Introduction to the Energy Industry

• Pages: 1-16

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CHAPTER I

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 t erms 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 literally 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 that serve this load must instantaneously produce more

electricity to drive the compressor machinery. However, in all

probability 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, the Antitrust Division of the U.S. Department of

Justice (DOJ) has observed to the Federal Energy Regulatory

Commission (FERC) that, in 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

generators that are in operation and the capacity available in the

1. See Comments of U.S. Dep’t of Justice, Inquir y Concerning the

Commission’s Policy on the Use of Competitive Models in Merger

Analysis, FERC Dkt. No. 98-6-000, at 2 (June 15 , 1998).

2 Energy Antitrust Handbook

transmission network to deliver electricity to customer destinations. This

capacity, however, can vary from hour to hour. In peak-load hours,

when demand is high, the transmission capacity into an area can be

“constrained”—that is, capacity is mostly or fully utilized. On the other

hand, when demand is low, particularly in off-peak seasons, certain

generators can be taken off line.

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

a network that is greatly affected by the actions of the various generators

connected to it has influenced both the historical development of the

industry and the evolution of competitive power markets.

2. Traditional Industry Structure

As the United States industrialized, metropolitan areas recognized

that they needed to ensure reliable supplies of electric power. Investor-

and municipality-owned utilities were created to fulfill this role. The

formation of rural electric cooperatives followed as the use of electricity

spread to rural areas.

Because electricity must be produced and delivered simultaneously,

most utilities were organized as vertically integrated firms. In other

words, they constructed and operated their own power plants, built high-

voltage transmission systems

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to transmit power from those plants to

their service areas, and distributed the output of their plants to their

customers through local distribution systems. However, some utilities

met their obligations by buying their 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. Thus, three large transmission

grids emerged in the United States: the eastern grid, the Electric

Reliability Council of Texas (ERCOT), which includes most of Texas

except for areas in its easternmost and westernmost parts, and the

western grid. Transfers between ERCOT and these other areas are

limited. Within the eastern and western grids, there are a number of

smaller regional organizations. These include several power pools

through which utilities share reserves and engage in short-term trading of

2. Transmission generall y refers to the system of higher voltage wires,

transformer substations, and computer control centers necessar y to

transport and deliver power at voltage levels created by generating plants

to distribution systems at substantially lower voltage for ultimate

distribution to the consumer at even lower voltage.