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Proponents of free markets for electricity assert that minor fixes to the California market and to FERC's proposed Standard Market Design would generate lower prices. We disagree. Designing a competitive market that remedies the problems seen in California and other restructured markets is difficult; emulating even good ISOs like PJM will not do the job. Each one of the problems can be overcome, but the costs of doing so might make full deregulation unattractive.

In the 1970s, the US electric utility industry was faced with rising costs and sluggish demand. Efforts at lowering costs and revitalising the industry through competition have largely been disappointing. Consumers have not seen prices fall, except where regulators have intervened. The merchant sector has suffered a financial crisis, hurting competition in both wholesale and retail markets. Advocates for deregulation assert that minor changes to market rules and regulations will yield the benefits promised. We argue that things are not so simple. Successful deregulation requires markets to be competitive and complete, neither of which is true in the US. Creating competitive markets is not impossible, but doing so imposes costs on the system which may outweigh the benefits of deregulation.

Restructuring efforts in the U.S. electric power sector have tried to encourage transmission investment by independent (non-utility) transmission companies, and have promoted various levels of market-based transmission investment. Underlying this shift to merchant transmission investment is an assumption that new transmission infrastructure can be classified as providing a congestion-relief benefit or a reliability benefit. In this paper, we demonstrate that this assumption is largely incorrect for meshed interconnections such as electric power networks. We focus on a particular network topology known as the Wheatstone network to show how congestion and reliability can represent tradeoffs. Lines that cause congestion may be justified on reliability grounds. We decompose the congestion and reliability effects of a given network alteration, and demonstrate their dependence through simulations on a 118bus test network. The true relationship between congestion and reliability depends critically on identifying the relevant range of demand for evaluating any network externalities.