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Restructuring Other Industries
While the electric utility industry was being questioned
about its status as a natural monopoly, other industries had begun to be
stripped of their protective cloak of regulation. In some industries, regulation
had been imposed to prevent abuses that had previously been endured and
to ensure that all parties had equal access to information and services
(as was the case with the creation of the Securities and Exchange Commission
in 1935). Other regulation ensured that safety and health (in the food,
drug, and aircraft industries, for example) would be maintained. Such regulation
attracted little criticism, since it clearly appeared in the public interest.
But in other areas, such as in determining prices and
business practices, regulation came under fire. Why not depend on the discipline
of the marketplace, with numerous sellers and service providers competing
against each other, to determine prices? In other industries, such competition
delivered an abundance of new products and services, often at declining
prices.
As this attitude became more prevalent in the 1980s, price
and service regulation was removed in several industries. While maintaining
some governmental oversight over safety and trying to prevent business
abuses, price regulation was lifted in the securities and banking businesses,
airlines, trucking, natural gas, and telecommunications industries. In
most cases, customers watched as the competitive industries introduced
new services and lower prices to gain market share.
Such experiences led politicians and policy analysts to
suggest that the competitive market could discipline industries better
than could the regulatory apparatus. Almost naturally, many people wondered
why the electric utility industry should remain regulated, and looked for
lessons from similar experiences in other industries. In particular, they
have sought guidance from the telecommunications, natural gas, and airline
industries, all of which share some characteristics with electric power.
However, they also exhibit major differences.
Telecommunications
Under Regulation
Until 1984, American Telephone and Telegraph (AT&T)
dominated the telecommunications business. Its 18 Bell Operating Companies
provided local telephone service, while its Long-Lines Department handled
almost all the nation's long-distance calls. AT&T also included Western
Electric, which produced phone equipment, and Bell Laboratories, which
provided research and development on new technologies.
In 1970, AT&T held $53 billion in assets and was the
largest company in the world. It controlled a virtual monopoly in telecommunications
because regulation prevented entry into the business by other companies
and because it employed superior technology that few others could match.
Deregulation
Deregulation of telecommunications took place as small,
entrepreneurial companies, starting in the 1960s, sought to introduce new
equipment for use on the AT&T network. In addition, Microwave Communications
Inc. (MCI) sought to bypass the AT&T system to offer private long-distance
service. In MCI's case, new technology--microwave and satellite equipment--obviated
the old justification for a monopoly of long distance service because that
service no longer depended on the use of dedicated wires.
Opposition by AT&T to these efforts led to a federal
anti-trust suit and the company's divestiture in 1984 of the operating
companies. AT&T retained Western Electric and Bell Laboratories, but
the subsidiaries were required to license patents freely. Essentially,
AT&T became a long-distance carrier and equipment manufacturer, though
it could also enter the information services business--a business that
a previous agreement with the federal government had prohibited. In theory,
the divestiture broke up the natural-monopoly aspects of the business--local
service--from the competitive aspect--long-distance calling.
Since divestiture, scores of companies have entered the
long-distance business, and prices to customers have generally declined.
Moreover, competition has motivated companies to offer new services, such
as voice mail, call-waiting, call-forwarding, and several other keypad-directed
choices. Many firms also provide services that link customers to the "information
superhighway" by way of the Internet and by offering cable TV, thus
blurring the differences between the telephone, computer, and television
industries. Though many people wondered whether Americans should risk losing
the best telecommunications service in the world when divestiture occurred
in 1984, most observers today would agree that innovation and price competition
has flourished in a deregulated environment.
Similarities to Electric Utility Industry
Like the electric utility industry, the telecommunications
business required huge capital investments--telephone lines, switching
equipment, control centers, etc.--to create a service network for customers.
Moreover, both industries shared at least one type of economies of scale:
once the network was in place, they benefited from increased use of it
to boost revenue from existing fixed costs.
At the same time, both industries had obligations to ensure
universal service (indeed, AT&T's motto used to be "Universal
Service"), and both became intimately involved with ultimate retail
customers through installation and maintenance of equipment, billing, and
providing information about new services (such as touch-tone dialing in
telecommunications or energy-efficiency in electric power).
Differences between Electric Power and Telecommunications
But the electric utility industry was different in many
other ways. First, the environmental impacts of electric power production
dwarf those in telecommunications. Because it relies heavily on fossil
fuels, the power industry is the nation's most significant polluter. Increased
use of power generally means increased pollution. Therefore, the industry
is subject to significant government regulation to protect the public welfare.
Increased use of the telecommunications industry, however, is often viewed
as a solution to pollution: telecommuting and teleconferencing reduce the
need to use fuel for travel; faxes employ a fraction of the energy needed
to send documents by overnight mail, and so on.
Perhaps more significantly, technological innovation in
telecommunications has occurred more rapidly than in electric power, thus
allowing competition to occur for new products and services. Of course,
innovation is occurring in electric power, perhaps even permitting on-site
generation in homes and businesses within the next decade or two. But the
traditional central-station industry of today is limited to innovations,
such as gas turbines and increasingly energy-efficient end-use equipment,
that have not yet had the same effect on stimulating new products and services.
At the same time, the telecommunications business is a declining cost industry--in
which expansion of business means lower unit costs. The situation mimics
that of the electric utility business before the 1970s, but not today,
when increased demand for power generally increases unit costs.
Natural Gas
Under Regulation
Until the late 1970s, the natural gas industry structure
generally consisted of state-regulated local distribution companies (LDCs),
which sold gas to customers and which acquired fuel from one or more gas
pipelines, whose activity was regulated by federal officials. The pipeline
companies, in turn, obtained gas from producers, who also were regulated
on the federal level. Contracts between LDCs and pipelines often were for
long periods, about 20 years, at regulated costs. Since much gas passed
across state boundaries, federal regulators had jurisdiction over transactions;
they often set upper limits to the price of gas as a way to protect consumers.
But the price caps also discouraged exploration companies
to seek new supplies, since they wouldn't be rewarded with attractive prices.
To avoid interstate regulation, many gas companies sold most of their output
within their producing states. During the late 1960s and early 1970s, therefore,
the nation endured several periods of natural gas shortages. Partly in
response, Congress passed the Powerplant and Industrial Fuel Use Act in
1978 to discourage electric utilities and other heavy users of gas from
burning the premium fuel.
Regulation of natural gas arose not because the industry
appears to be a natural monopoly, but as a means to overcome abuses of
holding companies in the 1920s--the same ones that owned electric utility
operating companies. Natural gas operations constituted only a small part
of holding company assets, but they were caught in the same web of financial
abuses and price discrimination which often hurt rate-paying customers.
The 1938 Natural Gas Act therefore gave the federal government jurisdiction
over wellhead and pipeline prices, but it forbade state regulators from
determining prices for intrastate sales.
Deregulation
Deregulation of natural gas occurred in several steps,
beginning with the Natural Gas Policy Act of 1978, which began limited
decontrol (and raising) of gas prices. As prices were freed from regulation,
a competitive market for wellhead gas developed, including a so-called
"spot market"--a commodity market where buyers and sellers agree
on price and delivery terms on the spot, with delivery to occur in one
month or sooner. Such markets are the hallmark of a competitive enterprise,
since they allow buyers and sellers to exchange information and determine
prices.
To encourage competition on a wider level still, the Federal
Energy Regulatory Commission in 1986 and 1987 issued orders that required
interstate pipelines to transport gas for any supplier. Essentially, the
rules ensured "open access" to all providers and removed the
pipeline companies as the sole wholesalers of gas (since they held a monopoly
on transporting the gas). Now LDCs could make contracts with wellhead producers,
marketers (who aggregated supply and resold it), or brokers--instead of
just from the interstate pipeline companies--and use the pipelines as "common
carriers."
The gas industry has moved away from its integrated structure,
where independent entities controlled production, transmission, and distribution.
Now producers and marketers deal directly with LDCs and customers (usually
industrial and commercial businesses). As more gas has been discovered
and as market-based principles have evolved in the industry, prices have
declined--about 33 percent between 1984 and 1993 for industrial customers.
Similarities to Electric Utility Industry
In performing functions of production, transmission, and
distribution, the gas industry looks similar to the electric utility industry.
Moreover, both industries provide what some customers view as a commodity,
in contrast to a service (like telecommunications).
Differences with the Electric Utility Industry
But differences with the utility industry are more prominent.
First, in contrast to the electric power business, the gas industry is
characterized by the lack of technical complexity. Natural gas is a product
that can be efficiently and economically stored, unlike electricity, and
load balancing of gas in pipelines is generally not as complex as balancing
supply and demand for electricity. The difference means that a level of
regulation may be desired in the electrical realm to ensure that electricity
flows consistently and reliably.
Additionally, natural gas consumption has fewer environmental
impacts than does electricity use. Direct combustion of gas creates fewer
pollutants than using coal or oil for electricity production. And because
some uses of gas are much more efficient than uses of electricity, such
as in heating water, environmental consequences are generally smaller.
Burning natural gas therefore has fewer public interest concerns than burning
other fuels to make electricity.
Airlines
Under Regulation
The airline business was regulated to provide stability
to companies' finances and to ensure service to cities. Carrying an increasing
number of passengers--up from 48,000 in 1928 to 383,000 in 1930 and more
than one-million in the late 1930s--the business was divided by 16 "trunk"
airlines by 1938 when Congress created the Civil Aeronautics Authority
(later Civil Aeronautics Board--CAB) to regulate the business. Since it
was fairly easy to enter the business, commercial aviation could not be
considered a natural monopoly. But the violent ups and downs of the industry
made it difficult for some firms to stay in business, and the federal government
offered air mail contracts to a core of airlines to help them maintain
healthy finances.
The CAB essentially froze the competitive situation as
of 1938, denying entry into markets by new companies, and protecting the
incumbent companies. It further eliminated price competition between carriers
serving identical city pairs, and it approved fares based on the cost of
providing service. Finally, it required airlines to fly less-used and uneconomical
routes in return for permission to transport passengers on more lucrative
cities, such as between the east and west coasts. This provision ensured
that small cities obtained airline service.
Deregulation
Under Chairman Alfred Kahn, a respected academic economist
at Cornell University, the CAB in 1978 began to dismantle the regulatory
framework of the airline industry and ease itself out of existence. The
regulatory protections of the federal government were lifted (except for
safety, which remained under the regulatory watch of the Federal Aviation
Administration), so that new airline companies could enter markets and
so they could charge whatever fares they desired.
Moreover, if they desired, airlines could easily enter
and withdraw from markets at will; unprofitable routes were quickly abandoned
while new, previously unserved markets obtained flights. Fares for some
markets plummeted, at least for the short term, as the classical economic
theory of competition appeared to work.
While vacation travelers often can get bargain fares these
days, business travelers and those who cannot plan trips in advance have
suffered under deregulation. In fact, since 1978, airfares in general have
risen faster than the consumer price index. Partly, the reason stems from
the airline merger movement of the 1980s, when airline companies merged,
with the blessing of the Reagan administration's Federal Aviation Administration
and Department of Justice, and began dominating markets. In a truly competitive
market, scores of sellers vie for market share. But by the mid 1990s, the
top three airlines controlled almost 60% of the industry's revenue passenger
miles. In some cases, individual airlines have virtual monopolies in city
hubs such as Salt Lake City, Pittsburgh, Charlotte, and St. Louis. To many
observers, deregulation of markets and prices of the airline industry has
not been successful.
Similarities to Electric Utility Industry
The commercial airline industry can be compared to the
electric utility business in that it constitutes a necessary infrastructure
for American business. Like the utility and telecommunications businesses,
the airline system is a complex network that requires careful coordination
and oversight. Moreover, the companies make long-term, capital intensive
investments (though these are supplemented by expenditures by the federal
government for airports, control systems, and safety.) When regulated,
airlines determined fares through a time-consuming and difficult process
that, like in the utility business, tried to mimic the cost of providing
service.
Differences with the Electric Utility Industry
Unlike parts of the utility industry, the commercial airline
business does not have (and never really did have) properties of natural
monopoly. Moreover, if airline companies stop providing service, for whatever
reason (such as during a strike), customers can usually find alternate
means of transportation or delay trips. In other words, airline transportation
is not as critical--to daily life or to business--as is electricity service.
If the power goes out, the economic and social impact on people and businesses
is tremendous.
Overall Comparisons
Clearly, similarities exist between the electric utility
industry and others that have recently been deregulated. Many lessons can
be learned from their experiences. For example, Americans learned that
deregulation of telecommunications brought a huge number of innovations
in services and products along with lower prices for core telephone service.
At the time of AT&T's divestiture, several observers feared whether
the phone company's break-up would endanger the lauded reliability of the
American telecommunication system. Why fix something that isn't broken,
they asked?
From the natural gas industry, people realized that when
price caps were removed and when buyers and sellers could develop new means
to make transactions--through spot markets, for example--customers benefited.
Gas explorers discovered new gas supplies, partly because the prospect
of higher prices stimulated exploration, and prices ultimately fell, as
supply exceeded demand and as new financial institutions arose to bring
buyers and sellers together efficiently.
Deregulation of the airline industry suggested that removing
barriers to entry and allowing prices to be set at will can yield benefits
to customers, in the form of lower prices and service to new cities. But
one also learned that effective competition requires an abundance of sellers
and that companies must still be overseen to prevent them from merging
and inhibiting competitive forces. (In other words, anti-trust regulation
should be maintained even though price and market regulation should be
eliminated.)
Despite all these lessons, there still remain several
differences between the electric utility industry and the three discussed
here. Perhaps most importantly, the electric utility industry retains characteristics
that make it "affected with the public interest" in a way that
the others are not. Electricity is generally viewed as a necessity whose
absence, even for a few seconds, can have significant ramifications for
economic and social welfare.
If a electricity provider went bankrupt and could no longer
provide service, as would be expected in a competitive business, or if
a firm simply decided to leave a market, then customers would be deprived
of a necessity. Such an outcome would be untenable in modern American society,
a society that had worked so hard, especially during the 1930s, to ensure
universal electrical service. Moreover, unlike in the other industries,
normal operations in the electric power business have tremendous environmental
implications, another reason, perhaps, to retain some level of government
oversight.
Finally, it is worth noting that deregulation of telecommunications,
natural gas, and commercial aviation occurred on the federal level. Congress
passed laws that removed various restrictions and protections on the incumbent
parties. While the federal government regulates aspects of the electric
utility industry, most of the price and market oversight occurs on the
state level. Thus, as we have seen in California and elsewhere, restructuring
activities have been most active in state legislatures and regulatory commissions,
where officials are swayed by different local conditions and by the persuasive
power of various interest groups. This difference alone may make the complexion
of restructuring very different than in the other industries.
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