 00:34:09,989 --> 00:34:11,590 We have maybe three in Europe. 623 00:34:11,590 --> 00:34:12,960 They tend to have more. 624 00:34:12,960 --> 00:34:13,860 That's easy. 625 00:34:13,860 --> 00:34:17,500 But wireline, that's tough. 626 00:34:17,500 --> 00:34:18,500 Yeah, David. 627 00:34:18,500 --> 00:34:20,310 AUDIENCE: So the shareholders are 628 00:34:20,310 --> 00:34:24,788 the people who are using the services, do You know? 629 00:34:24,788 --> 00:34:27,330 RICHARD SCHMALENSEE: Well, that would be a cooperative model. 630 00:34:27,330 --> 00:34:34,199 AUDIENCE: [INAUDIBLE] 631 00:34:34,199 --> 00:34:36,900 RICHARD SCHMALENSEE: That's exactly the cooperative model. 632 00:34:36,900 --> 00:34:39,330 And you do see it. 633 00:34:39,330 --> 00:34:42,060 You do see it. 634 00:34:42,060 --> 00:34:44,530 Let me just mention, there are a number of different ways. 635 00:34:44,530 --> 00:34:46,199 Those are the three main alternatives. 636 00:34:46,199 --> 00:34:47,699 There are a number of different ways 637 00:34:47,699 --> 00:34:49,980 to skin this one, to regulate. 638 00:34:49,980 --> 00:34:53,565 And I'll just say a little bit, not go into too much detail. 639 00:34:57,940 --> 00:35:00,040 Regulation, so I've got government ownership 640 00:35:00,040 --> 00:35:02,890 at the top and cooperatives at the bottom. 641 00:35:02,890 --> 00:35:05,847 I didn't talk about franchise bidding. 642 00:35:05,847 --> 00:35:07,930 I think that will take us a little too far afield. 643 00:35:07,930 --> 00:35:13,780 But that's the bid for the right to provide electricity. 644 00:35:13,780 --> 00:35:18,700 Different kinds of regulation, you could do-- 645 00:35:18,700 --> 00:35:22,480 the early streetcars and buses and electric power systems 646 00:35:22,480 --> 00:35:25,880 and cable systems were regulated by cities. 647 00:35:25,880 --> 00:35:28,010 And the city had jurisdiction because they 648 00:35:28,010 --> 00:35:30,490 needed to use the streets. 649 00:35:30,490 --> 00:35:35,080 So yes, you can put up your phone lines, 650 00:35:35,080 --> 00:35:36,790 yes, you can run the streetcars. 651 00:35:36,790 --> 00:35:41,770 But you need to comply with certain restrictions. 652 00:35:41,770 --> 00:35:44,080 I will talk about rate of return regulation. 653 00:35:44,080 --> 00:35:47,650 That's been the dominant way electricity 654 00:35:47,650 --> 00:35:50,560 has been regulated since the early 20th century. 655 00:35:50,560 --> 00:35:54,010 It's focused on profits. 656 00:35:54,010 --> 00:35:57,910 And incentive regulation is to try 657 00:35:57,910 --> 00:36:00,790 to hold prices constant for a while 658 00:36:00,790 --> 00:36:04,120 to give incentives to cut cost. 659 00:36:04,120 --> 00:36:05,770 I will cycle back to this. 660 00:36:05,770 --> 00:36:06,680 I will cycle back. 661 00:36:06,680 --> 00:36:09,197 But just to know that there are a whole set of approaches 662 00:36:09,197 --> 00:36:10,030 that have been used. 663 00:36:10,030 --> 00:36:14,270 They all become political. 664 00:36:14,270 --> 00:36:17,290 They involve decisions made by people. 665 00:36:17,290 --> 00:36:19,090 They involve decisions made by people 666 00:36:19,090 --> 00:36:23,660 who are subject to voters, typically, one way or another, 667 00:36:23,660 --> 00:36:26,770 either government enterprise or they are regulated 668 00:36:26,770 --> 00:36:32,050 or the co-op members vote. 669 00:36:32,050 --> 00:36:34,510 So one of the things you want to do is as little 670 00:36:34,510 --> 00:36:36,410 of this as possible. 671 00:36:36,410 --> 00:36:39,430 So transmission and distribution, 672 00:36:39,430 --> 00:36:44,980 natural monopolies pose a policy problem. 673 00:36:44,980 --> 00:36:50,610 In terms of the architecture, I don't know 674 00:36:50,610 --> 00:36:55,530 why this is a blackboard talk. 675 00:36:55,530 --> 00:36:59,280 But when I say that low voltage distribution systems are 676 00:36:59,280 --> 00:37:03,510 a tree, there will be a substation 677 00:37:03,510 --> 00:37:14,880 and feeders go out to serve neighborhoods and houses 678 00:37:14,880 --> 00:37:17,190 and so forth. 679 00:37:17,190 --> 00:37:19,470 The transmission system, if you look, 680 00:37:19,470 --> 00:37:21,150 I'll show you a map in a little bit. 681 00:37:21,150 --> 00:37:23,130 But you might have a generator here. 682 00:37:23,130 --> 00:37:26,430 You might have city or load here and load there 683 00:37:26,430 --> 00:37:28,590 and another generator here. 684 00:37:28,590 --> 00:37:30,660 The transmission system will be a mesh. 685 00:37:36,840 --> 00:37:38,828 It's a different architecture. 686 00:37:38,828 --> 00:37:40,245 It means there are multiple paths. 687 00:37:42,900 --> 00:37:46,290 In the tree structure, you'd have a substation. 688 00:37:46,290 --> 00:37:48,670 And this would be a house. 689 00:37:48,670 --> 00:37:50,940 There's only one path. 690 00:37:50,940 --> 00:37:54,570 There are multiple paths, well, in this case three 691 00:37:54,570 --> 00:37:56,520 from this generator to this load. 692 00:37:59,610 --> 00:38:03,660 The reason for multiple paths of course, is reliability. 693 00:38:03,660 --> 00:38:05,580 The reason for a tree structure is cost. 694 00:38:08,460 --> 00:38:12,060 In some dense urban areas, the distribution system 695 00:38:12,060 --> 00:38:14,490 is a mesh because the lines are short. 696 00:38:14,490 --> 00:38:16,090 And you might as well. 697 00:38:16,090 --> 00:38:19,290 But if you think of any rural or suburban area, it's a tree. 698 00:38:22,860 --> 00:38:26,310 The transmission system, I have to say for most of us 699 00:38:26,310 --> 00:38:27,930 it takes a little getting used to. 700 00:38:27,930 --> 00:38:31,910 You don't switch current, right? 701 00:38:31,910 --> 00:38:36,440 If you do the analysis, power from this generator 702 00:38:36,440 --> 00:38:42,080 to this load goes on all three paths, 703 00:38:42,080 --> 00:38:45,270 depending on the characteristics of the path. 704 00:38:45,270 --> 00:38:46,790 You can change those characteristics 705 00:38:46,790 --> 00:38:48,620 with expensive technology. 706 00:38:48,620 --> 00:38:51,470 But mostly it's passive. 707 00:38:51,470 --> 00:38:57,200 That means-- well, it means two things. 708 00:38:57,200 --> 00:39:08,630 That means if I demand more here, Demand goes up here, 709 00:39:08,630 --> 00:39:12,710 and I increase generation here, I could in fact 710 00:39:12,710 --> 00:39:15,680 cause a problem on this line because some power 711 00:39:15,680 --> 00:39:17,490 will flow through it. 712 00:39:17,490 --> 00:39:20,330 And if that line can't handle it, I could run into, 713 00:39:20,330 --> 00:39:21,410 it could overheat. 714 00:39:21,410 --> 00:39:22,760 It could sag. 715 00:39:22,760 --> 00:39:24,890 This is called loop flow. 716 00:39:24,890 --> 00:39:31,820 When electricity over multiple paths causes problems, 717 00:39:31,820 --> 00:39:36,530 particularly let's say, that's a national border. 718 00:39:36,530 --> 00:39:38,360 So I can cause congestion over here. 719 00:39:38,360 --> 00:39:40,970 I can cause a problem over here when I increase 720 00:39:40,970 --> 00:39:43,940 demand and generation here. 721 00:39:43,940 --> 00:39:46,685 Now, you might say, well, can't we fix that? 722 00:39:46,685 --> 00:39:47,810 The answer is a little bit. 723 00:39:47,810 --> 00:39:51,740 We can fix that now with power electronics. 724 00:39:51,740 --> 00:39:55,010 We can change some of the characteristics of these lines. 725 00:39:55,010 --> 00:39:57,890 But it's expensive, and it's not much done. 726 00:39:57,890 --> 00:40:01,760 OK, so it's a strange system. 727 00:40:01,760 --> 00:40:06,080 It's not intuitive, not intuitive. 728 00:40:06,080 --> 00:40:10,400 Question about the architecture or about the problem? 729 00:40:10,400 --> 00:40:12,080 OK, here's the picture. 730 00:40:12,080 --> 00:40:17,360 Yeah, there are about 170,000 miles 731 00:40:17,360 --> 00:40:20,490 in the US of high voltage. 732 00:40:20,490 --> 00:40:24,500 I think it's 200k, 200,000 volts, 733 00:40:24,500 --> 00:40:30,110 230,000 volts is the threshold for transmission. 734 00:40:30,110 --> 00:40:33,290 You will note that the country is 735 00:40:33,290 --> 00:40:36,550 divided into three things that are labeled interconnect. 736 00:40:40,550 --> 00:40:45,050 Technical description, the interconnects 737 00:40:45,050 --> 00:40:49,790 are connected with relatively low capacity, 738 00:40:49,790 --> 00:40:53,620 direct current lines in a couple of places. 739 00:40:53,620 --> 00:40:58,780 Each interconnect is basically one big machine. 740 00:40:58,780 --> 00:41:00,850 Everything is turning together, everything 741 00:41:00,850 --> 00:41:04,090 is synchronized, all the generators, all the frequency-- 742 00:41:04,090 --> 00:41:07,970 little variations, but not much. 743 00:41:07,970 --> 00:41:12,700 It's easy to see why there's an Eastern and a Western, right? 744 00:41:12,700 --> 00:41:14,710 Because you've got the Rocky Mountains, 745 00:41:14,710 --> 00:41:18,170 relatively low population density. 746 00:41:18,170 --> 00:41:20,710 It didn't make a lot of sense to try 747 00:41:20,710 --> 00:41:22,990 to connect New York and Los Angeles 748 00:41:22,990 --> 00:41:25,420 in the same synchronized system. 749 00:41:25,420 --> 00:41:28,240 It certainly didn't 50 years ago. 750 00:41:28,240 --> 00:41:30,190 Probably doesn't now. 751 00:41:30,190 --> 00:41:32,320 Why is Texas independent? 752 00:41:32,320 --> 00:41:34,870 Why is Texas a separate interconnect? 753 00:41:34,870 --> 00:41:37,030 Why isn't Texas synchronized? 754 00:41:43,750 --> 00:41:44,890 Oh, take a jump. 755 00:41:44,890 --> 00:41:46,446 Take a shot. 756 00:41:46,446 --> 00:41:49,800 AUDIENCE: Didn't want to. 757 00:41:49,800 --> 00:41:51,760 RICHARD SCHMALENSEE: There was a political deal 758 00:41:51,760 --> 00:41:53,780 made in the '30s. 759 00:41:53,780 --> 00:41:57,220 It was a political deal made in the '30s that 760 00:41:57,220 --> 00:42:04,970 has the fiction but near truth that electrons don't cross 761 00:42:04,970 --> 00:42:07,800 the boundaries of this area. 762 00:42:07,800 --> 00:42:10,410 Therefore what goes on in here is not 763 00:42:10,410 --> 00:42:12,780 subject to federal regulation because it's wholly 764 00:42:12,780 --> 00:42:15,330 within one state. 765 00:42:15,330 --> 00:42:17,150 Does that make electrical sense? 766 00:42:17,150 --> 00:42:21,650 No, Should it be obvious that Texas and Louisiana should 767 00:42:21,650 --> 00:42:23,330 be separate electrically? 768 00:42:23,330 --> 00:42:27,890 No, but in the '30s, it was part of getting a deal done. 769 00:42:31,220 --> 00:42:32,990 Whenever you see something like this, 770 00:42:32,990 --> 00:42:35,090 do not assume it's a technical reason. 771 00:42:35,090 --> 00:42:38,350 Because it usually isn't. 772 00:42:38,350 --> 00:42:40,060 I'll give you one other example and then 773 00:42:40,060 --> 00:42:44,380 I'll take your question. 774 00:42:44,380 --> 00:42:48,610 Within the country there are about 107 so-called balancing 775 00:42:48,610 --> 00:42:49,600 areas. 776 00:42:49,600 --> 00:42:52,060 Each balancing area is a control center 777 00:42:52,060 --> 00:42:55,210 that's responsible for electrical flows 778 00:42:55,210 --> 00:42:57,160 across its boundary, right? 779 00:42:57,160 --> 00:43:00,580 It will have certain obligations like not sending a lot out 780 00:43:00,580 --> 00:43:02,290 or not bringing a lot in. 781 00:43:02,290 --> 00:43:05,320 So there's one control, there's one balancing area 782 00:43:05,320 --> 00:43:06,790 in New England. 783 00:43:06,790 --> 00:43:09,490 There's one balancing area in New York. 784 00:43:09,490 --> 00:43:13,070 There are eight balancing areas in Arkansas. 785 00:43:13,070 --> 00:43:16,380 That is not the answer to any technical question, 786 00:43:16,380 --> 00:43:18,114 OK, Brendan. 787 00:43:18,114 --> 00:43:21,220 AUDIENCE: Because of this system, do people in Texas 788 00:43:21,220 --> 00:43:24,610 pay a higher, lower cost for electricity? 789 00:43:24,610 --> 00:43:28,397 RICHARD SCHMALENSEE: Oh, I would say 790 00:43:28,397 --> 00:43:30,230 trying to figure out whether this system has 791 00:43:30,230 --> 00:43:34,970 had any effect on Texas costs is probably impossible. 792 00:43:34,970 --> 00:43:37,880 Texas rates are reasonably low. 793 00:43:37,880 --> 00:43:39,170 Texas burns a lot of coal. 794 00:43:42,260 --> 00:43:47,350 Texas is big enough that the reliability implications aren't 795 00:43:47,350 --> 00:43:48,760 that great, right? 796 00:43:48,760 --> 00:43:51,040 If you decided to make Belmont, Massachusetts 797 00:43:51,040 --> 00:43:54,220 separate from the rest of the country with say one generating 798 00:43:54,220 --> 00:43:56,800 plant if Belmont has one, you would 799 00:43:56,800 --> 00:44:00,160 expect reliability problems just because if that plant goes 800 00:44:00,160 --> 00:44:01,930 down, which it has to occasionally, 801 00:44:01,930 --> 00:44:03,280 the system goes down. 802 00:44:03,280 --> 00:44:06,910 Texas is big enough that hasn't been an issue. 803 00:44:06,910 --> 00:44:10,540 Texas has a lot of renewables, which is kind of a surprise. 804 00:44:10,540 --> 00:44:13,150 But Texas has a lot of wind power. 805 00:44:13,150 --> 00:44:15,730 That's an issue, it is also is a cost issue. 806 00:44:15,730 --> 00:44:18,070 But I don't think this has much to do 807 00:44:18,070 --> 00:44:20,950 with the price of electricity in Texas. 808 00:44:20,950 --> 00:44:23,860 It's just a really interesting oddity, and is 809 00:44:23,860 --> 00:44:27,430 I hope always a cautionary flag. 810 00:44:27,430 --> 00:44:30,850 When you see something that looks like it's weird, 811 00:44:30,850 --> 00:44:34,600 it's either a political deal or a consequence of the tax system 812 00:44:34,600 --> 00:44:35,830 is my rule of thumb. 813 00:44:35,830 --> 00:44:36,700 And this is a deal. 814 00:44:36,700 --> 00:44:37,200 Yeah. 815 00:44:37,200 --> 00:44:38,950 AUDIENCE: So why isn't all of Texas? 816 00:44:38,950 --> 00:44:40,950 RICHARD SCHMALENSEE: Yeah, it's a good question. 817 00:44:40,950 --> 00:44:41,938 And I don't know. 818 00:44:41,938 --> 00:44:42,480 I don't know. 819 00:44:42,480 --> 00:44:46,380 You wonder why I say, I think that's Amarillo up there, 820 00:44:46,380 --> 00:44:47,130 that top dot. 821 00:44:47,130 --> 00:44:48,930 And I do not know why whoever made 822 00:44:48,930 --> 00:44:52,140 the deal wrote off North Texas. 823 00:44:52,140 --> 00:44:55,243 AUDIENCE: [INAUDIBLE]? 824 00:44:55,243 --> 00:44:57,160 RICHARD SCHMALENSEE: Same boundary, boundaries 825 00:44:57,160 --> 00:44:58,000 haven't changed. 826 00:44:58,000 --> 00:45:02,050 No, no, you don't want to say that too close to Texas. 827 00:45:02,050 --> 00:45:04,810 I mean, Texas is-- 828 00:45:04,810 --> 00:45:07,640 when I asked this question the first year I taught the course, 829 00:45:07,640 --> 00:45:09,700 the answer from a Texan was, so we can secede. 830 00:45:12,968 --> 00:45:15,260 I don't know why they wouldn't take Amarillo with them. 831 00:45:15,260 --> 00:45:17,440 And whoever that second dot is, I 832 00:45:17,440 --> 00:45:20,410 don't know who that is either. 833 00:45:20,410 --> 00:45:22,150 I don't have an answer. 834 00:45:22,150 --> 00:45:26,950 My guess is that actually was an electrical response. 835 00:45:26,950 --> 00:45:30,760 That part of Texas may have had closer electrical connections 836 00:45:30,760 --> 00:45:33,622 outside the state than inside. 837 00:45:33,622 --> 00:45:35,080 And somebody said, look, that would 838 00:45:35,080 --> 00:45:38,380 be really stupid to kind of reconfigure the transmission 839 00:45:38,380 --> 00:45:39,850 system. 840 00:45:39,850 --> 00:45:40,570 I'm guessing. 841 00:45:40,570 --> 00:45:42,250 I don't know. 842 00:45:42,250 --> 00:45:44,730 Anything else? 843 00:45:44,730 --> 00:45:52,870 OK, all right, let me spend most of the rest of the time 844 00:45:52,870 --> 00:45:55,270 on sort of how we got here and walk 845 00:45:55,270 --> 00:45:56,650 through the regulatory history. 846 00:46:01,100 --> 00:46:04,820 First, central generating station, Thomas Edison, 847 00:46:04,820 --> 00:46:09,530 New York, 59 customers, lighting. 848 00:46:09,530 --> 00:46:14,120 And by the way, you think you have a load variation problem 849 00:46:14,120 --> 00:46:16,230 now with those New England things, 850 00:46:16,230 --> 00:46:19,980 think about when your only product is lighting. 851 00:46:19,980 --> 00:46:23,480 You shut the whole system down in the daytime. 852 00:46:23,480 --> 00:46:25,952 This is not a good way to use your assets. 853 00:46:25,952 --> 00:46:27,410 So one of the first things they did 854 00:46:27,410 --> 00:46:31,010 was push for electric streetcars. 855 00:46:31,010 --> 00:46:33,470 These early systems, direct current systems 856 00:46:33,470 --> 00:46:37,190 were regulated mostly by cities. 857 00:46:37,190 --> 00:46:38,188 They were local. 858 00:46:38,188 --> 00:46:39,230 They were direct current. 859 00:46:39,230 --> 00:46:41,090 Direct current at low voltage doesn't 860 00:46:41,090 --> 00:46:43,792 travel very far efficiently. 861 00:46:43,792 --> 00:46:46,250 And you don't want to put high voltage into people's homes. 862 00:46:48,780 --> 00:46:52,550 So we had a bunch city-regulated systems 863 00:46:52,550 --> 00:46:55,650 and then we had a bunch of city-run systems. 864 00:46:55,650 --> 00:46:58,380 So in 1900, as far as I can tell, 865 00:46:58,380 --> 00:47:02,840 the peak of municipal systems, Belmont has one, 866 00:47:02,840 --> 00:47:11,310 Los Angeles has one, they peaked at 8% of generation in 1900. 867 00:47:11,310 --> 00:47:15,180 As alternating current came in, and the big thing 868 00:47:15,180 --> 00:47:18,480 with alternating current is you can change it's voltage 869 00:47:18,480 --> 00:47:19,640 relatively easily. 870 00:47:19,640 --> 00:47:22,530 So you can have high voltage to send it long distances. 871 00:47:22,530 --> 00:47:25,420 And then you can take it down for use in homes. 872 00:47:25,420 --> 00:47:32,700 So the transformer really makes alternating current the winner. 873 00:47:32,700 --> 00:47:35,460 Now, You can take DC up and down. 874 00:47:35,460 --> 00:47:37,140 But it's more expensive. 875 00:47:37,140 --> 00:47:39,670 And you couldn't do it for a long time. 876 00:47:39,670 --> 00:47:41,490 So alternating current wins. 877 00:47:41,490 --> 00:47:46,740 And as you begin to make it technically possible 878 00:47:46,740 --> 00:47:48,780 to go beyond a city-- 879 00:47:48,780 --> 00:47:50,438 if you're doing direct current, you're 880 00:47:50,438 --> 00:47:52,980 building a generating station, you're serving a neighborhood. 881 00:47:52,980 --> 00:47:54,990 We talked about the London system 882 00:47:54,990 --> 00:47:57,030 and how it stayed that way for a long time. 883 00:47:57,030 --> 00:47:58,410 That's how they grow up. 884 00:47:58,410 --> 00:48:00,610 You build a generator to serve a neighborhood. 885 00:48:00,610 --> 00:48:02,880 And then maybe you go to alternating current. 886 00:48:02,880 --> 00:48:07,170 But technically, once you can do higher voltages, 887 00:48:07,170 --> 00:48:09,120 you can expand. 888 00:48:09,120 --> 00:48:11,760 You can link up separate cities. 889 00:48:11,760 --> 00:48:14,730 And that began to happen after the turn 890 00:48:14,730 --> 00:48:20,460 of the century and states took over-regulation from cities. 891 00:48:20,460 --> 00:48:24,620 The idea was we'd set up these impartial commissions. 892 00:48:24,620 --> 00:48:27,980 And these impartial non-political public utility 893 00:48:27,980 --> 00:48:34,220 commissions, not elected in most states, not subject to removal 894 00:48:34,220 --> 00:48:35,970 by the government, independent commissions 895 00:48:35,970 --> 00:48:39,970 was an invention that started, I'm now forgetting, 896 00:48:39,970 --> 00:48:41,910 I think Wisconsin in 1907. 897 00:48:41,910 --> 00:48:45,400 And by 1920, everybody, almost everybody had them. 898 00:48:45,400 --> 00:48:46,650 Is anybody here from Nebraska? 899 00:48:49,400 --> 00:48:52,640 OK, Nebraska doesn't have a public utility commission 900 00:48:52,640 --> 00:48:55,430 because no private firm is selling 901 00:48:55,430 --> 00:48:56,990 electricity in Nebraska. 902 00:48:56,990 --> 00:48:59,000 It's all government and co-ops. 903 00:48:59,000 --> 00:49:02,130 But everybody else has one. 904 00:49:02,130 --> 00:49:05,040 The Europeans didn't do this. 905 00:49:05,040 --> 00:49:08,490 What happened, the European system started out like this. 906 00:49:08,490 --> 00:49:13,590 It started out local, began to grow 907 00:49:13,590 --> 00:49:17,080 and became government enterprises. 908 00:49:17,080 --> 00:49:17,580 Why? 909 00:49:24,980 --> 00:49:28,130 OK, you figure that's the answer to an engineering question. 910 00:49:30,710 --> 00:49:33,910 That is not the answer to an engineering question. 911 00:49:33,910 --> 00:49:37,470 The same electrons, same technology, 912 00:49:37,470 --> 00:49:39,480 similar densities in many areas. 913 00:49:39,480 --> 00:49:41,678 Jacob, save me here. 914 00:49:41,678 --> 00:49:43,470 AUDIENCE: Although they may have provinces, 915 00:49:43,470 --> 00:49:46,110 they're not as independent government institutions 916 00:49:46,110 --> 00:49:47,830 as they are in the United States. 917 00:49:47,830 --> 00:49:51,460 RICHARD SCHMALENSEE: Well, that's true to some extent. 918 00:49:51,460 --> 00:49:54,350 Although, take Germany. 919 00:49:54,350 --> 00:49:58,668 Germany is and has been to the extent that it was-- 920 00:49:58,668 --> 00:50:00,460 well, it wasn't democratic for a long time. 921 00:50:00,460 --> 00:50:03,868 But it began as a set of independent countries 922 00:50:03,868 --> 00:50:05,035 that became the [INAUDIBLE]. 923 00:50:05,035 --> 00:50:07,760 It became a federal system. 924 00:50:07,760 --> 00:50:14,050 So when the government took over the Berlin system, 925 00:50:14,050 --> 00:50:15,610 it was the Berlin government. 926 00:50:15,610 --> 00:50:18,410 It wasn't the national government. 927 00:50:18,410 --> 00:50:21,233 So not all of these government enterprises were national. 928 00:50:21,233 --> 00:50:22,150 But it's a good point. 929 00:50:22,150 --> 00:50:23,567 The political structures differed. 930 00:50:23,567 --> 00:50:26,440 And the US was if not unique, then 931 00:50:26,440 --> 00:50:29,920 it stood out as having this whole state structure. 932 00:50:32,810 --> 00:50:35,810 It's just an ideological difference. 933 00:50:35,810 --> 00:50:37,160 An ideological difference. 934 00:50:37,160 --> 00:50:40,490 The US had a strong preference for private enterprise. 935 00:50:40,490 --> 00:50:42,690 Europe had a less strong preference. 936 00:50:47,990 --> 00:50:51,110 It was a big debate in the US through the '30s. 937 00:50:51,110 --> 00:50:54,356 Should this stuff be government or should it be private? 938 00:50:54,356 --> 00:50:56,550 Private mostly won in the US. 939 00:50:56,550 --> 00:50:59,880 Government mostly won in Europe. 940 00:50:59,880 --> 00:51:02,640 You can make arguments both ways. 941 00:51:02,640 --> 00:51:06,570 I talked about various solutions to natural monopolies. 942 00:51:06,570 --> 00:51:08,940 The government solution is, look, 943 00:51:08,940 --> 00:51:11,730 there are no shareholders trying to rape and pillage here. 944 00:51:11,730 --> 00:51:14,580 We're just all trying to serve the customers. 945 00:51:14,580 --> 00:51:17,010 The private response is, yes, and you're all 946 00:51:17,010 --> 00:51:18,630 hiring your brother-in-laws. 947 00:51:18,630 --> 00:51:20,460 The costs are high. 948 00:51:20,460 --> 00:51:22,530 You have no stockholder pressure to be efficient. 949 00:51:22,530 --> 00:51:23,940 Costs will be too high. 950 00:51:23,940 --> 00:51:26,700 That debate ran for 30, 40 years. 951 00:51:26,700 --> 00:51:29,320 It still goes on in some quarters. 952 00:51:29,320 --> 00:51:30,420 One side won in Europe. 953 00:51:30,420 --> 00:51:31,530 One side won in the US. 954 00:51:35,160 --> 00:51:40,730 OK, so far the states, now the feds. 955 00:51:40,730 --> 00:51:45,650 The federal government got into electricity first in 1906 956 00:51:45,650 --> 00:51:50,030 selling cheap surplus power from irrigation projects. 957 00:51:50,030 --> 00:51:52,760 It gave preference to municipalities rather than 958 00:51:52,760 --> 00:51:54,540 private buyers. 959 00:51:54,540 --> 00:51:56,418 Why was it cheap, do you think? 960 00:51:56,418 --> 00:51:58,460 Why was the power cheap from irrigation projects? 961 00:52:01,390 --> 00:52:05,380 OK, today is quirky political explanations day. 962 00:52:05,380 --> 00:52:08,710 In calculating the cost of building something, 963 00:52:08,710 --> 00:52:11,950 the government tends to use its borrowing rate. 964 00:52:11,950 --> 00:52:13,630 The cost of capital to the government, 965 00:52:13,630 --> 00:52:17,290 which has the power to tax is lower than the cost of capital 966 00:52:17,290 --> 00:52:19,790 to private firms that don't. 967 00:52:19,790 --> 00:52:22,310 So all else equal, the government 968 00:52:22,310 --> 00:52:23,960 can produce power cheaper. 969 00:52:23,960 --> 00:52:25,910 And if the main cost is capital, which 970 00:52:25,910 --> 00:52:30,030 it is for a hydro facility, it could be a lot cheaper. 971 00:52:30,030 --> 00:52:32,360 So the government says, we're not making any money, 972 00:52:32,360 --> 00:52:34,010 we will sell it cheaply. 973 00:52:34,010 --> 00:52:36,020 But then you've got to figure out who gets it. 974 00:52:36,020 --> 00:52:38,090 And the decision was municipal utilities. 975 00:52:41,960 --> 00:52:44,540 During the run up to the '20s-- 976 00:52:44,540 --> 00:52:46,170 and that's an amazing period if you 977 00:52:46,170 --> 00:52:47,420 think about growth industries. 978 00:52:47,420 --> 00:52:48,860 I just ran the numbers. 979 00:52:48,860 --> 00:52:51,830 The growth in electric power between 1900 and 1929 980 00:52:51,830 --> 00:52:54,290 averaged 14% a year. 981 00:52:54,290 --> 00:52:55,430 That's a boom. 982 00:52:55,430 --> 00:52:57,350 That's a long boom. 983 00:52:57,350 --> 00:52:59,420 That was fun. 984 00:52:59,420 --> 00:53:02,390 It was fun except that these guys were being regulated. 985 00:53:02,390 --> 00:53:06,890 So their response was, we're being regulated by states. 986 00:53:06,890 --> 00:53:10,920 Let's have holding companies that operate in multiple states 987 00:53:10,920 --> 00:53:15,650 so we can kind of hide the ball from regulators. 988 00:53:15,650 --> 00:53:19,520 And it was used to fuel stock speculation. 989 00:53:19,520 --> 00:53:20,720 So they had a lot of fun. 990 00:53:20,720 --> 00:53:24,580 They built these big holding companies. 991 00:53:24,580 --> 00:53:25,600 I'll come back to that. 992 00:53:25,600 --> 00:53:28,510 The federal power commission, now the FERC, 993 00:53:28,510 --> 00:53:31,900 was formed in 1920 because all navigable waterways 994 00:53:31,900 --> 00:53:32,980 are federal. 995 00:53:32,980 --> 00:53:37,160 It began to do some regulation from 1935. 996 00:53:37,160 --> 00:53:40,610 In 1935 in response to these holding companies, 997 00:53:40,610 --> 00:53:43,910 which really were weird creatures. 998 00:53:43,910 --> 00:53:47,270 And they were blamed for the stock market crash of 1929. 999 00:53:47,270 --> 00:53:49,295 You always need to find a scapegoat. 1000 00:53:49,295 --> 00:53:51,170 So the scapegoat was these utility companies. 1001 00:53:51,170 --> 00:53:51,878 They were broken. 1002 00:53:51,878 --> 00:53:52,790 They were broken up. 1003 00:53:52,790 --> 00:53:56,083 You had to operate in one contiguous area. 1004 00:53:56,083 --> 00:53:58,250 You couldn't have a company here and a company there 1005 00:53:58,250 --> 00:53:59,760 under the same umbrella. 1006 00:53:59,760 --> 00:54:04,400 Well, that really enforced what was the vertically integrated 1007 00:54:04,400 --> 00:54:05,327 monopoly structure. 1008 00:54:05,327 --> 00:54:07,910 The same company would generate the power, transmit the power, 1009 00:54:07,910 --> 00:54:08,930 and sell you the power. 1010 00:54:12,740 --> 00:54:19,140 In the '30s, one of Roosevelt's initiatives 1011 00:54:19,140 --> 00:54:23,250 was to get power to rural areas, one of his priorities. 1012 00:54:23,250 --> 00:54:26,280 The existing utilities weren't interested in doing it 1013 00:54:26,280 --> 00:54:29,210 because it's expensive. 1014 00:54:29,210 --> 00:54:31,580 And their current customers didn't 1015 00:54:31,580 --> 00:54:34,250 want to pay higher prices so the farmer in the next county 1016 00:54:34,250 --> 00:54:37,240 can get power. 1017 00:54:37,240 --> 00:54:42,900 What the federal remedy was, we'll enable a set of co-ops. 1018 00:54:42,900 --> 00:54:47,455 And we'll sell them cheap power from federal facilities. 1019 00:54:47,455 --> 00:54:48,330 That's what was done. 1020 00:54:48,330 --> 00:54:50,730 TVA is the most visible sort of we'll 1021 00:54:50,730 --> 00:54:53,490 generate from federal facilities and sell cheap. 1022 00:54:53,490 --> 00:54:56,880 But we did a bunch of it. 1023 00:54:56,880 --> 00:55:01,080 And in 1950 when it peaked, the federal government 1024 00:55:01,080 --> 00:55:07,660 generated 12% of us electricity, OK. 1025 00:55:07,660 --> 00:55:09,220 So far so good? 1026 00:55:09,220 --> 00:55:10,060 That's the history. 1027 00:55:13,260 --> 00:55:26,080 State regulation-- so the bulk of the regulatory effort 1028 00:55:26,080 --> 00:55:31,020 from 1907, particularly after 1935, that's PUHCA, 1029 00:55:31,020 --> 00:55:34,370 always pronounced puka. 1030 00:55:34,370 --> 00:55:39,260 State regulators required just and reasonable rates. 1031 00:55:39,260 --> 00:55:42,350 This was rate of return regulation. 1032 00:55:42,350 --> 00:55:45,410 They would set prices in principle 1033 00:55:45,410 --> 00:55:49,697 so that the utility would just earn a fair rate of return. 1034 00:55:49,697 --> 00:55:51,030 You've got to have some profits. 1035 00:55:51,030 --> 00:55:51,740 What's a fair profit? 1036 00:55:51,740 --> 00:55:53,180 Well, we know what your cost of capital is. 1037 00:55:53,180 --> 00:55:54,770 We'll figure out what that is. 1038 00:55:54,770 --> 00:55:58,980 And we'll set the rates so you just earn that. 1039 00:55:58,980 --> 00:56:03,100 So what might go wrong? 1040 00:56:11,580 --> 00:56:14,760 Alex, Shirley you're about to raise your hand now. 1041 00:56:14,760 --> 00:56:17,010 I keep watching this hand going-- 1042 00:56:17,010 --> 00:56:17,760 What do you think? 1043 00:56:17,760 --> 00:56:18,600 What could go wrong? 1044 00:56:18,600 --> 00:56:19,100 Anything? 1045 00:56:23,450 --> 00:56:26,750 We're going to set prices so that you just earn 1046 00:56:26,750 --> 00:56:30,062 a reasonable rate of return. 1047 00:56:30,062 --> 00:56:34,710 AUDIENCE: [INAUDIBLE] what that is. 1048 00:56:34,710 --> 00:56:37,770 RICHARD SCHMALENSEE: You can get it wrong. 1049 00:56:37,770 --> 00:56:39,300 We'll set a price. 1050 00:56:39,300 --> 00:56:42,540 And we'll let it. 1051 00:56:42,540 --> 00:56:46,500 Well, we'll set a price and let's suppose we adjust it 1052 00:56:46,500 --> 00:56:48,180 when we get surprises. 1053 00:56:48,180 --> 00:56:50,220 Or let's say, we are worried about, 1054 00:56:50,220 --> 00:56:52,500 and this is what they did do after a while. 1055 00:56:52,500 --> 00:56:55,680 We know that you can't control your cost of fuel. 1056 00:56:55,680 --> 00:56:57,130 That's on the open market. 1057 00:56:57,130 --> 00:57:01,270 So we'll pass that through automatically. 1058 00:57:01,270 --> 00:57:02,193 Anything else? 1059 00:57:02,193 --> 00:57:04,360 Anything else that could go wrong if I make sure you 1060 00:57:04,360 --> 00:57:06,310 just earn a reasonable rate of return? 1061 00:57:10,220 --> 00:57:12,400 OK, let me not torture you, think about it. 1062 00:57:12,400 --> 00:57:13,203 Yes. 1063 00:57:13,203 --> 00:57:14,870 AUDIENCE: [INAUDIBLE] the variable cost. 1064 00:57:14,870 --> 00:57:18,510 They have no incentive to try to be efficient. 1065 00:57:18,510 --> 00:57:19,910 RICHARD SCHMALENSEE: So you would 1066 00:57:19,910 --> 00:57:24,230 expect the big problem would be that the cost would 1067 00:57:24,230 --> 00:57:25,940 be too high. 1068 00:57:25,940 --> 00:57:29,720 Suppose-- and we can even sharpen that a little bit. 1069 00:57:29,720 --> 00:57:35,450 And that is the main defect in that form of regulation. 1070 00:57:35,450 --> 00:57:38,790 Suppose we recognize the following. 1071 00:57:38,790 --> 00:57:41,150 If I say that a reasonable rate of return 1072 00:57:41,150 --> 00:57:46,450 is below your cost of capital, then you can't function, right? 1073 00:57:46,450 --> 00:57:49,210 If you can't raise money to invest because you can't earn 1074 00:57:49,210 --> 00:57:53,060 enough on it, if I've set the rate of return too low, 1075 00:57:53,060 --> 00:57:54,830 you can't go forward. 1076 00:57:54,830 --> 00:57:56,810 So I don't want that to happen. 1077 00:57:56,810 --> 00:58:00,070 So I make sure you earn more than your cost of capital 1078 00:58:00,070 --> 00:58:01,450 on the investments. 1079 00:58:01,450 --> 00:58:03,460 I have to make sure that every dollar you invest 1080 00:58:03,460 --> 00:58:08,720 earns more than what it costs you to raise that dollar? 1081 00:58:08,720 --> 00:58:12,390 What might that lead to, just intuitively? 1082 00:58:12,390 --> 00:58:13,290 David. 1083 00:58:13,290 --> 00:58:14,728 AUDIENCE: Over-investment. 1084 00:58:14,728 --> 00:58:16,270 RICHARD SCHMALENSEE: Over-investment, 1085 00:58:16,270 --> 00:58:19,450 which they referred to in the literature as gold plating, 1086 00:58:19,450 --> 00:58:19,950 right? 1087 00:58:19,950 --> 00:58:23,710 If I have a choice of doing it with three people or a $5 1088 00:58:23,710 --> 00:58:26,590 million investment, I'll do a $5 million 1089 00:58:26,590 --> 00:58:28,900 investment because I'll earn money on that. 1090 00:58:28,900 --> 00:58:32,160 And I won't earn any money on the three people. 1091 00:58:32,160 --> 00:58:34,520 So you have a tendency you would expect to have 1092 00:58:34,520 --> 00:58:38,090 capital investment too high. 1093 00:58:38,090 --> 00:58:40,130 There are a couple other problems, 1094 00:58:40,130 --> 00:58:41,060 we've hit two of them. 1095 00:58:41,060 --> 00:58:43,730 I'll just mention the others. 1096 00:58:43,730 --> 00:58:46,760 When people talk about this system, 1097 00:58:46,760 --> 00:58:47,795 they talk about capture. 1098 00:58:51,970 --> 00:58:57,070 Well, I actually gave a talk at the Massachusetts Commission 1099 00:58:57,070 --> 00:58:58,750 a couple of weeks ago. 1100 00:58:58,750 --> 00:59:02,560 And it turns out there's a little office 1101 00:59:02,560 --> 00:59:05,140 complex inside South Station. 1102 00:59:05,140 --> 00:59:07,390 You don't see it, but you kind of go around the corner 1103 00:59:07,390 --> 00:59:11,140 and you go up and they have some offices. 1104 00:59:11,140 --> 00:59:14,470 Who do you think goes into those offices? 1105 00:59:14,470 --> 00:59:17,290 The companies they regulate. 1106 00:59:17,290 --> 00:59:22,320 Who do you think says nice things to them, talks to them, 1107 00:59:22,320 --> 00:59:25,240 has any relationship with them at all? 1108 00:59:25,240 --> 00:59:28,850 The people they regulate. 1109 00:59:28,850 --> 00:59:31,760 Who has lots of lawyers and lots of PR people 1110 00:59:31,760 --> 00:59:35,000 to make a lot of noise if they're unhappy? 1111 00:59:35,000 --> 00:59:37,130 The people they regulate. 1112 00:59:37,130 --> 00:59:42,470 So a strong model not an entirely accurate model, 1113 00:59:42,470 --> 00:59:46,820 but not an entirely crazy model is, after a while, 1114 00:59:46,820 --> 00:59:52,520 the regulators serve the folks they regulate. 1115 00:59:52,520 --> 00:59:54,650 Because you want to make them happy. 1116 00:59:54,650 --> 00:59:57,830 You see them every day, they come in your office. 1117 00:59:57,830 --> 00:59:59,840 You can imagine a different kind of relationship 1118 00:59:59,840 --> 01:00:02,270 and sometimes you see it. 1119 01:00:02,270 --> 01:00:06,230 But one argument is, all the consumers are not organized. 1120 01:00:06,230 --> 01:00:08,450 The utility is. 1121 01:00:08,450 --> 01:00:10,140 The electric companies are organized. 1122 01:00:10,140 --> 01:00:10,760 They have the lawyers. 1123 01:00:10,760 --> 01:00:11,630 They have their lobbyists. 1124 01:00:11,630 --> 01:00:12,505 They're in every day. 1125 01:00:12,505 --> 01:00:14,720 They write the stuff. 1126 01:00:14,720 --> 01:00:19,170 Those of us who only pay bills aren't in there every day. 1127 01:00:19,170 --> 01:00:20,280 So that's one problem. 1128 01:00:20,280 --> 01:00:25,280 The other problem, it's a more subtle problem is, 1129 01:00:25,280 --> 01:00:29,120 who determines who pays what price? 1130 01:00:29,120 --> 01:00:32,150 And the simplest example is, prices to industry 1131 01:00:32,150 --> 01:00:35,550 versus prices to consumers. 1132 01:00:35,550 --> 01:00:37,470 Industry takes power at higher voltages. 1133 01:00:37,470 --> 01:00:39,450 So they ought to pay a lower price. 1134 01:00:39,450 --> 01:00:41,128 What's the price difference? 1135 01:00:41,128 --> 01:00:42,920 Well, I submit to you that price difference 1136 01:00:42,920 --> 01:00:47,450 is a political decision as much as it is anything. 1137 01:00:47,450 --> 01:00:49,910 And under a regulated regime, it's 1138 01:00:49,910 --> 01:00:52,310 hard to see how it could be anything else. 1139 01:00:52,310 --> 01:00:55,840 OK, so this system actually worked. 1140 01:00:55,840 --> 01:00:57,590 And I'm going to answer this question just 1141 01:00:57,590 --> 01:01:00,740 in the interest of our leaving today. 1142 01:01:00,740 --> 01:01:04,610 This system generated almost no complaints until the 1970s, 1143 01:01:04,610 --> 01:01:08,590 in electric power, despite all of these well known, 1144 01:01:08,590 --> 01:01:11,190 well-documented problems. 1145 01:01:11,190 --> 01:01:14,280 And the reason for that is in electricity, 1146 01:01:14,280 --> 01:01:17,260 technical change was very rapid. 1147 01:01:17,260 --> 01:01:19,820 Energy costs were pretty stable. 1148 01:01:19,820 --> 01:01:24,250 And so the price of electricity was dropping. 1149 01:01:24,250 --> 01:01:26,740 Very often the utility would come in and ask 1150 01:01:26,740 --> 01:01:29,380 for a rate decrease, all right. 1151 01:01:29,380 --> 01:01:31,840 If you fixed my price, and my costs keep dropping, 1152 01:01:31,840 --> 01:01:34,210 there comes a point at which the price is embarrassingly 1153 01:01:34,210 --> 01:01:36,130 high above the monopoly price. 1154 01:01:36,130 --> 01:01:38,110 I'm going to make me too much money 1155 01:01:38,110 --> 01:01:39,790 to survive political scrutiny. 1156 01:01:39,790 --> 01:01:42,350 I'll ask for a lower price. 1157 01:01:42,350 --> 01:01:44,000 So an awful lot of that happened. 1158 01:01:44,000 --> 01:01:45,990 That's a great system. 1159 01:01:45,990 --> 01:01:47,550 The regulators don't have to do much. 1160 01:01:47,550 --> 01:01:50,950 The utility comes in and says, may we please lower our price. 1161 01:01:50,950 --> 01:01:51,923 We do a big fuss. 1162 01:01:51,923 --> 01:01:52,590 We have lawyers. 1163 01:01:52,590 --> 01:01:56,190 We write briefs, after a while we say, yeah, lower your price. 1164 01:01:56,190 --> 01:01:57,270 We all go out to lunch. 1165 01:01:57,270 --> 01:01:58,890 This is a good system. 1166 01:01:58,890 --> 01:02:00,900 It didn't work in the '70s very well 1167 01:02:00,900 --> 01:02:03,535 when fuel costs began to rise. 1168 01:02:03,535 --> 01:02:05,160 And the utilities came in and said, now 1169 01:02:05,160 --> 01:02:07,390 let us raise our prices. 1170 01:02:07,390 --> 01:02:09,370 And then people began to say, wait a minute, 1171 01:02:09,370 --> 01:02:10,570 your costs are too high. 1172 01:02:10,570 --> 01:02:12,830 You are gold plated blah, blah, blah. 1173 01:02:12,830 --> 01:02:14,980 And it began to be nasty. 1174 01:02:14,980 --> 01:02:20,425 OK, so let me take this up to date. 1175 01:02:23,840 --> 01:02:30,070 In the 1970s, we deregulated a lot of things in this economy. 1176 01:02:30,070 --> 01:02:31,920 We deregulated airlines. 1177 01:02:31,920 --> 01:02:33,480 We deregulated trucking. 1178 01:02:33,480 --> 01:02:35,280 We deregulated railroads. 1179 01:02:35,280 --> 01:02:39,590 We deregulated the wellhead price of natural gas. 1180 01:02:39,590 --> 01:02:43,100 And most of those worked. 1181 01:02:43,100 --> 01:02:44,540 Price of natural gas went up. 1182 01:02:44,540 --> 01:02:46,310 But we stopped having shortages. 1183 01:02:46,310 --> 01:02:47,780 Airline prices came down. 1184 01:02:47,780 --> 01:02:49,100 Trucking prices came down. 1185 01:02:49,100 --> 01:02:50,370 Railroad prices came down. 1186 01:02:50,370 --> 01:02:51,410 And costs came down. 1187 01:02:53,960 --> 01:02:57,650 And electricity prices were going up. 1188 01:02:57,650 --> 01:02:59,660 Fuel costs were going up. 1189 01:02:59,660 --> 01:03:01,320 There was excess capacity. 1190 01:03:01,320 --> 01:03:03,830 People had to pay for that capacity. 1191 01:03:03,830 --> 01:03:09,290 There became a move to deregulate electricity. 1192 01:03:09,290 --> 01:03:12,750 But I just told you it was a natural monopoly. 1193 01:03:12,750 --> 01:03:15,770 So the first step was this law that said, 1194 01:03:15,770 --> 01:03:17,660 you have to buy from renewables. 1195 01:03:17,660 --> 01:03:20,580 And you have to buy from combined heat and power 1196 01:03:20,580 --> 01:03:28,050 co-generation, hexion type units at avoided cost. 1197 01:03:28,050 --> 01:03:29,550 What's avoided cost? 1198 01:03:29,550 --> 01:03:32,100 Well, each state got to determine that. 1199 01:03:32,100 --> 01:03:34,590 Big mess, there were no markets. 1200 01:03:34,590 --> 01:03:40,200 But an interesting step, early '80s, and I 1201 01:03:40,200 --> 01:03:43,110 will cite myself here because I do tend to get cited for this. 1202 01:03:43,110 --> 01:03:45,120 In the early '80s, Paul Joskow and I 1203 01:03:45,120 --> 01:03:46,540 were working in this area. 1204 01:03:46,540 --> 01:03:50,580 And we began to hear from people in the Reagan administration, 1205 01:03:50,580 --> 01:03:52,650 all this other stuff worked. 1206 01:03:52,650 --> 01:03:55,860 We deregulated gas and trucking and airlines, why don't we 1207 01:03:55,860 --> 01:03:58,770 just deregulate electricity. 1208 01:03:58,770 --> 01:04:02,040 Why don't we just let the market determine electricity prices? 1209 01:04:02,040 --> 01:04:06,690 I have to say, the words natural monopoly came to mind. 1210 01:04:06,690 --> 01:04:11,100 You're not going to have competition in transmission. 1211 01:04:11,100 --> 01:04:15,000 You're not going to have competition in distribution. 1212 01:04:15,000 --> 01:04:19,080 But you know you could have competition in generation. 1213 01:04:19,080 --> 01:04:20,840 It's not like there's only one generating 1214 01:04:20,840 --> 01:04:23,450 plant per city or per state. 1215 01:04:23,450 --> 01:04:25,330 There are a bunch of them. 1216 01:04:25,330 --> 01:04:26,570 So maybe you could. 1217 01:04:26,570 --> 01:04:28,790 So we actually wrote a book called Markets for Power 1218 01:04:28,790 --> 01:04:32,570 that people tell me was influential more outside the US 1219 01:04:32,570 --> 01:04:34,100 than in. 1220 01:04:34,100 --> 01:04:38,230 But we said well, you could do it if you were careful. 1221 01:04:38,230 --> 01:04:41,830 If you were careful, and you worried about market power, 1222 01:04:41,830 --> 01:04:43,977 and you worried about the proper rules, 1223 01:04:43,977 --> 01:04:46,060 and you worried about a half a dozen other things, 1224 01:04:46,060 --> 01:04:49,510 you could actually deregulate generation. 1225 01:04:49,510 --> 01:04:51,250 Well, it happened. 1226 01:04:51,250 --> 01:04:53,410 And I don't claim credit for this. 1227 01:04:53,410 --> 01:04:56,380 It was mostly because the Thatcher administration 1228 01:04:56,380 --> 01:04:58,410 in England needed money. 1229 01:04:58,410 --> 01:05:02,370 So they sold the electric power system. 1230 01:05:02,370 --> 01:05:03,880 This was a shock. 1231 01:05:03,880 --> 01:05:05,780 It had happened in Chile a few years earlier, 1232 01:05:05,780 --> 01:05:09,440 nobody noticed Chile, besides they did it in Spanish. 1233 01:05:09,440 --> 01:05:12,470 But in England and Wales, they did it. 1234 01:05:12,470 --> 01:05:18,050 They kept the grid, the transmission system together. 1235 01:05:18,050 --> 01:05:20,630 They regulated the distribution companies, 1236 01:05:20,630 --> 01:05:23,160 but they sold the generators. 1237 01:05:23,160 --> 01:05:24,988 They sold the generators. 1238 01:05:27,680 --> 01:05:29,270 This was pretty exciting stuff. 1239 01:05:29,270 --> 01:05:34,160 And it actually worked, not perfectly. 1240 01:05:34,160 --> 01:05:37,220 They had monopoly power problems in generation in some areas. 1241 01:05:37,220 --> 01:05:38,900 They had to make changes. 1242 01:05:38,900 --> 01:05:41,100 But it sort of worked. 1243 01:05:41,100 --> 01:05:42,760 Other countries started to follow. 1244 01:05:42,760 --> 01:05:46,290 We started to follow. 1245 01:05:46,290 --> 01:05:50,340 Suddenly transmission lines had to be 1246 01:05:50,340 --> 01:05:52,920 willing to carry anybody's power from anybody to anybody 1247 01:05:52,920 --> 01:05:55,830 just like trucks do. 1248 01:05:55,830 --> 01:05:59,280 The FERC set up, independent system operators, they 1249 01:05:59,280 --> 01:06:03,150 set up a regime where you could have one entity run the system, 1250 01:06:03,150 --> 01:06:05,280 not own it, but run it. 1251 01:06:05,280 --> 01:06:09,360 And you could have wholesale markets for electricity. 1252 01:06:09,360 --> 01:06:12,390 Some people did it, and I'll show you what happened. 1253 01:06:12,390 --> 01:06:15,130 Then we had California. 1254 01:06:15,130 --> 01:06:17,520 Who's from California? 1255 01:06:17,520 --> 01:06:19,300 Was that fun? 1256 01:06:19,300 --> 01:06:20,770 That was not fun. 1257 01:06:20,770 --> 01:06:25,270 Prices went crazy in California, around 2000, 2001. 1258 01:06:25,270 --> 01:06:26,980 There were blackouts. 1259 01:06:26,980 --> 01:06:28,210 There was screaming. 1260 01:06:28,210 --> 01:06:29,500 There was political crisis. 1261 01:06:29,500 --> 01:06:32,840 There was Enron doing various interesting things. 1262 01:06:32,840 --> 01:06:36,820 There's litigation, which may now have finished. 1263 01:06:36,820 --> 01:06:46,227 I'm not sure about who did what to whom, reform stopped. 1264 01:06:46,227 --> 01:06:47,560 We'll say a little bit about it. 1265 01:06:47,560 --> 01:06:52,230 But let me just say sort of where we are. 1266 01:06:52,230 --> 01:06:54,660 So basically nothing's happened since California 1267 01:06:54,660 --> 01:06:56,460 to a first approximation. 1268 01:06:56,460 --> 01:06:59,580 But a lot happened before California. 1269 01:06:59,580 --> 01:07:04,980 So there is competition in generation. 1270 01:07:04,980 --> 01:07:06,480 Generators sell into a market. 1271 01:07:09,460 --> 01:07:13,600 In England and Wales, it's the core European Union policy. 1272 01:07:13,600 --> 01:07:16,600 All these state owned monopolies are moving toward markets, 1273 01:07:16,600 --> 01:07:18,580 dramatically, dramatically. 1274 01:07:18,580 --> 01:07:21,160 And about 2/3 of US consumers are served by markets. 1275 01:07:21,160 --> 01:07:23,170 This is the picture. 1276 01:07:23,170 --> 01:07:25,480 The colored areas are roughly-- 1277 01:07:25,480 --> 01:07:27,550 they change slightly over time-- 1278 01:07:27,550 --> 01:07:31,700 roughly the boundaries of organized wholesale markets. 1279 01:07:31,700 --> 01:07:33,880 So in New England, I showed you these day 1280 01:07:33,880 --> 01:07:35,950 ahead clearing demands. 1281 01:07:35,950 --> 01:07:39,340 And I'll show you some prices in a little bit. 1282 01:07:39,340 --> 01:07:43,090 This part of Texas runs a very nice market. 1283 01:07:43,090 --> 01:07:47,650 California after a while restarted. 1284 01:07:47,650 --> 01:07:51,070 This part of the country is traditional, vertically 1285 01:07:51,070 --> 01:07:52,190 integrated. 1286 01:07:52,190 --> 01:07:52,870 We generate. 1287 01:07:52,870 --> 01:07:53,590 We transmit. 1288 01:07:53,590 --> 01:07:54,340 We distribute. 1289 01:07:54,340 --> 01:07:57,340 What's a market utilities. 1290 01:07:57,340 --> 01:08:01,270 In the West, the federal government has a huge presence, 1291 01:08:01,270 --> 01:08:05,260 operates a lot of the transmission system. 1292 01:08:05,260 --> 01:08:07,600 There are sort of elements of market, but not really. 1293 01:08:07,600 --> 01:08:09,580 And there's an awful lot of preference power. 1294 01:08:09,580 --> 01:08:12,320 Because there's a lot of government-owned hydro. 1295 01:08:12,320 --> 01:08:15,230 If you go up the Columbia River, you pass a dam after dam 1296 01:08:15,230 --> 01:08:19,960 after dam which you all own. 1297 01:08:19,960 --> 01:08:23,710 So New England, one of the earlier ones, 1298 01:08:23,710 --> 01:08:27,439 very nice little market. 1299 01:08:27,439 --> 01:08:29,950 These are average wholesale prices 1300 01:08:29,950 --> 01:08:34,000 in New England for the last year. 1301 01:08:34,000 --> 01:08:37,200 The prices are hourly I think. 1302 01:08:37,200 --> 01:08:38,950 Maybe they've gone down to 15 minutes now. 1303 01:08:38,950 --> 01:08:40,450 But at least hourly. 1304 01:08:40,450 --> 01:08:44,870 They also are differentiated by region. 1305 01:08:44,870 --> 01:08:47,990 If there's a problem transmitting power from A to B, 1306 01:08:47,990 --> 01:08:50,870 the prices in A and B can differ. 1307 01:08:50,870 --> 01:08:53,990 If there is no problem, they differ trivially. 1308 01:08:53,990 --> 01:08:56,540 So again, this is the day ahead price, 1309 01:08:56,540 --> 01:08:58,069 and this is the real time price. 1310 01:09:01,399 --> 01:09:05,149 I don't know what happened last August, or late July, 1311 01:09:05,149 --> 01:09:07,580 whether that was a particularly hot day. 1312 01:09:07,580 --> 01:09:10,270 It was clearly anticipated. 1313 01:09:10,270 --> 01:09:15,620 You see the blue shot up as well as the green. 1314 01:09:15,620 --> 01:09:17,390 Sometimes the day ahead is too high. 1315 01:09:17,390 --> 01:09:19,670 Sometimes the day ahead is too low. 1316 01:09:19,670 --> 01:09:21,319 There is a day ahead market. 1317 01:09:21,319 --> 01:09:23,510 And then there is what actually has 1318 01:09:23,510 --> 01:09:25,620 to happen to follow the load. 1319 01:09:25,620 --> 01:09:31,370 So sometimes the day ahead market overestimates 1320 01:09:31,370 --> 01:09:32,899 demand and thus costs. 1321 01:09:32,899 --> 01:09:34,580 Sometimes it underestimates. 1322 01:09:34,580 --> 01:09:39,649 But those are daily prices. 1323 01:09:39,649 --> 01:09:45,710 I'll show you some hourly prices on Monday. 1324 01:09:45,710 --> 01:09:49,010 And here's what the US looks like. 1325 01:09:49,010 --> 01:09:50,930 No other country has a system that 1326 01:09:50,930 --> 01:09:55,390 is this fragmented and diverse, with the possible exception 1327 01:09:55,390 --> 01:09:57,790 of Japan depending on how you count fragmentation 1328 01:09:57,790 --> 01:10:00,940 and diversity, since half of Japan 1329 01:10:00,940 --> 01:10:03,220 runs on 50 cycles a second and half of Japan 1330 01:10:03,220 --> 01:10:05,630 runs on 60 cycles. 1331 01:10:05,630 --> 01:10:08,230 We at least beat that. 1332 01:10:08,230 --> 01:10:13,210 So about 2/3 are served by organized markets. 1333 01:10:13,210 --> 01:10:15,400 ISO is Independent System Operator, 1334 01:10:15,400 --> 01:10:18,400 RTO is Regional Transmission Operator. 1335 01:10:18,400 --> 01:10:21,200 Differences are immaterial. 1336 01:10:21,200 --> 01:10:23,020 We have a transmission system owned 1337 01:10:23,020 --> 01:10:27,700 by about 450 different entities, some federal, some local, 1338 01:10:27,700 --> 01:10:29,770 some state, some private. 1339 01:10:29,770 --> 01:10:35,660 About 2/3 of the system is owned by private firms. 1340 01:10:35,660 --> 01:10:40,880 We have on the order of 3,200 entities 1341 01:10:40,880 --> 01:10:48,020 selling electricity, 3,200 entities selling electricity. 1342 01:10:48,020 --> 01:10:50,090 Cooperatives aren't regulated by anybody. 1343 01:10:50,090 --> 01:10:53,360 Investor owned utilities, which are about 2/3 1344 01:10:53,360 --> 01:10:56,150 regulated by states and by feds. 1345 01:10:56,150 --> 01:10:57,890 The munis and the federal systems 1346 01:10:57,890 --> 01:11:00,530 are not regulated by anybody. 1347 01:11:00,530 --> 01:11:05,270 And that retail competitors at the bottom 1348 01:11:05,270 --> 01:11:08,585 is a development that was under way before California. 1349 01:11:08,585 --> 01:11:13,310 It has gotten stalled because of California. 1350 01:11:13,310 --> 01:11:18,530 But in Texas is where it's most prevalent. 1351 01:11:18,530 --> 01:11:22,100 You can buy electricity from any one 1352 01:11:22,100 --> 01:11:23,750 of a number of competing firms. 1353 01:11:23,750 --> 01:11:28,670 It will be delivered by the monopoly distribution company. 1354 01:11:28,670 --> 01:11:31,400 But you will pay for it to some other firm that's 1355 01:11:31,400 --> 01:11:34,610 responsible for making sure there's enough electricity 1356 01:11:34,610 --> 01:11:36,360 to serve its customers. 1357 01:11:36,360 --> 01:11:38,540 That's the model in Europe. 1358 01:11:38,540 --> 01:11:43,850 It exists in Massachusetts, but isn't very effective. 1359 01:11:43,850 --> 01:11:46,580 Just last week I got my first solicitation-- 1360 01:11:46,580 --> 01:11:48,320 this has been 10 years-- 1361 01:11:48,320 --> 01:11:50,030 to switch suppliers. 1362 01:11:50,030 --> 01:11:53,120 And because I believe in computation, I did. 1363 01:11:53,120 --> 01:11:54,950 So there's enough retail competition 1364 01:11:54,950 --> 01:11:57,820 that people who don't own wires-- 1365 01:11:57,820 --> 01:11:59,570 plus I thought I'd see what would happen-- 1366 01:11:59,570 --> 01:12:04,550 plus people who don't own wires sold 8% of the electricity 1367 01:12:04,550 --> 01:12:06,440 in the country. 1368 01:12:06,440 --> 01:12:08,930 I think these are 2010 numbers. 1369 01:12:08,930 --> 01:12:10,880 That's a big change. 1370 01:12:10,880 --> 01:12:12,560 That was 0. 1371 01:12:12,560 --> 01:12:16,850 The bigger change is on the generation side. 1372 01:12:16,850 --> 01:12:18,920 So you have government systems-- 1373 01:12:18,920 --> 01:12:22,100 and this is a big number, 16%. 1374 01:12:22,100 --> 01:12:25,610 Not all federal, some state, some municipal, 1375 01:12:25,610 --> 01:12:28,070 Los Angeles for instance, 16%. 1376 01:12:28,070 --> 01:12:30,080 Investor owned utilities with retail sales, 1377 01:12:30,080 --> 01:12:33,530 42%, independent producers, folks 1378 01:12:33,530 --> 01:12:37,040 who have entered the wholesale market who do not sell directly 1379 01:12:37,040 --> 01:12:40,700 to retail customers 42% of generation. 1380 01:12:40,700 --> 01:12:43,460 So we have moved a fairly long way 1381 01:12:43,460 --> 01:12:45,870 toward a market based system. 1382 01:12:45,870 --> 01:12:48,200 But we're not quite there.