Restructuring or Deregulation?

 

Restructuring is not Synonymous with Deregulation

The almost-century old structure of the American electric utility industry is in flux. Almost all interested parties accept the fact that technological change and altered views of the nature of government intervention have made the idea of increased competition attractive. But just how should the competitive market be structured? Some participants want complete deregulation so they can derive the fullest benefits of competition quickly. Others argue that the unfettered free market, however, will cause hardship and inequities.

In California and elsewhere, lawmakers realized that new institutions--overseen by government--had to be created to ensure fair play by all parties. Moreover, regulation needs to remain in place to safeguard the environment and to maintain programs (such as low-income programs, energy-efficiency initiatives, and R&D on alternative technologies) formerly run by regulated utility companies. These programs are clearly desired by the public, but they might hold little interest among competitive companies that seek to minimize costs.

On one hand, restructuring of the electric utility industry in the coming years means that deregulation may occur in terms of prices and entry of competitors into the market. On the other hand, government intervention of some areas of the business are likely to continue to ensure maintenance of socially desirable functions. Restructuring, therefore, is not synonymous with complete deregulation.

 

Problems with Traditional Regulation

As much as some utility executives may protest deregulation of prices, many parties agree that traditional regulation appears flawed. In the golden years, when new construction of power plants reduced the average cost of electricity, regulation that set rates based on the value of the new equipment worked fine, since rates generally decreased. But in the 1970s and later, utility construction became increasingly costly, and rates reflected those higher costs. Moreover, regulatory rules encouraged utilities to complete long-delayed power plants even if the demand for power was not likely to warrant such a big plants or because poor management caused costs to escalate.

 

Management of Electric Utility Companies

During the Golden Years

During the years after World War II and until the 1970s, utility management focused on the major chore of building enough power plants and improving the transmission and distribution grid. Not surprisingly, most managers rose through utility ranks after getting college degrees in engineering. Mechanical and electrical engineers in particular, they knew how to solve problems relating to the installation, coordination, and operation of huge generation units within an increasingly complex grid of power plants and transmission lines. As nuclear power appeared in the 1960s to be the technology of the future, more engineers trained in the esoteric and challenging field also entered utility management.

 

Good Natured Competition

Competition between utility companies could not exist on the retail level, since regulation parceled out monopoly franchises to each firm. But a form of competition existed nevertheless, and it tells much about the pride and spirit of utility managers. Reflecting their engineering backgrounds, many executives competed against others by trying to install the largest power unit of the day (with the company president's name adorning it), or the most thermally efficient one. Beyond this type of competition, however, utility executives remained cooperative with their colleagues in other firms, feeling that they belonged to a fraternity made up of like-minded managers.

On most political and regulatory issues dealing with electric power, they held common views, which were often expressed by their trade association, the Edison Electric Institute. And in 1972, they created an industry-wide R&D organization, the Electric Power Research Institute which shared its fruits with all members. Few secrets existed among utility executives. They employed similar business and technological strategies, and they enjoyed seeing their work yield social and economic benefits.

 

Troubled Times and Competition

The 1970s signaled the beginning of the end of the clubby attitude of managers as they tried to cope with myriad challenges. As engineers, they frequently sought answers to problems by suggesting the introduction of new or more technology. Hence, the solution to the energy crisis would be to build more nuclear power plants, despite the fact that vocal opponents and the public increasingly disapproved of them.

As rate increases became commonplace, customers became more active and complained to regulators, who hampered managers' ability to do whatever they wanted. Moreover, executives generally opposed the spread of facilities qualified under the Public Utilities Regulatory Policy Act--unregulated generators who quickly entered the business in the early 1980s--because they could not be controlled by utility companies. All in all, power company officials lamented the erosion of their authority over an industry that once brought near-universal benefits.

 

New Leadership

To deal better with the problems and challenges of the time, several utility companies placed people with different backgrounds into leadership positions. Instead of only engineers, more utility decision-makers had training in law, accounting, public relations, and even environmental advocacy. Some new managerial recruits deliberately had little utility experience, coming instead from competitive industries. Holding different perspectives on the business, they helped utility companies better address regulatory issues and work more effectively with increasingly powerful opponents of traditional utilities. They also looked forward to the potential of more competition.

 

An End to Business As Usual

Splits in the Ranks

By 1990, that potential for a less-regulated market in electricity appeared ever more ominous. In fact, some managers believed that their firms would soon be rivals with other power companies. As a result, industry meetings lost much of their fraternal fellowship. Utility executives wistfully noted that with competition on the horizon, the industry had become less friendly, with managers refraining from talking and socializing with each other as in earlier days.

While most executives did not look forward to an end to some regulation, others welcomed it, thinking that their companies (often low-cost companies) would thrive in the competitive environment. Additionally, the increasingly divided industry lost its ability to speak with one voice, even through the Edison Electric Institute, thus weakening its political clout on issues such as how to reduce acid rain.

 

New Strategies for Competition

The managers had reason to fear open dialog as companies in the mid-1990s tried to buttress themselves for a new era. In one approach to make themselves more competitive, many utilities slashed payrolls and cut costly "social" programs, such as energy efficiency, that may have been popular. Additionally, many utilities began merging with others in attempts to reduce administrative costs and create synergies that would help them deal with new rivals. Mergers increased from one in 1994, to 30 in 1996.

At the same time, gas companies and electric companies started forming new relationships. Even more unusual, some energy firms foresee offering electric, gas, water, and telecommunications services to customers, who would then need to make only one phone call to obtain all their utility needs. In such an environment, it is no wonder managers didn't talk to each other as openly as in the 1960s!

 

New Technologies Can Change Everything

Even as states and the federal government debate bills for restructuring the utility industry, technological innovation could change the entire nature of the electric supply business. For nearly a century, the accepted structure of the regulated industry has included large, central power-plants that generated electricity for distribution to homes and businesses, with customers linked to utility companies through a network of wires. That structure may soon change as new technologies allow decentralized and disconnected users.

Fuel cells making electricity and water, micro-turbines using natural gas, photovoltaic cells and energy storage systems which allow people to obtain electricity from the sun. These new technologies may allow homes and businesses to remove themselves from the electric power grid or connect with neighbors and other businesses to create similar synergies that utilities obtained by interconnecting their transmission systems. With the flourishing of smart electronic technologies used for communications, monitoring, and energy efficiency, this scenario becomes more feasible.

 

Coming Full Circle?

Actually, the new scenario is a throwback to the 1880s, when Edison sold small direct-current generating systems to hotels, industrial companies, and other isolated businesses. But with the growth of alternating current, which allowed long-distance transmission of power, and growing economies of scale in central generation power plants, isolated generation diminished. Today, traditional economies of scale no longer exist, though economies of small scale seem to be thriving. In a very real sense, the enterprise of electricity supply could be returning to its roots of more than 100 years ago.

 

The Public Utilities Regulatory Policy Act of 1978
(Public Law 95-617)

PURPA's Impact

The enactment of PURPA started the industry on the road to restructuring, by ending promotional rate structures, establishing unconventional "Qualifying Facilities" (or QFs), and encouraging conservation. While hoping for non-conventional sources of power to come on line as a result of PURPA, no one anticipated the changes that the law would have on the regulation of electric power and the overall structure of the electric utility system.

Unintentionally, PURPA started the questioning process because it enabled non-utility generators to produce power for use by customers attached to a utility's grid. In other words, the law broke the stranglehold on power companies' previous monopoly in the generation function. Now, any unregulated cogenerator or renewable energy producer could sell electricity into the power grid, with regulated utilities helpless to dictate terms.

 

PURPA's Limits

In a sense, however, PURPA did not create a competitive market for power yet. After all, the PURPA QFs did not literally compete with regulated utilities since those companies were required by law to purchase whatever power came their way from the cogenerators and alternative power generators. Still, the PURPA producers caused real grief to many utility managers, since the new players represented a source of power they could not control. The QFs sold power into the grid whenever they wanted, or whenever they had excess power remaining in a cogeneration plant, and utility managers had to find ways to limit their own production, or boost it, to ensure that customers obtained the power they needed without interruption.

 

Questioning the Rationale of Natural Monopoly for Regulation

These realities of electricity production made many people within and outside the industry question one of the rationales for acceptance of utilities at natural monopolies and, consequently, the justification for regulation. In the theory accepted early in the 20th century, electric power production and distribution constituted a natural monopoly because, by dint of huge capital investment in expensive generating equipment and associated facilities, one company could produce power more economically than could competitive firms. Many companies in the same market would not enjoy the large market of diverse customers, and they would be limited to using smaller and less-efficient equipment. All customers, therefore, would be deprived of the benefits that could be accrued if only one company produced power for an entire market.

But the end of technological progress combined with the economic woes of the 1970s and 1980s turned this argument upside down. It now appeared, thanks to incentives provided by PURPA and innovation in small-scale technologies, such as gas turbines, that non-utility companies could produce power as cheaply or more so than could regulated firms. In short, the existence and success of PURPA QFs appeared to destroy one important justification for regulation of utilities.

 

The Energy Policy Act of 1992

Exempt Wholesale Generators

Containing measures that would help spur production of domestic energy resources, such as a credit for electricity generated from renewable resources, EPAct also contained measures for creating greater numbers of producers of power along more conventional means. For example, it created a new class of producers called Exempt Wholesale Generators, which could generate power any way they saw fit and without regard to energy efficiency concerns (as was the case for PURPA QFs). The measure increased competitive pressure on existing generating companies and utilities in the same way as a new supermarket in town would force others to become more efficient and cost-conscious.

 

Utilities Could Expand Outside their Franchise Areas

Utility companies won some new rights under the Energy Policy Act as well. The law allowed utilities to own some EWG facilities, even outside their franchise area. Conceivably, then, a utility on the west coast could own generating facilities on the east coast if it believed the practice made good financial sense. Moreover, utilities did not even have to keep all their business in the United States. If they saw profit opportunities abroad, they could purchase companies there, so long as customers of domestic operations were not disadvantaged.

 

Wholesale Competition Only

On another front, utilities also won a major concession. While the law required utilities to open their transmission systems to other companies that sought to wheel power over them, only wholesale transactions were permitted. While some lobbyists for large industrial electricity users sought to permit sales to retail customers, so they could take advantage of cheap power wherever it came from, the law limited sales to wholesale customers. These included other utility companies, municipal power systems, and rural electrification networks, which would then resell the electricity to ultimate customers.

In accordance with EPAct requirements, the FERC issued Orders 888 and 889 in 1996. The Orders outlined the process of "open access" to transmission facilities, and specified the use of "Open-Access Same-Time Information Systems" (or OASIS) to prevent discriminatory practices. One impact of modern computer technology on the industry has been to make possible the control systems needed to oversee transmission reliability in this open environment. Another has been to permit OASIS to function as intended, as the system is designed to function via the Internet.

 

Door Left Open for Retail Competition in States

Though the federal law limited sales to wholesale customers, it left the door open for competition on the retail level. It did so by allowing state legislatures and regulatory commissions to take the final step by allowing suppliers to sell electricity all customers--whether they be big factories or small residential households. Within a few years, several states began plans to pass through that open door.