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PPI | Policy Report | April 1, 2000
Competition in the Electric Utility Industry
Rewire Regulation to Make Markets Work For Consumers and the Environment
By Debra S. Knopman
Like other industries that were once unshakable monopolies, electric utilities in the
United States now face a rapidly shifting competitive environment. Bigger always used
to be better in the electricity industry, but that is no longer true. Smaller and more efficient
power generating and transmission technologies, and new wholesale business
arrangements offer consumers and businesses more choices at lower prices. There is no
longer an economic or technological rationale for power generation, transmission, and
distribution to be controlled by a single company. Nor should large disparities in prices
among regions persist in an increasingly interconnected electricity system.
Legislatures in nearly half the states have already hammered out their own transition
to competitive retail markets, and businesses and consumers in these states now choose
their own electricity companies.1 The rest of the states are
in various phases of legislative or public agency investigation.2 Congress is considering whether and how to direct the transition
in the electricity industry from monopolies to competitive markets--as it has already done
for airlines, trucking, railroads, and financial services.
The introduction of retail competition in the electric utility industry nationwide is
highly likely; the only questions are what the transition to a fully competitive market may
look like in the remaining states, what Congress may do to influence the outcome, and how
soon will the transition be complete.
Through their public service or public utility commissions (PUCs), states since the early
1900s have regulated the electric utility monopolies operating within their borders.3 State PUCs decide whether a utility should build a new power
plant, and how construction costs should be passed through to customers. They decide
what kind of rate of return utilities should receive on their investments in generation,
transmission, and distribution capacity; and establish power prices designed to produce
that return. Most PUCs also require utilities to operate low-income energy assistance
programs, "demand management" programs to reduce the need for
constructing new generating capacity, and other special programs. In short, states struck
complicated social bargains in their regulation of utilities. Now, states are doing the
difficult work of untangling those policies and reworking them to fit a competitive market.
The federal government regulates the transmission of electricity in interstate
commerce. Over the last two decades, Congress and regulators began taking actions that
cumulatively have had the effect of opening up competition in "wholesale"
electricity markets.4 The development of wholesale
markets--and the ability of suppliers to share transmission facilities--has made it possible
for states to allow competition among energy providers in retail markets.
Here are the top issues facing Congress and the states:
Federal action. There are several competing views of federal action on
restructuring, the term used to describe the transition from regulated monopolies to
competitive markets. One view is that Congress should wait for the states to finish their
work, and thus narrow the scope of congressional actions necessary to complete the
economic transition and cope with undesirable environmental and distributional
side-effects. Another view is that competition at the state level is being inhibited by
congressional foot-dragging on repeal of the Depression-era federal law known as the
Public Utility Holding Company Act (PUHCA), and portions of the 1978 Public Utility
Regulatory Policies Act (PURPA). In this view, federal action should be taken as soon as
possible to remove these barriers to interstate competition. A third view is that the
dominant role played by the traditional utilities will slow progress toward genuine
competition, requiring a boost in federal regulatory authority to address the problem of
"market power" (the term "deregulation" may be a misnomer, if
Congress chooses to act on the potential anti-trust issues arising from the spate of mergers
taking place in the electricity industry). Still others believe that the environmental
consequences of states-only restructuring already demonstrate the need for federal
legislation. In the fall of 1999, the Administration forwarded a detail legislative plan to
Congress.5
Mandate for state action. Some proponents of congressional action
believe that the federal government should require all states to move forward on
deregulation by a certain date, or otherwise deprive utilities in those states from competing
elsewhere. Some states oppose such a mandate, preferring to remain in full control of their
own restructuring process. The Administration and some congressional proponents
advocate a deadline on state restructuring, with provisions for an "opt out" if
states can demonstrate that customers would be better off under an alternative
arrangement.
Open access to interstate transmission and distribution facilities.
Perhaps the single most important condition for full interstate wholesale and retail
competition is the ability of suppliers to use transmission and distribution facilities
owned by others. The buzz word is "non-discrimination," meaning that
those who control these facilities may not favor their own customers, or affiliated
suppliers, over others. The policy question is how Congress should direct the
regulation and management of these common carrier lines and facilities to ensure
reliability, fairness, economic efficiency, and safety. Voluntary regional
transmission organizations already exist in some regions, but the pricing policies
among the transmission owners are inconsistent and inefficient. Another related
issue is whether the federal government should extend its power of eminent domain
to ease the building of new interstate transmission lines in situations where local
opposition may prevent the construction of lines which can benefit a larger area.
Environmental safeguards. Because the Clean Air Act exempts old--and
often dirty power plants from the same pollution controls as newer plants, restructuring
could have negative environmental consequences if it leads to a net increase in generation
from these dirtier plants. (The theory is that more competition means competition based
on price, and plants exempted from controls can afford to sell at a lower price.)
Competition also could breath life into cleaner alternative energy sources if consumers are
willing to pay a premium for solar-, wind-, or hydro power. This is a matter that Congress
should address; no state alone can protect air quality. The question is whether
environmental safeguards should be included directly in federal restructuring legislation,
or run on a parallel track of broader-based air quality legislation.6
Reliability and consumer protections. Customers value more than just
the price of electricity. They remain concerned that restructuring may reduce
reliability and access to service. The industry has a big stake in making sure that a
competitive system is just as reliable as the old system. Formed in the 1960s, the
voluntary North American Electricity Reliability Council (NERC) establishes rules
and procedures for reliability.7 NERC is presently
revamping its rules, and its membership, to accommodate competition. Congress
may choose to more tightly regulate interstate transmission, and state public service
commissions may further intensify existing oversight of consumer services. Some
also have advocated the formation of a special federal fund, fed by a small tax on
electricity sales, to pay for low income energy assistance, research on alternative
energy sources, public information, and other public programs. California and a
few other states have already established these funds.
Renewable energy sources. Some states like California, Pennsylvania,
and New Jersey require all electric competitors to offer a set percentage of their electricity
from renewable energy sources. Some environmental advocates would like to see a
requirement on renewables set in federal legislation. The Administration's proposal
includes a "renewables portfolio standard" of 8 percent of electricity sold in
competitive markets. If renewables obligations could be traded among suppliers, the
economic efficiency of the portfolio standard could be enhanced. Some industry advocates
oppose any federal mandate on renewables.
Stranded assets. Stranded assets are large utility investments that were
undertaken in part to satisfy past public service commission requirements to build
additional generating capacity to serve projected demand. These assets are valued between
$100 billion to 200 billion.8 In a competitive market, some
utilities may be unable to recover costs of constructing nuclear power plants and other
large facilities and still offer competitive rates. The policy question is whether the federal
government should impose requirements on the states that allow utilities to be
compensated for their likely losses. In reality, states are managing to reach their own
accommodations on stranded assets, and hence it is unlikely that Congress will choose to
intervene.
Preferences for public power. In the highly regulated world of the past,
electricity was provided by either investor-owned utilities or public power agencies at the
regional and local levels. Nearly 80 percent of the electricity purchased in the U.S. comes
through investor-owned utilities. 9 Public power agencies
like municipal and rural electric cooperatives were instrumental in electrifying rural and
other under served areas. In return for offering universal access to electricity and
providing other services, public power agencies could issue tax-free bonds to raise capital.
The policy question is whether these agencies should continue to receive their
"preference" under the tax code, or be treated like other utilities if they operate
in competitive markets.
Power marketing administrations. Some regions get their electricity
from federal hydro power projects and other facilities whose construction and operations
have been subsidized by taxpayers. Some proponents of restructuring believe that power
marketing administrations (like Bonneville Power Authority, Tennessee Valley Authority,
and Western Area Power Administration) lose their rationale for existence in a competitive
market. Because their prices tend to be lower than the national average, regions served by
power marketing administrations generally resist efforts to eliminate them.
Electricity prices vary widely across the country: in 1999, a kilowatt-hour in New York
cost residential users about 14 cents compared to 5 cents in Washington State, home of the
federally-backed Bonneville Power Administration.10 As
a consequence, state interest in letting competitive markets set prices varies widely. In the
states that have already taken action to restructure the industry, pressure to act typically
came from energy suppliers who clearly saw benefits for themselves, and from large
industrial users with the clout to negotiate competitive rates.
The issue of restructuring is sufficiently complex and variable from state to state that
few in Congress appear to have the confidence to move forward on restructuring
legislation at this time. Indeed, the lessons learned from the states that have moved toward
retail competition thus far point to the care Congress will need to exercise in moving the
transition to retail competition forward:
Retail competition does not happen overnight. In some states like Ohio and Arizona,
the previously established utilities continue to have the advantage of
"incumbency," and competition has barely emerged. Ohio has built in a five-
to ten-year transition period. In Arizona, the goal is to offer 100 percent of consumers retail
choice by the close of the 2000, but delaying actions by regulators slow the pace for the
investor-owned utilities.11
Savings to customers may not be seen for years. Because of the stranded assets
problem, the transition to retail competition may be slow in states like New York that
promised their existing providers that they would be compensated for their prior
investments in generating capacity. To demonstrate progress to consumers before real
competition develops, most states, including New York, have mandated rate reductions
of 4 to 10 percent over the next several years.
Markets need credible and accessible information about prices, quality of services,
and environmental claims. Consumer education is vital. Pennsylvania is widely credited
with the most effective consumer information campaign among the states. For example,
as of April 1, 2000, about 15 percent of the residential customers of Pennsylvania's largest
utility, PECO Energy (formerly Philadelphia Electric Company), had switched to
alternative suppliers, and more than 60 percent of its industrial customers.12 In contrast, California's retail market began a year earlier than
Pennsylvania's, but only about 2 percent of its residential customers have so far made a
switch.13 Consumers in Arizona, where public outreach
was minimal, have barely nibbled.
Most states look for federal regulatory leadership. As the role of the state public
service commissions change--and diminish--states are looking to the Federal Energy
Regulatory Commission (FERC), to effectively oversee mergers and acquisitions, ensure
a level playing field for interstate transmission, and foster truly competitive markets at the
retail level.
Depending on their particular blend of assets, some existing utilities stand to gain from
restructuring; others saddled with large power plants that have not been paid off yet are
less certain whether they can survive in a competitive environment. As a consequence of
these differences, the investor-owned utility trade group, the Edison Electric Institute (EEI),
has been reticent to press for pre-emptive federal action. Instead, EEI has advocated that
the states continue to work through their own restructuring programs while Congress
focuses on removing federal barriers to competition and addressing transmission and
reliability.14
In those states that have yet to take the plunge, uncertainty among consumers and
regulators is greater about the relative benefits of restructuring. Most consumers will see
lower prices from competition, but consumers in some regions--particularly those that have
benefitted from historically low-cost hydro power from federally-subsidized projects--may
actually see their rates go up. Consumer interest groups are mostly focusing on public
right-to-know about their choices in a competitive market, assurances of reliability and
universal service, and concerns about anti-competitive practices in a less regulated
industry.
With time short in an election year, Congress will likely use the remainder of 2000 to hold
hearings and keep watching the action in the states. Although efforts will be made to
address reliability issues before the summer to lessen the chance of blackouts,
congressional advocates of more comprehensive reform will likely resist a piecemeal
approach.
Several comprehensive restructuring bills have been introduced in Congress so far.
On October 27, 1999, the House Energy and Power Subcommittee reported H.R. 2944, the
Electricity Competition and Reliability Act, championed by Subcommittee Chairman Rep.
Joe Barton (R-TX). Other bills with more limited scope have been introduced by, among
others, Reps. Largent (R-OK) and Markey (D-MA), H.R. 2050; Reps. Waxman (D-CA) and
Boehlert (R-NY), H.R. 2900; Rep. Pallone (D-NJ), H.R. 2569. Senators Murkowski (R-AK)
and Landrieu (D-LA) introduced a comprehensive bill, S. 2098, on February 24, 2000. In
May 1999, the Clinton Administration's comprehensive restructuring proposal was
introduced by request on the House side by Reps. Bliley (R-VA) and Dingell (D-MI) as H.R.
1828, and on the Senate side by Senators Murkowski and Bingaman (D-NM) as S. 1047 and
S. 1048.
Senators Jeffords (R-VT) and Lieberman (D-CT) introduced S. 1369, the Clean Energy
Act, to revamp controls on power plant pollution emissions and address other consumer
issues related to restructuring. Senator Slade Gorton (R-WA) introduced S. 2071, the
Electric Reliability 2000 Act, to deal specifically with the reliability of the interstate
transmission grid.
The goal of restructuring is to improve economic efficiency through genuine
competitive retail markets in electricity. Such markets would have room for many buyers
and sellers offering products and services based on their present merits and not on their
previous position in the old world of utility monopolies. Consumers--regardless of income
level--should reap the full benefits of competition, not just the utilities and large business
customers who are thus far its strongest advocates.
Here are the basic principles that should guide congressional and state actions:
Grow markets, not new monopolies. The benefits of competitive electricity
markets are worth fighting for: lower prices, regional parity in pricing, and market
pressure for cleaner and more efficient energy sources. However, Congress and state
legislatures--and the state PUCs--still need to guard against the resurgence of de facto
monopolies in energy supply through vigilant oversight.
Redesign federal regulation. The states created the tangle of utility
regulation; they need to do most of the untangling--including compensation for stranded
assets--to clear the way for full and fair competition. Congress should focus on breaking
down the barriers to interstate commerce, entry to competitive markets, and threats to the
environment. For example, transmission lines and pipelines need to be better regulated
to assure reliable, fair, and open access. Sufficient experience has now been gained at the
state level to support federal legislation.
Protect consumer interests. State legislatures and Congress--where
interstate commerce and the environment are concerned separately need to take active
steps to ensure reliable service, universal access to competitive rates, accessible and
transparent consumer information, consumer protections against unfair business practices
like "slamming," and sufficient environmental protections. In those states
where restructuring is still under consideration, the state PUC--or some other credible,
independent source--should conduct an analysis of the likely benefits and costs of
restructuring to consumers and businesses.
Level the playing field. Economic subsidies to producers in
competitive markets distort investments and other economic choices. Subsidies for
particular fuels and technologies should be phased out. The four federal power
marketing administrations (PMAs) and the Tennessee Valley Authority are
complicated operations closely tied to regional economic development. Until details
of how they might be converted to a competitive market are thought through,
PMAs should not be allowed to compete with for-profit enterprises while still
retaining the competitive advantages connected to their non-profit
status.
Protect the environment. Congress should champion "cap and
trade" emissions programs for sulfur dioxide, nitrogen oxides, and greenhouse gases
as the most market-friendly and effective means of controlling the environmental
consequences of restructuring. Reducing dependency on fossil fuels is best accomplished
through the discipline of a cap and trade domestic emissions trading program for
greenhouse gases. At a minimum, Congress should act on emissions trading for nitrogen
oxides from power plants before or in parallel with restructuring legislation.
Honor state choice. Congress should not force states to provide their
consumers with a competitive retail market by a certain date, but should make sure that
retail competition is not impaired in states that have chosen to restructure, for example, by
restrictive use of transmission facilities in the "closed" states.
Give renewables a chance. Congress should set a specific percentage
requirement on renewable energy sold, but allow suppliers to trade their renewables
obligations across state lines to achieve higher levels of economic efficiency.
Simultaneously, Congress should phase out market-distorting tax and spending subsidies
for non-renewable energy sources.
Judge public power on its merits in specific regions. Preference for
public power should not be removed across the board. Instead federal and state regulators
should consider it on a case-by-case basis, depending on the competitive conditions and
service options available to consumers and businesses in the affected areas. Preference
should be withdrawn prospectively from those public power entities that choose to
compete with for-profit enterprises.
Because restructuring is already underway and is certain to continue, members of
Congress and legislators in the still-regulated states continue to have the opportunity to
influence the shape and speed of the transition to competition. Leaders in these states
should drive toward full competition with the goal of providing the most efficient and
reliable system for all users. However, they should also redefine regulation in a
competitive market-- recognizing that regulators still need to play an active role in
ensuring universal access, setting standards for reliability, blocking monopolistic mergers
and activities, devising public disclosure requirements, and protecting the environment.
Rewiring the market rules for a complex, heavily regulated, capital-intensive electric
industry is as difficult as any previous efforts to introduce competition in other
monopoly-dominated economic sectors. Utility restructuring is already happening, but its
success ultimately will be judged by whether consumers see prices drop and the industry
burns cleanly and runs fairly. For now, the jury is still out.
1. Restructuring legislation has been enacted in:New Hampshire, New Jersey, New
Mexico, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, Texas, and Virginia.
Comprehensive regulatory orders have been issued in: Michigan, New York, and Vermont.
2. Energy Information Administration, Status of
State Electric Industry Restructuring Activity as of January 1, 2000.
3. For a good overall summary, see Timothy J. Brennan, Karen L. Palmer, Raymond J.
Kopp, Alan J. Krupnick, Vito Stagliano, and Dallas Burtraw, A Shock to the System:
Restructuring America's Electricity Industry (Washington, DC: Resources For the
Future, 1996).
4. Key actions included: the 1978 Public Utility Regulatory Policy Act (PURPA), the
Energy Policy Act of 1992 (amending sections 211 and 212 of the Federal Power Act of
1935), the Federal Energy Regulatory Administration (FERC) Order 888, which set new
rules for transmitting wholesale power.
5. The Administration's proposal was introduced by request in the House as H.R. 1828,
and in the Senate as S. 1047 and S. 1048.
6. For example, the Jeffords-Lieberman Clean Energy Act (S. 1369) would eliminate the
distinction between old and new power plants; control multiple air pollutant and carbon
dioxide emissions; and rely on flexible market mechanisms like emissions trading to gain
economic efficiency. For more information, see Senator Joseph I. Lieberman, "Planning for
grandfather's retirement," The Environmental Forum, Vol. 17, No. 2, pages 46-47,
March/April, 2000.
7. For general information on NERC, see NERC.Com
8. Energy Information Administration, The Changing Structure of the Electric Power Industry: Select Issues, 1998,
Executive
Summary
9. Brennan and others (see note #2), page 20.
10.
Energy Information Administration 1999 data.
11. Energy
Information Administration April 2000 data.
12. Pennsylvania Office of Consumer Advocate Pennsylvania
Electric Shopping Statistics, April 1, 2000. (See testimony of Irwin A. Popowsky,
Consumer Advocate of Pennsylvania, May 27, 1999,
13.
California Public Utility Commission February 29, 2000 data.
14. Edison Electric Institute, Straight Talk about Electricity Competition Rules,
Debra Knopman is the director of the Progressive Policy Institute's (PPI) Center
for Innovation & the Environment. The author wishes to thank Scott Hempling, Attorney
at Law, and Joan Simmons, consultant, for their comments on an earlier draft of this
policy brief; their reviews do not imply endorsement.
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