The Transformation of American Energy Markets and the Problem of Market Power

IntroductionInstitutions shape markets,1 and that has certainly been true of energy markets. Throughout most of their history, American energy markets have been regulated using a combination of antitrust law and public utility law: the former has predominated in oil markets and the latter in markets for natural gas and electricity. Each of these approaches is aimed at preventing abuses of market power and other forms of unfair competition in energy markets. Antitrust regulation relies primarily on ex post enforcement to punish unfair competition after it occurs, hoping that punishment will deter future anticompetitive behavior; whereas traditional public utility regulation relies on ex ante regulation, controlling the terms and conditions of competition in natural gas and electricity markets from the outset.2 As energy markets have grown increasingly complex and competitive, these traditional approaches have been supplemented and pardy supplanted by a new approach-one that uses a model of regulation borrowed from securities law; that model is focused less on controlling market power and more on market manipulation based upon fraud and deceit.We argue that this new approach increases consumers' exposure to price risks associated with the exercise of market power. Part I of this Article recounts the development and evolution of the traditional energy regulatory regime during the twentieth century, examining the management of competition in oil markets using antitrust law separately from that of natural gas and electricity markets using public utility law.3 This Part concludes by documenting the rise of competition in late twentieth-century energy markets, owing to the declining influence of so-called "western oil majors" in oil markets and the regulatory restructuring of natural gas and electricity markets. Part II examines the implications of these changes that eventually led regulators to transplant the securities regulation model into energy markets in a series of legislative and regulatory developments over the last five years.4 We note here that increasingly competitive energy markets meant increased risk for energy' companies, which turned to energy derivatives5 as a way to hedge that risk. The last decade has seen increasingly active and robust markets for both the physical delivery of energy and energy derivatives. Regulators, cognizant of the possibility that sophisticated energy traders might be able to manipulate prices in these markets at consumers' expense, looked to securities regulation for ways to regulate that risk. Part III examines the limits of this securities regulation model in energy markets.6 We argue that, by focusing on fraud and deceit, the securities regulation model misses ways in which sellers of energy in physical markets can exercise market power at the expense of buyers, even in the absence of fraudulent or deceptive conduct. We argue further that regulators exacerbate this problem by employing some erroneous assumptions about the self-correcting nature of energy markets-assumptions that have led regulators to tolerate scarcity-induced high prices for extended periods of time, particularly in electricity markets. Finally, we offer some concluding thoughts and brief observations about the future trajectory of energy' regulation.7I. The Evolution of Regulation in American Energy MarketsFrom their beginnings, oil, gas, and electricity markets in the United States provoked public concern about the vulnerability of consumers to the machinations and manipulations of powerful producers, transporters, and sellers of energy. Commercial development of oil and natural gas8 arose in the mid and late nineteenth century.9 Both products almost immediately enjoyed wide use in heating, lighting, and industrial applications. The development of electricity as a commercial product lagged a few decades behind, but quickly penetrated the lighting, household appliance, and industrial applications markets in urban areas during the early decades of the twentieth century. …