Chapter 1 - Reevaluation of Vertical Integration and Unbundling in Restructured Electricity Markets

Abstract

This chapter critically reviews the argument for vertical integration in the electricity industry. It also reviews the argument for restructuring based on unbundling of its products and organizations in favor of market mechanisms. It concludes that both arguments are deficient and that a balanced mixture of vertical integration and liberalized markets is superior to the extremes. Their central conclusion is that efficient management of the risks inherent in the electricity industry requires that restructuring retain universal service for the core of non-industrial customers who rely on regulated rates smoothed over time to recover the costs of service. It addresses basic economic issues posed by restructuring. The central issue is whether the overall technology of the industry— wholesale generation, transmission, and retail service—necessarily implies more or less vertical integration. It was long thought and is still being argued by many that vertical integration of retail utilities was essential for efficient investments and operations. On the other hand, restructuring has often been motivated by the view that the purported advantages of vertical integration are obsolete, that liberalized markets can work well, and that they bring stronger incentives that are likely to result in more efficient investments and operations. The argument presented in this chapter is that neither view is conclusive that pros and cons can be mustered on either side without any clear indication that one or the other extreme is better.