Energy Policy 31 (2003) 1103–1115 Electricity market reform failures: UK, Norway, Alberta and California Chi-Keung Woo a,b, *, Debra Lloyd c , Asher Tishler d a Energy and Environmental Economics, Inc., Suite 1700, 353 Sacramento Street, San Francisco, CA 94111, USA b Hong Kong Energy Studies Center, Hong Kong Baptist University, Hong Kong c Energy and Environmental Economics, Inc., San Francisco, CA 94111, USA d Faculty of Management, Tel Aviv University, Israel Abstract An analysis of electricity market reforms already taken place in the UK, Norway, Alberta (Canada) and California (USA) leads to our overall conclusion that the introduction of a competitive generation market, of itself, has failed to deliver reliable service at low and stable prices.Themarketreformfailuresareattributedtomarketpowerabusebyfewdominantsellers(especiallyattimesof transmission congestion), poor market design that invites strategic bidding by suppliers, the lack of customer response to price spikes,capacityshortagecausedbydemandgrowthnotmatchedbynewcapacity,andthintradingofforwardandfuturescontracts thatarecriticalforpricediscoveryandriskmanagement.Thepaperthenexplainswhyanelectricitymarketreformcaneasilyfailto deliver the promised gains of better service at lower and more stable prices. The policy implication is that an electric market reform can be extremely risky, and may lead to a disastrous outcome. Thus, it is imprudent to implement such a reform in countries with limited sites for new generation and no indigenous fuels (e.g., Israel and Hong Kong). These countries should therefore consider introducing performance-based regulation that can immediately benefit electricity consumers in terms of lower prices, more stable prices, improved reliability, more choices, while encouraging the electric sector to pursue efficient operation and investment. r 2003 Elsevier Science Ltd. All rights reserved. Keywords: Electricity market reform; Reform failures; Performance-based-regulation 1. Introduction The perceived failure of traditional cost-of-service regulation (COSR) for the electricity industry is its lack of strong incentives for cost cutting and optimization of asset management (Biewald et al., 1997; Schmidt, 2000). This is because the regulated utility’s costs, subject to prudence review, are fully recovered from ratepayers (Liston, 1993). 1 Costly investments (e.g., nuclear plants) and expensive long-term contracts for fuel and power purchase contracts are often based on erroneous forecasts of electricity demand and fuel costs (Newbery, 1999). Whereas the failure of COSR has catalyzed the political push to introduce regulatory reform in the industry, technological advances in combined cycle gas turbines (CCGT) have made small-scale generation a cost-effective alternative, thereby making competitive generation markets feasible (Newbery, 1999; Joskow, 1997). These developments, among other factors, have been the driving force behind the efforts of many countries to examine the various alternatives for restructuring their electricity sectors. What has prompted the electricity market reforms that are taking place around the world? The story is similar in many countries and is succinctly captured in the White Paper from the Ontario Ministry of Energy Science and Technology (1997): Competition among suppliers will create the condi- tions for lower electricity prices, thereby supporting investment and job creation across the province. It will ensure that investments in electricity generation and transmission are made prudently and that assets are managed carefully and responsibly. It will mean more choices for customers and will lead to new *Corresponding author. Energy and Environmental Economics, Inc., Suite 1700 353 Sacramento Street, San Francisco, CA 94111, USA. Tel.: +1-415-391-5100; fax: +1-415-391-6500. E-mail address: ck@ethree.com (C.-K. Woo). 1 Laffont and Tirole (1993, pp. 18–19), however, note that COSR canhaveincentivesforcostcuttingbecausearegulatedutilitytypically retains its cost savings between rate cases. 0301-4215/03/$-see front matter r 2003 Elsevier Science Ltd. All rights reserved. PII:S0301-4215(02)00211-2