Let Market Forces Prevail in the Deregulation of Electric Utilities

Deregulation, for the most part, has proven to be a good deal for American consumers. We are past most of the bumps brought by changes in essential industries, such as transportation, airlines, trucks and railroads, telecommunications, banking and natural gas.

So what is in store for the electric industry, the last of the so-called natural monopolies to undergo transformation?

The quick answer is that it’s too soon to tell. The picture is still fuzzy. But if you are a follower of macroeconomic forces, you most likely are optimistic that things will work out, even if they unfold unevenly across the United States.

At this point, the only serious setback will come if government--at all levels--tries to inject itself too much in the process. I make this claim having closely studied the unfolding of electric restructuring in California over the past six months, and having observed that the push of market forces, locally and nationally, is already leaving a positive mark on the economy and on consumers. There is no reason for government to micro-manage the transformation, although it obviously will still have a legitimate role to play.

To understand and help smooth the transition, we must first remember where we have been and where we are right now. The past is easy because for most of the 20th Century there was little change. Describing the present is more difficult.

Historically, electricity was viewed as an essential service that was best provided by tightly regulated, local monopolies--either owned by investors or the government. With the growth of America and the growth of the great industrial fortunes of the early 20th Century, abuses by large concentrations of wealth (“holding companies”) spurred legal restrictions and close regulation of utilities. This occurred in the 1930s and stayed unchanged for decades.

During that period electric utilities became increasingly vertically integrated, with ever-larger companies controlling all aspects of the business: power generation, transmission and distribution to customers. Imagine the agriculture industry if production, processing, transport and retail markets were all tightly controlled by local monopolies.

For electricity, things began to change in 1978 when Congress passed the Public Utilities Regulatory Policy Act. For the first time, federal law encouraged those besides investor-owned or government-run utilities to produce electricity.

Out of that law came the development of independent power producers which were guaranteed a market through local utility companies that would buy whatever power was produced. Regulators at the same time continued to stress two aspects in their oversight: safe, reliable power, and fair, reasonable rates.

The two were not always compatible. With incentives to invest more and more in generating capacity and other capital assets to earn a profit, utilities overbuilt capacity and transmission, and regulators went along with it for the assurances it provided consumers. This excess measure of reliability skewed economics when regulators charged the cost of these capital improvements back to the customers. As appointees of elected officials, regulators assessed rate increases most heavily on large-volume business customers and less on smaller customers, who are also the voters who elect the bosses of the regulators.

These subsidies by business--which existed in the other essential industries before their deregulation--made for bad economic policy, but good politics. And it happened for both investor-owned and government-run utilities. The Los Angeles City Council for years has shielded the Department of Water and Power’s residential customers from the full economic impact of running the nation’s largest municipal electric utility. As a result, L.A. residential customers pay relatively low rates today; businesses, which increasingly are threatening to leave the city, are paying uncompetitively high electric rates.

Before the 1980s, when the United States still operated as a virtual monopoly in most global markets, these subsidies by American businesses could be tolerated. Today they amount to economic suicide if they are left unaddressed. How do we obtain a level playing field for utilities and non-utility players in a restructured electric industry?

I know what won’t work: more government mandates put into law to respond to political concerns. What will work is already under way: common sense economic responses to market pressures--whether it’s a wholesale pool or direct access contracts between generators and customers.

Developments in California since the federal Energy Policy Act of late 1992, which offers more incentives for opening up the electric industry, make it clear that electric restructuring is already here. The major players--utilities, marketers and regulators--are already pushing ahead. (In less than two years, the number of electric marketers/brokers has increased from a handful to more than 100, and they will probably number more than 1,000 in another year.)

All major California utilities have frozen their rates and have publicly committed themselves to decreases in their average rates of up to 25% in the next five years. Operations and staffing are being streamlined at all the major power providers as they rush to cut costs. Customers are being offered more choices of how they get their power and what they pay for it. The quasi-social-welfare role of public utilities is being redefined, and this is one of the areas in which elected officials should concentrate their efforts in the months ahead.

All that is needed now is for leadership in both the private and public sectors to harness the full power to open markets that is already under way. I would urge that we don’t try to slow the momentum; rather, stimulate it. Listen to the bold demands of customers and respond. It can reignite California’s anemic economy and help U.S. business compete more effectively worldwide by having energy that is safe, reliable and priced competitively. Not all of the existing players will be winners, but consumers should be.

In fact, it is the customers, through organized coalitions, from whom more needs to be heard. Large manufacturing and oil interests last week combined with environmental and consumer groups to oppose the proposed power pool approach. Earlier, another coalition with smaller businesses, environmental and consumer groups endorsed the proposal. They both have legitimate concerns that must be accommodated.

Electric utilities must respond boldly and redefine themselves, and in some cases, dismantle themselves by separating generation, transmission and distribution to give customers more choices. And regulators need to redefine themselves too.

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But rather than incentives to build ever-greater (and more expensive) infrastructure, the emphasis in the next decade will be on operating more efficiently. Thus, the so-called performance-based rate-making will assign profits based on how efficiently electric power is distributed to the users--not by new capital investments.

It can be argued, I think, that current reliability, safety, research and technological transfer in the U.S. electric industry is the envy of the world. It is only in the area of rates that we are not competitive on a worldwide basis. Thus, there is no reason for a lot of time-consuming political interference. There are no “bad guys” to round up as there were earlier in the 20th Century.

We can all be winners if the long-term interests of consumers are put ahead of short-term tinkering. The electric industry and some in the regulatory community, particularly in California, are addressing the transformation. They should push ahead. The state Legislature should add political motivation and oversight, but get out of the path of economic forces that are greater than a single state or nation.