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April 7, 1978 Power to the North west Winter rains in the Pacific Northwest have brought an end to that region's serious drought-related shortage of hydroelectric power. None too soon, either, because the shortage had forced Bonneville Power Administration - the wholesale marketing agency for power generated from Federal dams along the Columbia River - to curtail power supplies to aluminum companies and other industrial users throughout the past year. (Interruptible supplies are those which, under contract, can be discontinued in the event of a deficiency.) But despite this short-term improvement, the Pacific Northwest may yet be faced with a chronic long-term shortage of electricity unless actions are taken both to slow the growth of consumption and to encourage the development of new thermal-generating capacity. Under this so-called Hydro-Thermal Program, the Federal government agreed to develop the remaining hydroelectric power pote'ntial of the Columbia River System and to construct the necessary high-voltage transmission lines to accommodate the growth in regional power deliveries. The utilities agreed to build and operate the required new coal and nuclear generating plants. Bonneville was to acquire some of this thermal power to add to the supplies available from its existing and planned hydro capacity. The idea was that Bonneville would then have enough energy to supply both its statutory preference customers - the publicly-owned power agencies- and other customers such as the privatelyowned utilities and the several dozen manufacturing firms that had originally come to the Northwest in pursuit of low-cost hydro power. SUll'plil.ll§ shortage to Until a few years ago, the Pacific Northwest was blessed with a surplus of low-cost hydroelectric energy from dams in the Columbia River Basin. But most of the available dam sites were developed by the late 1960's, and it then became evident that higher-cost thermal capacity would have to be added to meet the region's future needs. As a result, Bonneville Power Administration and over one hundred public and privately-owned utilities agreed to develop the new generating and transmission facilities deemed necessary to meet the growth of demand over the 1970-90 period. But in the early 1970's, as rising costs and environmental restrictions led to delays in thermal-plant construction, Bonneville began to cut back on its private customers in order to meet the future load growth of its preference customers. Denied new contracts for power - assured contract supplies - the private utilities were required to meet nearly all of their own new power requirements, generally from more expensive thermal sources. This situation in turn led to a wide disparity in retail rates to ultimate consumers. Rates are now more than twice as high in the state of Oregon, where private utilities account for (continued on page 2) ---. _---_. ___----, . --- about 80 percent of all retail requirements, than in the state of Washington, where the private-public mix is closer to fifty-fifty. The situation worsened in the mid 1970's, and in June 1976 Bonneville notified its preference customersthe - that it would be unable to supply their requirements for additional power after July 1, 1983. And since public utilities would have first call on the limited energy available, Bonneville might not be able to renew the expiring contracts of its industrial customers - forcing those customers to turn to the privately-owned utilities, which will have troubles of their own developing new generating capacity. Reduced power supplies for these major industrial users could have serious regional and national consequences. The industries involved employ about 15,000 persons with an annual payroll of about $200 million, and supply 30 percent of the nation's primary aluminum, 100 percent of its ferronickel, and substantial quantities of other key materials. Allocation plans Most proposed solutions to the problem have focused on the use of ne\A/ institutional arrangements, rather than on the use of the pricing mechanism to balance supply and demand. The most notable example is the plan proposed by the Pacific Northwest Utilities Conference Committee, an organization composed of Bonneville's utility and industrial customers. That plan, as embodied in legislation submitted to Congress last fall, would establish a new planning organization to coordinate the development of the region's 2 thermal-power resources and to plan procedures for Bonneville purchases of power needs. It would also give Bonneville expanded authority to purchase power from plants outside the Federal system - thereby providing for power pooling through the Bonneville transmission network. Also, it would establish a region-wide energy conservation program, as well as a formal allocation and pricing scheme for distributing available power at various rates to Bonneville's utility and industrial customers. The problem with this and similar plans is that they would perpetuate Bonneville's current practice of average-cost pricing for determining power rates. Indeed, they ignore the traditional economist view that marginal-cost pricing is required for the efficient allocation of resources. In other words, they ignore the use of proper price signalsas a rationing device for allocating ayailable power supplies. Role of price There can be little doubt that low Federal power rates helped contribute to the present situation. Bonneville power rates remained virtually unchanged through the first three decades of the agency's history, thereby encouraging a 7 1 -percent annual rate of increase /2 in the Pacific Northwest's electrical consumption over the 1950-70 period. But consumption growth then slowed to a 3 V2 -percent rate between 1970 and 1975, as a result of the recession and supply shortages - as well as Bonneville price increases, from 2.40 to 3.27 mills per kilowatt hour between 1973 and 1976. Nonetheless, the region's per capita electrical energy consumption continues to be almost Billions 120 Cents/KWH KWH Pacific Northwest 0.5 100 80 60 0.4 Electric power consumption "" / / - -. 40 - --. --- --, . ( ----- Average Federal power rate / 0.3 / 0.2 0.1 20 1950 1960 double the national average, because of Bonneville's policy of "'encouraging the widest possible diversified use of energy* through low-cost Federal power. In setting wholesale power rates, Bonneville is required by law to produce sufficient revenues to recover the government's costs of producing, purchasing, and transmitting electricity. Bonneville has consistently interpreted this budgetary requirement to mean that rates should be determined on the basis of average cost - that is, by dividing total cost by the number of units sold in a given period to obtain the unit cost and therefore the average price of electricity. But critics question whether Bonneville has actually recovered its average costs, because its average power rates remained stable during the 1960's when less advantageous - and therefore more costly - hydro sites were being developed. More importantly, economists generally contend. that Bonneville should have based its power rates, not on average costs, but rather on marginal costs - that is, the cost of providing for the last increment of supply. They argue that when new blocks of capacity are required to meet demand, electricity rates should be set on the basis of long-run incremental cost pricing. (Long-run incremental cost is defined as the cost of producing additional electricity, taking into account that additional fixed factors, i.e., plants, must be added.) In essence, it approximates the cost of electricity produced from a new plant. This approach thus should result in the most efficient allocation of resources, because rates would re3 1970 flect the true cost of the resources expended to provide consumers with each additional block of power. However, long-run incremental cost pricing could conflict with Bonneville's statutory budgetary requirement of covering costs. When incremental costs are below average costs - when economies of scale or superior technology make new blocks of power less costly to develop than previous blocks of power - incremental-cost pricing would create losses and therefore would require subsidies to cover the agency's costs. On the other hand, when long-run incremental costs are clearly above average costs - the current situation, as the Pacific Northwest moves from a nearly pure hydro to a mixed hydro-thermal power baseincremental cost pricing would result in a surplus of revenue over costs. Most economists would argue' that· power pooled through the Bonneville system should be priced to reflect the cost of adding this more expensive thermal generating capacity, so that Bonneville's wholesale customers could make the choices that would help lead to an optimal allocation of resources. This shift would encourage Bonneville's utility customers to make a similar switchover to iricrementalcost pricing, thereby providing ultimate electricity customers with the price signals required to allocate available supplies more efficiently. Otherwise, unless the price system is utilized to restrain consumption and to finance necessary additions to capacity, the supply-demand situation for Northwest electric power is likely to become increasingly unbalanced. Yvonne levy uOl8u!4SEM • 4Eln • uo8aJO G EpEAaN • o4EPI !!EMEH E! U J0:l!I E). EUOZPV. E)ISEIV Jr 'J!lU!:)'OJSPUl?J:I Ul?S (;SL'ON lUWlBd OI Vd : J9¥lS Od 's'n llVW SS",:) lS}l1::B JJ, BANKING TA- TWElfTH fEDERAL DA RESERVE DISTRICT (Dollaramountsin millions) Selected Assets and liabilities large Commercial Banks Amount Outstanding 3122/78 Change from 3/15/78 - Loans (gross,adjusted)and investments* Loans (gross,adjusted) total Securityloans Commercial and industrial Realestate Consumer instalment US. Treasury securities Other securities Deposits(lesscashitems) total* Demanddeposits(adjusted) US. Governmentdeposits Time deposits total* States and politicalsubdivisions Savings deposits Other time depositst Largenegotiable. CD's 107,938 84,772 1,831 26,139 28,720 15,081 8,718 14,448 105,423 28,529 375 74,869 6,444 31,735 33,892 15,657 Weekly Averages of Daily Figures Week ended 3122/78 - + + + - - + + + + + 421 92 306 65 132 48 69 260 750 497 486 516 49 125 353 310 Changefrom year ago Dollar Percent + 13,845 + 12,965 + 403 + 2,588 + 6,473 + 2,656 - 653 + 1,533 + 12,110 + 2,332 + 151 + 9,668 + 1,093 42 + + 7,835 + 6,204 Week ended 3/15178 + + + + + + - + + + + + + + + + 14.71 18.06 28.22 10.99 29.10 21.38 6.97 11.87 12.98 8.90 67.41 14.83 20.43 0.13 30.07 65.63 Comparable year-agoperiod Member Bank Reserve Position Excess Reserves(+)/Deficiency (-) Borrowings Net free(+)/Net borrowed (-) Federal Funds-Seven large Banks InterbankFederalfund transactions Net purchases )/Net sales( (+ -) Transactions with US. securitydealers Net loans(+)/Net borrowings(-) + + 432 42 16 58 72 13 59 + + 1,059 110 + + 529 *Includesitems not shownseparately. tlndividuals,partnerships and corporations. 3 50 53 + 117 + 147 Editorial comments may be addressed to the editor (William Burke) or to the author ... . Information on this and other publications can be obtained by calling or writing the Public Information Section, Federal ReserveBank of SanFrancisco,P.O. Box 7702,San Phone (415) 544-2184.
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