Montana’s experiment with electricity restructuring didn’t deliver its promises of lower costs. NorthWestern Energy’s residential customers currently pay some of the highest electricity rates in the region. And prices are likely headed higher. This has important consequences for policymakers concerned about Montana’s poor and elderly citizens.

Is there a fix? A group called Montana Public Power (MPP) thinks so. They’ve convinced five cities -- Missoula, Great Falls, Helena, Butte, and Bozeman -- to invest $1 million ($200,000 per city) to explore the purchase of NorthWestern Energy. By creating a publicly owned, nonprofit utility, they promise to keep energy costs low and pass the savings on to consumers. Really?

MPP plans to purchase transmission, rather than generation capability. Thus, like NorthWestern, they’ll have to buy energy on the wholesale market. Even the most ardent supporters admit it’s not a sustainable business strategy to buy electricity and sell it at a loss. What’s going on?

Montana was one of the first states to undertake electricity restructuring. Throughout the 20th century, state-regulated monopolies served most U.S. electricity markets, for electric power was considered a natural monopoly. It would be wasteful if companies competed to wire homes and businesses, or build multiple long-distance transmission lines. Thus, power companies were given monopolies and then subjected to regulated rates.

The Montana Power Company (MPC) was typical. It was vertically integrated, owning its own generation, transmission, distribution, and metering services. In exchange for having its profits set by Montana’s public services commission, it was insulated from competitive pressures.

Electricity competition came into vogue and in 1997 the legislature passed SB 390, the Electric Utility Industry Restructuring and Consumer Choice Act. The rationale was straightforward. Competition between electricity suppliers would allow consumers to choose providers the same way they choose long-distance telephone carriers. Competition would lower prices and enhance efficiency and service, just as it had with airlines, railroads, and telecommunications.

The move had the support of the Racicot administration, MPC, and its large industrial customers, e.g., Smurfit-Stone Container and Montana Refining Company. These companies consume a lot of electricity. They believed they could get cheaper rates in an open market. (MPC’s rates were relatively high because ratepayers were stuck paying for poor investment decisions that built excess generation capacity in the 1970s and ’80s.)

And indeed in some places competition has worked. A recent report from the Public Utility Commission of Texas finds consumers are paying less for electricity than they would have if the market were highly regulated (Texas deregulated its electricity markets in 2002). For each of the past four years, the average price of the five lowest competitive prices in the Houston and Dallas markets was lower than the estimated regulated price there for each year.

Might this work for Montana? I’m not sure. If it is to, our policymakers need to understand a few things. First, electricity is unlike other commodities. It cannot be stored, has no ready substitutes, and requires perfect, instantaneous balance between supply and demand. Further, because it is an “essential” good, electricity demand is often unresponsive to short-run price increases.

Second, Montana’s population is small and dispersed, with no significant metropolitan concentrations of consumers. Why would our small market attract multiple suppliers?

And last, and perhaps most importantly, free markets are not a magic elixir of perfection. Institutions generate information and the incentives on which people act. When thinking about electricity deregulation it is critical that the institutions be arranged to assure individual and social welfare. For example, to make real competition work, the distribution lines must be open to competing suppliers (e.g., wind turbines). People who think in slogans (e.g., “Power to the People!”) rather than in causal relationships will miss this.

Paul Joskow, director of the MIT Center for Energy and Environmental Policy, is one of the nation’s leading energy experts. About electricity restructuring he wrote: “[It] is likely to involve both costs and benefits. If the restructuring is done right ... the benefits ... can significantly outweigh the costs. But the jury is still out on whether policymakers have the will to implement the necessary reforms effectively.”

Do we have reason to believe Montana’s policymakers have the patience and the expertise to design fair, open, and efficient electricity markets?