De-regulation of the Electric Power Industry

Introduction

The electric power industry has operated as a regulated monopoly since the late Nineteenth Century, but the idea of utility monopolies is becoming extinct (Philipson & Willis, 1999). The industry will now be de-regulated. Deregulation is the process of changing the rules and economic benefits that the electric power industry is allowed to operate under. This industry joins the telecommunications industry in having less government regulation and giving consumers the ability to have a choice in their provider.

Purpose

The first section will study the organization and history of the electric industry while the second section will study what deregulation is and what stranded costs are. The third section will study how electricity is unique and its technical aspects while the fourth section will study different ideologies on deregulation. The fifth section will study actors in deregulation while the sixth section will study how consumers will be protected. The seventh section will study deregulation’s spread across the country while the eighth section will study the history of the California power crisis.

The ninth section will study the problems discovered from this power crisis while the tenth section will study perspectives on price hikes. The eleventh section will study how possible solutions to the power crisis failed while the twelfth section will study short term problem solving. The thirteenth section will study the objectives and risks of restructuring while the fourteenth section will study how deregulation is appealing. The fifteenth section is a proposal to solve the problems associated with deregulation.

Organization & History of the Industry

In the 1930s, between five and ten companies controlled most of the nation’s electric power industry (Higley, 2000). At this time, only ten percent of farms had electricity and the problem caught President Franklin D. Roosevelt’s attention. He explained that an effort needs to be made so that Americans should no longer be dependent on holding companies who have unwarranted economic power. It was important for an electric grid to be started and for all Americans to have access to electricity. In 2002, ninety-nine percent of Americans have electricity and as a result the rules created in the 1930’s are ancient.
Electric utilities consist of four parts: generation, transmission, distribution, and retail sales (Philipson & Willis, 1999). Generation is power production, transmission is the ability to move large amounts of power long distances, distribution breaks up these large amounts of power to route to homes and businesses, while retail sales provides customer services such as measuring and billing for their use of electricity.

In order to understand the principles regarding deregulation, one must understand how the electric industry was regulated (Philipson & Willis, 1999). Regulation was based on five factors: monopoly franchise, the obligation to serve, guaranteed rate of return, corrective operating and business practices, and least-cost operation.

Under a monopoly franchise, only one company was given the right to sell electricity to electric customers in a specific region or otherwise known as a franchise territory (Philipson & Willis, 1999). No other company was allowed to produce or sell electricity in the franchise territory.

Utilities had an obligation to serve all of the needs of consumers in their franchise territory (Philipson & Willis, 1999). If the utilities meet these needs, the local government guarantees that the regulated rates will allow the utility to make a reasonable profit margin.

Corrective operating and business practices are when the local government had the right to tell a local power company how to build its system, how to plan for new construction projects, or how much stock one individual can own of that company (Philipson & Willis, 1999).

The local government tells the utility how to calculate costs and set rates (Philipson & Willis, 1999). It tells the utility the best way to operate with the lowest cost and defines the specific ways the company should finance its operations.
Electric companies were subjected to more regulation than other industries and had to follow laws made by the Federal Energy Regulatory Commission (FERC), state agencies, and rural electric membership cooperatives (Philipson & Willis, 1999).

A regulated system worked at the time because no businessman would want to run an electric system unless he was guaranteed a profit (Philipson & Willis, 1999). If competition were allowed when the electric industry first started, it would be possible that there would be overlapping grids that may or not be owned by the original electric company who built them. In a regulated electric system, the electric company owned the power lines and grid it designed. State and local governments limited the amount of profits a utility could make, then that utility returns to customers all or a portion of the excess profit (Gordon, 2001).

Explanation of Deregulation and Stranded Costs

Deregulation is an attempt to solve a problem of over-regulation of the electric industry. One of the key concepts why deregulation is necessary is that no company has a monopoly on production, the wholesale sale, or the retail sale of electricity services (Philipson & Willis, 1999). Deregulation will still allow the electric industry delivery system to operate as it does today. The point of deregulation is to keep the ability to have only one set of transmission lines and distribution poles but to allow power production to be competitive.

Utilities were reluctant to embrace deregulation at first because it is predicted that the electric industry will have over one hundred billion dollars in stranded costs (Kolbe & Bourcki, 1998). In order for investors to have faith that a utility will increase in value, the company must be guaranteed that the stranded costs will be passed through to customers through transmission and distribution costs.

Stranded costs are costs incurred by a company that would be unrecoverable in a competitive market (McCarthy, 2002). Consumers must pay for stranded costs so that electric utilities can be competitive. For example, nuclear power plants have many stranded costs since it is more expensive to maintain and operate a nuclear power facility than a coal power plant. This is because nuclear power plants must follow rules dictated by the Nuclear Regulatory Commission (NRC).

Competitive Transition Assessment (CTA) charges and a system benefit charge make up stranded costs (McCarthy, 1998). CTA’s consist of above market costs of generation plants and related assets as well as regulatory assets in terms of deferred taxes, conservation programs, and public policies that have already been approved by a state’s DPUC. CTA’s can also consist of regulatory assets that are the costs of purchased power contracts the utility entered into before deregulation took effect in the state or were previously approved by the Federal Energy Commission. The system benefits charge covers dislocated utility workers and municipalities that lost property tax revenue from power plants (McCarthy, 2002).

Stranded costs increase during a recession and decrease when the economy is doing well (Kolbe & Bourcki, 1998). This is because people tend to use less electricity during a recession, primarily because they have less money to spend. However, if a utility works an agreement through transmission and distribution companies, than that utility can still make profits during a recession. Even though the price per megawatt hour (mWh) would decrease, as there is decreased demand, the transmission and distribution charges would probably remain fixed. A megawatt (MW) is one million watts of electricity per hour.

The electric industry is not the only industry to implement a way to recover transition costs (Edison, 1999A). Airlines, railroads, trucking, telecommunications, and the natural gas industries have all received assistance through government subsidies, compensation to laid-off workers, special consumer charges, or merger standards.

Many of the states that have passed deregulation laws have a transition period lasting about four years. During this time, residential customers will receive a discount on their electricity rates but after there is no assurance that deregulation will actually lead to lower prices for small consumers (Higley, 2000). Deregulated power suppliers took six billion dollars out of California’s economy taking two hundred dollars out of each person on average. According to Higley, utilities and large industrial customers have used campaign contributions to get lawmakers to enact legislation benefiting corporate interests at the cost of the consumer.

Uniqueness of Electricity and Technical Aspects

Electricity is unique in that it can’t be stored easily, it must have a constant voltage system, it must have a synchronous alternating current (AC) generation, it must have a constant frequency, electrical losses occur in transit, and it is a challenge to move power to where it is needed (Philipson & Willis, 1999).

Electricity must be made and sent to the consumer at the time it is needed because it is expensive to store (Philipson & Willis, 1999). Power systems need to be able to respond to changing demands of consumers and the equipment and systems need to be able to deliver the electricity when it is required.

Electrical systems are designed to change the power delivered by varying the current supplied and are also designed to keep a constant voltage (Philipson & Willis, 1999). A typical house has one hundred ten to one hundred twenty volts and that supply is available whether the house is using most of this or none at all. The current drawn from the power system varies so when a consumer is using eleven kilowatts (KW) of electricity, the power system is providing the house with ninety amps.

The amount of voltage to a home can change depending on the demand for electricity from the power system (Philipson & Willis, 1999). Voltage will drop as demand increases; sometimes it will increase to the point where not enough voltage will be provided to some consumers causing a brownout. Most of the time usage changes will result in a home experiencing a voltage drop. A voltage drop means that consumers using a lot of energy will experience a drop in the amount of volts that can be used. For example, residential consumers using a lot of power will only be given one hundred thirteen volts while residential consumers using no power will be given one hundred sixteen volts.

Power engineers have designed the electric system so that voltage stays as close to constant as possible (Philipson & Willis, 1999). Their goal is to make a voltage source, an unchanging supply of constant voltage regardless of demand.
A synchronous AC generation is when an electrical system is built on a standard frequency of power. (Philipson & Willis, 1999) One cycle per second is a hertz. The American system uses power at sixty hertz meaning sixty cycles per second. Power in large assembly factories and military ships often exceeds sixty hertz due to their dependence on machines and other electrical systems. Other countries have different hertz rates but as America moves toward deregulation, all electrical utilities must continue to operate on sixty hertz because if they do not problems will occur due to incompatibility issues.

The frequency of any power system is constant and accurate (Philipson & Willis, 1999). The American power system rotates on sixty cycles per second. This frequency allows analog clocks to give the correct time and allows utilities to have multiple generators synchronized with each other so that they all run at the same rate. This is important because it is a challenge to keep generators running at peak performance.

One of the problems with moving electricity is that delivery over long distances results in electrical loss due to the amount of effort required to move electricity (Philipson & Willis, 1999). Electrical loss means that the more energy that is being transported at the same time, the larger the loss. For example, if one hundred megawatts went across two hundred miles of transmission line, only ninety-seven megawatts would be available at the other end. Two hundred megawatts going across the same length of transmission line would result in only one hundred eighty-eight megawatts at the other end. Utilities usually loose between six percent and ten percent of their electricity each year.

Voltage, phase angle of the AC pulses, and other conditions dictate how power is able to flow (Philipson & Willis, 1999). Engineers study how to build an electrical system based on demand by analyzing the electrical flow by using a load flow, a computer program that can determine whether power requirements are being met and how they are being met.
Consumers should be aware that deregulation will result in varying pricing of a mWh based on time of day and season (Newberry, 1999). It is likely consumers will be charged more if they are using power during a high demand period compared and charged less if they are using power during a low demand period. For example, a ninety degree Fahrenheit July day at 1pm could be a high demand period while a low demand period could be a sixty-five degree Fahrenheit April night at 2am.

Ideologies on Deregulation

Conservatives want to restructure the industry because they believe deregulation would save the average consumer twenty dollars a month (Greenwald & Allis, 1997). They argue that the success of regulatory programs and new competition in markets will ensure that monopolists will not manipulate the power market (CBO, 1997). Conservatives are for deregulation because they are for a free-market economy with little government involvement. Many conservatives hold political positions in the Republican Party.

Liberals believe that it is government’s job to be involved with the economy and for regulations to exist so that government can protect consumers. Some liberals believe that no deregulation should take place while other liberals believe that some type of deregulation should take place. Some liberals support the idea that antiquated laws need to be revised. The liberal ideology would not support total deregulation because the ideology is based on the premise that a total free market would create a monopolistic market resulting in consumers having no choice at all. A monopolistic market is one in which only the biggest corporation survives while the competition is forced to close resulting in higher prices. Many liberals hold political positions in the Democratic Party.

In terms of whether deregulation should be up to the federal government or state governments, many liberals believe that a federal deregulation law should be adapted while many conservatives feel that each state should make their deregulation laws (Electricity Deregulation, 2002). Liberals believe that if each state made their own decisions on deregulation, the states with prices below the national average will suffer and that deregulation will lead to higher prices for consumers in those states.

The conservative ideology would like to see the 1935 Public Utility Holding Company Act (PUHCA) repealed. This law allows large utilities to have a monopoly in their region but prevents them from expanding their reach (Electricity Deregulation, 2002). PUHCA’s purpose is to prevent national conglomerates from taking over the electric industry. Many large utilities say that PUHCA prevents them from having real competition and that real competition would lead to lower prices and improved services since companies would be vying for consumers.

The liberal ideology does not want to repeal PUHCA because it would take away important consumer protections. Most liberals would like to revise PUHCA so that competition is allowed but restrictions on electric utilities remain.
The liberal ideology favors a bigger government that will set regulations to protect its citizens. Most liberals want everyone to be at an equal playing field. Some liberals believe that deregulation will allow citizens to choose between different electricity providers with the help of government intervention to ensure that providers do not attempt to gauge consumers. Those liberals would like to see the utility lowering the price as it makes more profit.

Even though liberals are supportive of more regulations, many are not in support of limits on the choice of the consumer. Conservatives are against creating more regulations on the electric industry.

Actors in Deregulation

According to the Edison Electric Institute, a level playing field means that even though companies have different sizes, services, service areas, and strengths, they should still all operate under the same rules (Edison, 1999B).

The 1986 Economic Report of the President said that competition must be on a level playing field or the electric producers would have select privileges that would not be in the interest of the consumers (Edison, 1999B).

A manager of Media and Public Affairs for National Rural Electric Cooperative Association, an energy cooperative that serves rural customers believes that consumers may lose out in deregulation. One of the fears of deregulation is that residential and small-business consumers will experience high rates while big companies will be able to setup contracts with utility companies to buy power at low rates. Big companies would be purchasing power in bulk amounts compared with residential and small-businesses which would purchase power in smaller amounts because they would not be using as much power (Ota, 1997A).

The Executive Director of one of California’s most important utility watchdog groups, The Utility Reform Network (TURN), said the group recently withdrew their opposition to the deregulation plan (Weisman, 1997). She opposed that decision because deregulation allows utilities to charge consumers the cost of unprofitable nuclear power plants and because it allows utilities the ability to recover about one hundred thirty five billion dollars in uneconomic investments, an electricity bailout paid by consumers.

Many big utilities such as Carolina Power & Light of North Carolina, Consumers Energy of Michigan, Commonwealth Edison of Illinois, Florida Power & Light, and Electric USA oppose federal legislation requiring deregulation to occur by a specific date and believe the issue of deregulation should be up to state governments (Ota, 1997B).

Protecting the Consumer

Many guidelines have already been put into effect to protect the consumer (Edison, 2001). The Federal Energy Regulatory Commission (FERC) required utilities in 1996 to provide access to transmission lines to competing companies in the same manner as it does to its own power plants. In 1999, FERC adapted a rule to require all transmission-owning utilities to place their transmission facilities under the control of a regional transmission organization (RTO). RTO’s manage transmission
facilities in an area and are independent from generation facilities.

According to the Edison Electric Institute, regulatory agencies and legislatures have developed standards of conduct to make sure that dealings between utilities and competitive affiliates are fair (Edison, 2001). These standards of conduct will prevent affiliates business costs from being pushed onto consumers of the regulated distribution services. Regulation distribution services will have a rate the consumer must pay to have the electricity delivered from the power plant to their home or business.

Several federal agencies including the Department of Justice, the Securities and Exchange Commission (SEC), and the Federal Trade Commission (FTC) are responsible in approving electric industry mergers (Edison, 2001). The utility’s state public utility commission also must approve mergers.

Deregulation spreads across the country

As of October 2000, twenty-three states and the District of Columbia have had restructuring legislation enacted including Connecticut (Morris, 2001). At that time, one state, New York, had a comprehensive regulatory order issued, two states had legislation and orders pending, and seventeen states had an ongoing commission or legislative investigation. Seven states have not taken action to deregulate their electric utility systems. At the retail level, states will regulate the electricity industry.
When looking at how to develop a deregulation system that would meet the demands of consumers and businesses while providing affordable rates, we must understand what caused California’s Power Crisis.

California Power Crisis: History

California is part of the Western System Coordinating Council, one of three Interconnections of the electric power system serving both the Untied States and Canada. Plants outside California generate most of the power for the state (Lee, 2001). Before deregulation, California’s power rates were forty percent higher than the national average, fifty percent higher than Texas rates, sixty-five percent higher than Nevada rates, and one hundred twenty percent higher than Oregon rates (Weisman, 1997).

California launched the nation’s first and broadest electric deregulation plan in 1995 (Greenwald, Jackson, Ressner, & Thomas, 2001). The plan was designed to cut rates, but backfired and resulted in many consumers paying triple what they used to pay. The state’s economy expanded thirty four percent during this period and then Republican Governor Pete Wilson believed that monopoly utilities needed to be broken up.

When outsiders such as Duke Energy of Charlotte, N.C., and Reliant Energy of Houston purchased the plants, the state refused to grant them long-term agreements for fear that this would lead to locked fixed-price contracts for consumers (Greenwald, Jackson, Ressner, & Thomas, 2001). The state also required that there be a rate freeze until 2002.
The freeze was eliminated in 2002 when it was determined that electric suppliers were billing the utilities responsible for delivering the electricity to the consumer (Wasserman, 2001).

California Power Crisis: Problems

One of the problems that occurred with the rate freeze is the fact that the utilities experienced higher demand for power in a state with low generating capacity (Greenwald, et. al., 2001). Twenty five percent of electricity in California comes from the southwest and the Pacific Northwest.

The original utilities of California became middlemen who had to buy power from suppliers but because of the high demand for electricity. Due to the inability to increase electricity costs for consumers, Pacific Gas & Electric (PG&E) and Southern California Edison (SCE) owed more than twelve million dollars (Greenwald, et. al., 2001). In some cases, electric suppliers were selling the utilities power at one thousand four hundred dollars an mWh and were forced to charge consumers sixty-four dollars a mWh (Wasserman, 2001).

Companies were reluctant to sell power to utilities that were on the verge of going bankrupt. The utilities’ credit risk was forced upon suppliers with no promise of payment (Greenwald, et. al., 2001).

According to FERC, adequate supply, adequate number of sellers, effective organizational structures in the industry, and sound market rules are essential for competition to flourish (FERC, 2001). Adequate market monitoring and the ability to step in and take appropriate action are essential to prevent market malfunction or market power abuse. They support RTO’s that would be independent from those who buy and sell power. RTO’s would monitor wholesale electricity trading patterns and provide conditions for transmission service over large regions that often cross state borders.

Perspectives on Price Hikes

FERC’s study suggests that companies in California did not withhold electricity supplies to cause an increase in prices (FERC, 2001).

The Director of Natural Resources and Environment in the U.S. General Accounting Office said that the agency did not analyze whether the companies were using other techniques to influence prices (FERC, 2001). Such techniques could include not offering bids, selling capacity, or bidding at prices high enough to exclude them from the market.

A study was conducted in January 2001 that concluded that prices increased significantly during the summer of 2000 (FERC, 2001). The level of outages by generating plants during this time cannot be explained by reasonable repairs, maintenance, or the need to hold power in reserve to make sure the power system stayed reliable.

Possible solutions fail

California’s power demand increased twenty five percent from 1995 and 2001 without any new plants coming online while Texas, also with increased power demand, built a large number of plants in an attempt to increase capacity (Greenwald, et. al., 2001). Power companies wanted to enter California to build power plants but faced too much opposition from environmental groups, corporations, and state agencies.

Calpine Corporation wanted to build a six hundred MW generator in Silicon Valley that would provide power to six hundred thousand homes in a region that had already experienced blackouts due to power shortages (Greenwald, et. al., 2001). Groups like the Sierra Club supported it but San Jose’s largest employer, Cisco Systems, argued that the plant would be a monstrosity next to their facility.

California regulatory bodies had proposals for forty-four plants in 2001 but only a handful have come online (Greenwald, et. al., 2001). Forty percent of the state’s capacity originates from facilities built more than thirty years ago making them both obsolete and susceptible to equipment problems.

Short Term Problem Solving

A short-term way to solve this problem might be to ensure that utilities are not creating an artificial shortage (Wood, 2002). An artificial shortage occurs when an industry makes less of a good or service so that consumers perceive that there is a shortage. This allows utilities to charge more for electricity because most other goods and services increase in price when demand is up and supply is down. In contrast, if consumers believed that there was an abundance of power than they would expect prices to decrease because when demand is down and supply is up, prices usually do decrease.
In terms of adding more power supply to an area, it is important to note that smaller power plants can be built in about two years while it takes three to five years to build larger power plants (Lee, 1997). Power operators must have obtained environmental permits and licenses before construction of a plant can start.

Objectives and Risks of Restructuring

When looking at the California Power Crisis, it helps to look at the objectives and risks of market competition and restructuring (Lee, 2001). The objectives include lower electricity cost and improved efficiency, encouraging innovation in technology through profits, and encouraging investment with potentially higher profits.

According to Lee, potential risks of marketing restructuring may include volatile pricing of electricity, frequent blackouts, and the possibility that government would have to bail out financially troubled power companies using taxpayer money (Lee, 2001). Market restructuring may also lead to an unstable business cycle if proper regulations are not imposed on it. An unstable business cycle could lead to concerns by the public if price spikes and blackouts occurred. Most importantly, an unstable business cycle could lead to an economic recession.

How deregulation is appealing

Even though deregulation experienced problems in California, it is important to note why deregulation is appealing. Innovation in building power plants along with competition is expected to result in electricity prices dropping between one and three cents per kWh (Philipson & Willis, 1999). In 1990, when many countries made progress toward electric utility deregulation, costs for electricity decreased more than at any other time. Electricity rate reductions did not reflect the decrease in equipment prices for a variety of reasons. These reasons are so complicated that there is no agreement on how this problem could be solved.

Through competition, consumers are heard more than through monopoly-franchise utilities (Philipson & Willis, 1999). A monopoly-franchise utility may listen to its customers’ problems but a competitive electric service company needs to predict the needs of consumers before they complain. In this way, competitive electric service companies are able to provide better customer service than a monopoly-franchise utility.

Proposal to solve the problem

It is important for deregulation to strike a balance between simply giving consumers a choice for electric power with much governmental control over the utilities and giving electric utilities full control without governmental intervention.
The 1935 PUHCA should not be repealed. It is obvious that the act protects against electric corporations from merging with each other in ways that would squeeze out small electric utilities. The act prevents electric utilities from taking unnecessary risks which would be paid for through an increase of electric costs to consumers (Clean Energy, 2003).
The deregulation of electricity is surely more important than the deregulation of utilities of the past such as cable, telephone, and airlines. Our dependence on electricity requires us to ensure that the industry has more regulation than other utilities but consumers should be able to choose between suppliers and allow utilities to try different innovative techniques using its profits.

The need for national law for electric deregulation should be apparent in the fact that of the twenty-three states that already have deregulation, according to Morris, almost no consumers have switched electric suppliers unless they were threatened by a penalty if they did not do so. Pennsylvania is one of the only states that impose a penalty, but according to Morris, even though there is a penalty few customers have switched (Morris, 2001).

If consumers are not switching electric suppliers even though they will be penalized, than they do not clearly understand deregulation or the consequences that will result from it. More than one hundred fifty thousand utility workers have lost their jobs because of deregulation (Higley, 2000). Laying-off people is a cost-cutting procedure resulting in more response time to restore power to areas affected due to a power outage.

The U.S. Congress should pass a national deregulation law giving FERC control over the process of deregulating electricity. FERC should create provisions requiring utilities to slowly shift over to more environmentally friendly forms of energy. Even though electricity made through natural resources will be more expensive than energy made by conventional fossil fuel power plants, it is possible that many will pay the extra charge in an effort to help protect the environment.

FERC should monitor the power grid and ensure that utilities do not attempt to create an artificial shortage. To help take politics out of electricity deregulation, there should be more strict guidelines into how much power utilities are allowed to give to Political Action Committees (PACs). In the 2000 election cycle, electricity providers gave eight million dollars in soft money contributions (Electricity Deregulation, 2002). If FERC had the ultimate power to create deregulation laws and not the U.S. Congress, more would get done in less time.

A cross-sanction is necessary to ensure all fifty states comply. States who fail to comply and allow FERC to create deregulation rules and regulation should be denied their annual highway money allotment. States regard their highway fund as valuable and this is the biggest amount of money that states receive directly from the federal government. Highway money from the federal government has been used to create, maintain, enlarge, and reconfigure highways all across our country. With increased reliance on motor vehicles, especially in light of the events of September 11, 2001, which resulted in fewer people flying and consequently more people driving to their destination, it is imperative that states maintain their highways for both residents and visitors.

The airline deregulation process has already proven that if deregulation is not setup properly, it will only lead to corporate gain as competitors were forced to close and prices went skyrocketing up. It is ironic that our democracy supports a process that offers fewer choices rather than more.

The national government has an interest to take steps to educate the public about deregulation and to impose a system in which electric utilities could not increase prices without just cause. The deregulation of electricity should give consumers choices and not allow utilities already serving a region to stomp out potential competitors so that they can increase the price. It was obvious that the deregulation of the cable industry did not help northeastern Connecticut because no competitors stepped in to offer cable. Yet, the current cable companies were allowed to increase the cost of their service, often adding cable channels that some consumers did not request or want, without needing approval from the state Department of Public Utility Control (DPUC).

Developing enough support in the U.S. Congress to pass adequate rules to give FERC control over deregulation may be difficult. Especially since the electric industry has placed and continues to place money into political PAC’s influencing politician’s decisions.

Electricity is no longer regarded as a luxury; it is a need that should be protected by our national government. Our government should not tolerate excessively high prices, frequent brownouts or blackouts, or a slow response time for utilities to restore power to areas that could lose power due to problems with the electric distribution system. These problems stem from the fact that we are using an old-fashioned distribution system that was originally built in the 1960s and not built to handle the current power demands of today.