How DWP Can Become Competitive When Deregulation Hits

Deregulation of California’s electric utilities is finally law--and for L.A.’s elected officials, who oversee the municipally owned Department of Water and Power, the tough choices are just beginning.

Specifically, the new law, signed by Gov. Pete Wilson last week, will force the mayor and City Council to choose between the city’s large business customers demanding low-cost power and its residential and small-commercial users who have long enjoyed lower rates because of a $265-million annual subsidy. That decision is likely to be put off until after municipal elections next spring. But when the council debates and votes on a proposed $25-million rate reduction for DWP’s largest commercial and industrial customers early next month, we may get a hint of which way the council members are leaning.

The new law compromised the competing interests of corporate and residential users, but only for investor-owned utilities. Residential customers of Southern California Edison, for example, will receive an immediate 10% cut in their utility rates. The promised reduction eliminated virtually all resistance to deregulation, and big business, led by the California Manufacturers Assn., succeeded in finally establishing a competitive market in the electric-utility industry.

The deregulation law encourages municipal utilities to join the game, too, allowing them to collect a “competitive transition charge” if they do. This charge, which investor-owned utilities can also impose, enables them to recover their investment in power generation that is no longer economic in a deregulated marketplace. As a result, deregulation need not mean debt default or even bankruptcy.

The right to impose such a transition charge should be a significant inducement for the DWP to enter the waters of competition. The utility has more than $8 billion in outstanding debt, several times, proportionately, that of private utilities. Until that debt is paid down, DWP cannot begin to be competitive. It will take a combination of new savings and revenues of at least $350 million a year to accomplish that--in 10 years. Forgoing the opportunity to collect a transition charge would make it extremely difficult for the DWP to ever be competitive.

Under the new law, municipal utilities that want to collect the transition charge must begin to phase in direct competition for their customers by New Years’ Day 2000, two years after investor-owned utilities must start. But they can take until the end of 2010 to complete implementation, almost eight years after the private-utility deadline. Most important for municipal utilities, their governing bodies can determine how much to change rates and how long to take to write off pre-deregulation investments using the competitive-transition charge.

Unlike the investor-owned utilities, the DWP will not want to lower its residential rates, because they are already 25% lower than, say, Edison’s. It would be more logical for the utility to raise the rates of its long-subsidized residential and small-commercial users, applying the additional revenue to reducing its debt.

Eventually, city residential customers may reap the benefits of deregulation when “aggregators” form large blocs of them to bargain for lower rates. Until then, the most immediate and intense competition will be for the business of large customers that already have major buying clout. DWP’s 100 largest customers account for approximately 20% of its revenues, a large chunk of cash flow of any organization.

But its electric rates already put many of these large customers at a competitive disadvantage vis-a-vis rivals that are supplied by investor-owned utilities. Consequently, the DWP has asked the City Council to approve the $25-million rate cut for these users to diminish the rate disparity in the short term.

If Los Angeles wants to attract new business, while retaining and encouraging expansion of its existing business, it is going to have to bite the bullet and permit the DWP to compete head-on with private utilities. That means the council should approve the rate cut.

Historically, the city has used the DWP as one of its chief magnets for bringing in new business. It would be a sad irony, indeed, if the utility were to become an impediment because of its relatively high rates. The only way to avoid such a fate is to reduce DWP’s debt fast.

Toward that end, city officials should end the DWP’s annual $100-million transfer to the general fund and, yes, eliminate the subsidy for residential and small-commercial customers. These solutions do not incorporate the new law’s politically attractive compromise for residential customers. But residential customers in Los Angeles already have, and will continue to have, lower rates than their friends served by private utilities.