deregulated, but retail prices were regulated for the incumbents as part of a deal with the regulator, allowing the incumbent utilities to recover the cost of assets that would be stranded as a result of greater competition, based on the expectation that “frozen” rates would remain higher than wholesale prices. This assumption remained true from April 1998 through May 2000.
Energy deregulation put the three companies that distribute electricity into a tough situation. Energy deregulation policy froze or capped the existing price of energy that the three energy distributors could charge. Deregulating the producers of energy did not lower the cost of energy. Deregulation did not encourage new producers to create more power and drive down prices. Instead, with increasing demand for electricity, the producers of energy charged more for electricity. The producers used moments of spike energy production to inflate the price of energy. In January 2001, energy producers began shutting down plants to increase prices.
When electricity wholesale prices exceeded retail prices, end user demand was unaffected, but the incumbent utility companies still had to purchase power, albeit at a loss. This allowed independent producers to manipulate prices in the electricity market by withholding electricity generation, arbitraging the price between internal generation and imported (interstate) power, and causing artificial transmission constraints. This was a procedure referred to as “gaming the market.” In economic terms, the incumbents who were still subject to retail price caps were faced with inelastic demand (see also: Demand response). They were unable to pass the higher prices on to consumers without approval
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