A New Era for Electricity

Energy Policy Act of 1992

Exempt Wholesale Generators

Though failing to pass Congress in 1991, President Bush's Energy Policy Act passed the following year. Containing measures that would help spur production of domestic energy resources, such as a credit for electricity generated from renewable resources, the law 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.

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.

Supporters and Detractors of Competition in the Utility Business

The academic economists and ideologues who liked the idea of increased competition in the utility business were not alone. Real, practical business people felt that the introduction of market principles could benefit customers and lead to introduction of new services and better prices than could the existing system. So did other interested parties.

Disparity of Prices

The promise of competition stemmed in part from the greatly disparate prices paid by customers across the nation. Under traditional regulatory practice, every state commission helped determine rates paid by customers for each utility in the state. The rates were based on the value of the equipment used to generate, transmit, and distribute electricity, plus the actual cost of variable expenses such as fuel, within the state. In some parts of the country, such as California and several New England states, rates were high, partly because of the high cost of construction and fuel in general but also because of utilities' building of nuclear plants whose costs escalated due to delays and construction headaches. In other parts of the country, however, utilities employed relative cheap fuel that powered older and largely depreciated power plants.

Big Industrial Customers wanted Lower-cost Power

Industrial customers typically used large amounts of power, and their rates usually were lower than for residential customers. Nevertheless, in California and New England, big industrial users paid more than 7 cents per kWh in 1995 on average. In Nevada, however, rates averaged between 5 and 7 cents per kWh. Meanwhile, some low cost states, such as those in the Pacific Northwest, which drew much power from flowing water rather than fossil fuel, and in states that had ready access to cheap coal, rates dropped to between 2.8 and 5 cents per kWh. Imagine how a California industrial customer, paying more than 7 cents per kWh would have liked to obtain power from a company just across the border in Oregon, where rates were half that rate! Yet, under regulation, California customers could not directly buy the Oregon power. No wonder large industrial users were among the most eager to see regulatory restraints lifted so they could have access to cheaper electricity around the country.

Natural Gas Prices Decline

Additionally, independent generators (PURPA QFs and EWGs) that used natural gas-burning turbine-generators found they could easily underprice existing utilities. With the generating equipment becoming cheaper, due to mass production techniques, and with natural gas prices dropping since being deregulated in the mid-1980s, the independents could offer electricity to large customers at about 3 cents per kWh, well below the rate most utilities could offer. Who wanted to pay 7 cents or more per kWh to a regulated utility when independents could exploit new technology and low fuel prices to produce power at such a cheap rate?

Other Parties Sought Competition Too

Other parties also saw advantages in allowing competition between suppliers and between utilities and generators in various states. One such group included the independent power producers, those generators empowered by PURPA or by the Energy Policy Act who set up business outside the traditional utility system. They felt they could get better prices for their electricity if they had the opportunity to sell to a larger number of customers, both near them and far away.

And under the right conditions, environmental and consumer groups also looked forward to competition. Generators that used renewable resources or those the used natural gas--a fuel that burned more cleanly than coal or oil--would also have a larger potential market if traditional rate regulation were relaxed. Even residential customers could look forward to lower rates if they could attract low-cost providers to sell power to their service areas.

Opponents of Competition

High-cost utility companies

Of course, not everyone liked the prospects of increased competition. A large number of regulated utilities, especially those in high-cost states, for example, feared the prospect of competition, largely because they still owned expensive assets that would not allow them to sell electricity as cheaply as new entrants into the business. For example, a company that operated an expensive nuclear power plant would need to charge higher rates--to recover the costs--than would an exempt wholesale generator that bought an inexpensive gas turbine-generator and used cheap natural gas. According to these opponents of competition, regulated utilities would be holding "stranded costs" due to their purchase of assets (such as power plants and long-term contracts with independents) made in a formerly regulated environment, when they had an obligation to serve all customers. In a competitive business, that obligation would be waived, but the companies would be responsible for paying off expensive power plants acquired earlier. If no compensation were made for these stranded costs, they argued, there could be no "level playing field" upon which all parties competed fairly.

Residential Consumers

At the same time, some consumer groups feared that competition would short-change the small residential customer. On one hand, the promise of competitors knocking on the doors (or calling on the phone at dinner time) and offering new rates had appeal. After all, a similar situation occurred when telecommunications services underwent deregulation, leading to generally lower long-distance telephone rates. But in the electricity business, would there be enough electrons to go around to all users? Since there were just so many generating plants in the country, maybe the low-cost providers would compete primarily to obtain contracts with the largest and easiest-to-serve industrial customers. Individual residential customers use much less power than industrials, and they would have to be contacted individually, thus raising the cost of doing business with them. As a result, competition also raised the specter of residential rates increasing because all the cheap producers would sell their power to large users. Only the high-cost producers would remain to serve residential customers.

California takes a big step

Overseeing utilities that sold power at nearly the highest rates in the Union, California regulators since the 1980s had investigated various methods to introduce competitive principles into the electricity supply business. But the Energy Policy Act of 1992 gave regulators the chance to pursue comprehensive restructuring of the utility business. It took advantage of the opportunity in 1992, by beginning a study of regulation's history and prospects for change.

Following publication of the commission staff's report in 1993, numerous hearings, further proposals, and still more public hearings, the California legislature took control of the restructuring process in 1996. By August 1996, legislators had bargained with numerous interest groups and passed unanimously a bill, signed by the governor in September, that would allow retail customers to choose their suppliers of electricity by January 1, 1998. (At first, only large customers were allowed to shop for power by 1998; later modifications opened the competitive market to all customers by New Year's Day, 1998.)

The California law should not necessarily be viewed as a model upon which other laws will be passed. Rather, it is described in some detail because it deals comprehensively with several of the major issues being debated around the country. Laws in other states can deal with the same issues in different ways.

Features of California's Restructuring Law

New Infrastructural Institutions

Due to the need to ensure a level playing field, the law created a new infrastructure for transmitting and selling electric power so that no one company would have excessive "market power"--the power to inhibit transactions and make competition among other companies difficult. Conceivably, a formerly regulated utility company could charge high rates to other firms for transmitting power over its transmission lines, thus giving itself a major advantage. The California law remedied this potential problem by establishing an "Independent System Operator," which would control utilities' transmission networks (without actually owning them), coordinate scheduling of power supplies, and ensure open access of the lines to all power providers. Simultaneously, the state created a "Power Exchange" for maintaining a competitive marketplace where suppliers could offer electricity and where buyers would come to purchase power. Both institutions would operate without discriminating against any party, and both would be overseen by a board composed of members nominated by state regulatory bodies and by members of the state legislature.

Divesting Assets

Competitive markets only work when there are lots of sellers and lots of buyers. To help ensure that an existing utility does not have too much control over the market, California power companies were required to divest some of their assets. In other words, the companies needed to sell some of their generating stations, for example, so they would not dominate the market of those who wanted to sell power to the Power Exchange. By divesting these assets, market share would be spread among a greater number of players, thus leading to a more competitive environment that would benefit buyers of electricity.

Freedom to Choose Suppliers

The California restructuring law had something for all types of consumers, which perhaps explains why it won unanimous support in the legislature. First of all, it allowed customers in all classes to choose their suppliers of power. This provision benefited large industrial customers particularly, since they eagerly sought the opportunity to buy power from independents or utilities anywhere within or outside the state. But before getting the full benefits of competition, these customers (and any others leaving their previous utility supplier) would be required to pay a "competition transition charge"--something like a tax that would go to pay for utilities' stranded costs (estimated at up to $30 billion) and other publicly valuable programs. This feature of the law pleased utilities, which would undoubtedly lose some of their most prized customers.

Retention of Popular (but non-competitive) Programs

The law also recognized that utilities previously provided several functions that were viewed as socially valuable but which would not be provided by competitive companies. These functions included encouragement of conservation and energy-efficiency efforts, spurring technological advances on alternative (and low-pollution) technologies, and providing electrical service for low-income residents.

As a result of these concerns, the California law required continued spending of almost $900 million to spur energy-efficiency work until 2001--work that budget-trimming companies sought to eliminate because it made the cost of their electricity more expensive (and hence, less competitive). Meanwhile, $250 million would finance research and development on new technologies that were not yet commercially viable, but which might be within a few years. Renewable resource technologies would get another $540 million. At the same time, low-income customers would retain subsidies and assistance so they could maintain electrical service--something cut-throat competitors might be loathe to provide.

Residential Rate Cut

Meanwhile, residential customers who feared that the benefits of competition might pass them by would obtain an immediate 10% rate decrease and another 10% discount by 2002. After then, legislators hoped the restructured utility business would have found mechanisms, such as firms that aggregated residential customers and brokered lower rates for them, so that small electricity users would profit from competition without government mandates.

Other States Pass Restructuring Laws

Even before California passed a law restructuring its utility system, other states had made similar efforts. But none was as comprehensive as California's. Moreover, due to the Golden State's economic clout and position as a trend-setter, its new law would have a tremendous impact on events in other states.

New Hampshire

Interestingly, the state of New Hampshire was the first state to develop a pilot program of actual retail competition. With the highest retail rates in the country, largely because its major regulated utility built the hugely expensive Seabrook nuclear power plant, New Hampshire had little to lose by allowing 11,000 residents to choose their electricity supplier, starting in May 1996. About thirty companies descended upon the state, eager to gain experience in the retail competitive market, and they offered lower prices along with inducements such as rebates, bird feeders, free ice cream, and the promise to sell only electricity generated with no or little environmental degradation.

Other States

In other states, restructuring activities picked up steam as well. By the spring of 1996, all but 10 states had started consideration of bills and regulatory actions that would have introduced competitive principles into the electricity supply business. Several states had pilot programs, while eight had already passed laws, by July 1996, setting up the rules for restructuring. In some states, stranded costs--a big issue to currently regulated utilities--were to be paid for by customers leaving their traditional utility company. In other states, companies and their stockholders were told to absorb those costs.

Go Slow Attitude

Despite this flurry of activity, many state legislators and regulators have consciously decided to move slowly toward a totally competitive utility system. While they see advantages to partial deregulation in theory, they also wonder--especially in low-cost states--how much competition can truly help all their citizens. In Virginia, for example, customers already pay significantly below the national average for electricity. Will competition help industrial users, who have the most market clout, at the expense of small residential customers? That unanswered question and similar ones have stalled some restructuring efforts, perhaps until after California begins retail competition in 1998.

Federal Legislation?

At the same time, the promise of benefits to restructuring have convinced some federal lawmakers that a national law needs to be implemented for requiring the states to restructure their utility systems. While Congressmen have held hearings around the country dealing with a host of proposals, no consensus has yet been achieved. Many representatives feel that restructuring should remain a state-by-state activity, so that various models can be evaluated and incorporated into other states' laws. In any case, it appears that no federal legislation will emerge at least until 1997 at the earliest.

An On-going Process

Learning from Experiences

Restructuring of the electric utility industry remains an on-going process. While most states have begun studying possible scenarios for introducing competitive principles into the business, much work needs to be done. Meanwhile, activities on the federal level will continue. In many cases, analysts and policy makers look forward to learning of events occurring in California and other states that have passed restructuring laws. The lessons of successes and mistakes made elsewhere will help shape the laws that will be passed in the next few years. Observers also pay close attention to restructuring efforts in other countries, such as Great Britain, Norway, Chile, Australia, and elsewhere. While differences exist between the American electric utility system and those in other countries, perhaps we can learn from their experiences too.

Restructuring is not Synonymous with Deregulation

In short, 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 function. Restructuring, therefore, is not synonymous with complete deregulation.