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.