Introduction to the Energy Industry

• Pages: 1-25

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CHAPTER 1

INTRODUCTION TO THE ENERGY INDUSTRY

The characteristics of an industry often play a significant role in

antitrust cases, and this is particularly true in the energy industry. This

chapter provides a brief, nontechnical introduction to the energy

industry. It also defines some of the basic terms used in the chapters that

follow.

A. The Electric Power Industry

1.

Unique Features of Electricity

Electricity is an unusual product. It cannot be efficiently stored or

inventoried. It must be produced by electric generators and

instantaneously delivered over transmission and distribution wires in

response to customer demand. Nor can the flow of electricity be readily

channeled. Once produced by a generator, electricity does not flow

directly from seller to buyer. Rather, it flows over the path of least

resistance (least impedance) according to the laws of physics.

For example, when an air conditioning compressor in a downtown

office building starts up on a hot August afternoon, electric power

generators t hat serve this load must instantaneously produce more

electricity to drive the compressor machinery. In all probability,

however, this electricity will not flow directly from the generator to the

city. Instead, it will flow along several different paths depending on the

configuration of the transmission network.

For these reasons, when analyzing competitive electricity markets it

can be difficult to determine whether a generator located at one point can

serve customer load located elsewhere.

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The amount of competitively

priced electricity that can reach buyers in a particular area depends on the

customers’ demands, the generators that are in operation, and the

capacity available in the transmission network to deliver electricity to

customer destinations. This capacity, however, can vary from hour to

hour. In particular, “constraints” can arise on the transmission network,

which can affect the choice and output of generation units selected to run

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. See, e.g., Comments of DOJ, Inquiry Concerning the Commission’s

Policy on the Use of Competitive Models in Merger Analysis, FERC Dkt.

No. PL98-6-000, at 2 (June 15, 1998).

2 Energy Antitrust Handbook

to serve load. Constraints do not necessarily correlate to peak-load hours.

Sometimes the transmission constraints arise during off-peak hours.

The fact that electricity cannot be stored and must be delivered over

a network that is greatly affected by customer demands and t he

generators available to respond to them has influenced both the historical

development of the industry and the evolution of competitive power

markets. Variable output associated with increasing amounts of

generation powered by intermittent wind and solar energy is another

factor affecting these markets.

2.

Traditional Industry Structure

The growing industrialization of the United States at the end of the

19th and beginning of the 20th Centuries gave rise to a recognition of the

need to ensure reliable supplies of electric power. Private investors and

municipalities formed investor- and municipally owned utilities to fulfill

this role. Later, with encouragement from the federal government, rural

electric cooperatives formed as the use of electricity spread to rural areas.

Because electricity must be produced and delivered simultaneously,

most utilities took the form of vertically integrated f irms. In other words,

the utilities constructed and operated t heir own power plants, built high-

voltage transmission systems to transmit power from those plants to their

service areas,

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and distributed the output of their plants to their customers

through local distribution systems. Some utilities, however, did not

vertically integrate and instead bought their electricity requirements from

other utilities.

Over time, it became clear that to bolster reliability individual

utilities needed to interconnect their transmission systems with the

systems of adjacent and nearby utilities. Eventually, t hree large

transmission areas, commonly referred to as “interconnections,” emerged

in the United States to facilitate the provision of reliable electricity

supplies: the Eastern Interconnection, generally covering areas east of the

Rocky Mountains, the Western Interconnection, generally covering areas

west of the Rockies, and the Electric Reliability Council of Texas

(ERCOT), which includes most of Texas except for areas in its

easternmost and westernmost parts. Historically, utilities within an

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. Transmission generally refers to the system of higher voltage wires,

transformer substations, and computer co ntrol centers necessary to

transport and deliver power efficiently from plants generating electricity

to distribution systems, which o perate at lower voltages for ultimate

distribution to the consumer.