Electric Power Industry Deregulation Essay, Research Paper
The roots of modern day regulation can be traced all the way back to the late 1800’s and found in the form of antitrust. By the beginning of the 20th century, the U.S. government had formed the interstate Commerce Commission to regulate the railroad industry, and shortly thereafter, many other regulatory commissions were founded in the transportation, communication, and securities fields. The main goal of these regulatory commissions was to create a reasonable rate structure that would be appealing to both producers and consumers. While this system has worked for many years, it has recently come under heavy criticism, with many people pushing for open competition among electric power producers. Although once believed to be an impossible proposal, competition among electric power producers is finally a reality in a few areas. Massachusetts is just one state where legislation implemented to create competition among electric power producers is not only favored by the people of the state, but has also provided significant rate reductions as well.
The attempt at regulating price in the electric industry is a troublesome one. The objective is not only to minimize the cost to consumers, but also to create a rate structure that will entice the electric company to remain in the industry. The regulatory commission wants the electric company to have a reason to innovate so that they will be able to provide cheaper power in the future. However, if the commission captures all gains from innovation in the form of lower prices, then the electric company has no incentive to undertake any type of innovation. Therefore, a compromise must be reached which would provide adequate incentives for firms to undertake cost-reducing actions while at the same time ensuring that the price for consumers is not exorbitant.
The term regulation refers to government controlled restrictions on firm decisions over price, quantity, and entry and exit. Each factor of an industry must be regulated for producers and consumers to truly benefit. The control of price does not mean setting one fixed price, but rather entails the creation of a price structure for purchasing electricity during peak and non-peak times. The control of quantity refers to the government’s attempt to control the amount produced or in this case the amount of electricity produced. For example, in the electric industry, it does not make sense to have a lot of small power plants produce electricity. However, at the same time one company can not be allowed to monopolize the industry and set prices at its own discretion. Another factor in this problem is the control of entry and exit in the electric industry. By controlling who can enter the industry, the government can control who produces the electricity and how much of it they produce. However, the effectiveness of regulation has begun to be questioned, and created the evolution of a more competitive market.
Ever since the Public Utility Act of 1935, which in turn created the Federal Power Commission, the role of electric utility regulation and its effectiveness has been questioned. Since that act was passed into legislation, the question has always remained: has electric regulation made a difference? Major studies done throughout the 20th century found conflicting results. A study published in 1962 and conducted by Stigler and Friedland compared the price of electricity in states with regulation to the price in states without regulation. However, at the time all states had electric regulation, so Stigler and Friedland had to go back to the 1920’s and 1930’s to find states without regulation. Their finding was as expected. In 1922, the average price of electricity was 2.44 cents per kilowatt-hour in states with regulation. However, in states without regulation, the average price increased to 3.87 cents per kilowatt-hour. While many would say that prices could vary for reasons other than regulation, Stigler and Friedland controlled the analysis of other variables and found that no significant difference in price existed. Other critics felt that this study was done in a time when regulation was just getting started, and that regulators in the present day are more effective.
Two other studies which found different results were those conducted by Meyer and Leland and another done by Greene and Smiley. In their study, which used data from 1969 and 1974, Meyer and Leland utilized econometric estimates of demand and costs to find hypothetical unregulated prices. Their conclusion was that the regulated prices were significantly lower, but that even lower prices were demanded. In a similar study conducted by Greene and Smiley, they found that unregulated prices were 20-50% higher than actual regulated prices. Although these studies seem to reach conclusions that support regulation, the alternative finding by Leland and Meyer that even lower prices were demanded seems to be an indication towards open competition among electric producers. Soon thereafter, the trend toward competition between electric producers began to emerge.
The passage of the Energy Policy Act in 1992 created the first means of competition among electric companies by giving the government power to order companies to “wheel” power from one company, over their own lines, to another company. In 1990, there were over 3,000 electric systems in the U.S. alone, and most of them were publicly owned. However, the 267 privately owned utilities accounted for 71% of the sale of electricity. Also, most of these privately owned utilities have been vertically integrated, meaning they own the power plants, the substations, the transmission lines, and the distribution systems. The different utilities are then linked through a national grid, meaning it is possible for the sale of power, or wholesale wheeling, from one utility to the other. The Federal Energy Regulatory Commission is responsible for the regulation of these wholesale transactions, and has done so through market based transactions. As wholesale wheeling has become more important, large industrial buyers have begun to demand participation. Instead of only being able to buy power through their local utility, they want the choice to purchase it from other companies, thereby creating some type of open market competition. As this has
occurred, the trend has trickled down to the individual consumer level, thereby creating legislation such as the Massachusetts Electric Utility Industry Restructuring Act that was signed into law on November 25, 1997, and upheld with the passage of Issue 4 in the general election on November 4, 1998. This piece of legislation has allowed consumers to choose their power supplier, and has led to decreased prices without regulation.
The Massachusetts Electricity Law, passed by legislature and signed into law on November 25, 1997, was developed over three years with input and support from consumer advocates, small businesses and large employers, energy providers and experts, labor and environmental groups. The main objective of the new law was to allow Massachusetts consumers to choose their electricity supplier by breaking up the utility monopolies, and creating competition that will lead to lower rates in the future. Under the new law, local electric companies still own and maintain the wires that bring the electricity to homes and businesses, but consumers are now able to choose the company that provides the electricity they use. The distribution of electricity remains regulated to ensure reliable service to all consumers and to set distribution rates based on cost and performance, not at market prices. However, competitive power suppliers whose prices for electricity are not regulated now provide the generation of electricity.
In addition to breaking up the utility monopolies, the new law also provides electricity rate cuts to consumers while they choose which company to buy their electricity from. The rates are guaranteed to drop 15%, with 10% coming by March 1, 1998 and another 5% occurring by September 1, 1999, as the law provides a rate cap to lock these lower rates in for years to come. The law also provides the opportunity to eliminate sales tax on electricity transmission costs for non-industrial businesses, saving this sector an estimated $30 million a year. The law also created a 10% rate discount for farmers and others in the agricultural industry. Therefore, under the new system, your local electric company still delivers electricity to your home or business. However, you can purchase the electricity from the local company at the guaranteed minimum rate reduction, or you can choose to buy your electricity from another competing supplier if you decide that company offers better rates.
In addition to lowering rates and allowing consumers to choose their power suppliers, the new law also provides many other provisions designed to protect the consumer. The law requires all competitive power suppliers to be registered with the state Department of Telecommunications and Energy, and also requires the suppliers to continue to provide reliable service. The law also prohibits suppliers from switching a customer to a different supplier without the customer’s consent. The law also creates rate reductions for low-income consumers, such as senior citizens on a fixed income. As well as providing for these consumer protections, the law also entices economic growth within the state by lowering the cost of doing business through lower electric rates. This lower cost of doing business due to lower electric rates will encourage new employers, both large and small, to move into Massachusetts, as well as encouraging existing businesses to stay. In fact, in the short period of time the law has been in effect, it has spurred the forecasts of new job growth, and in the years ahead, is expected to create thousands of new jobs throughout Massachusetts. However, even though the law seems to have many more benefits than it does negatives, it has come under recent criticism.
Many opponents of the law feel it is not doing its designed purpose, and consumer backlash was so great that Issue 4 asking whether or not the law should be repealed. An organization called “The Campaign for Fair Electric Rates”, backed by failed congressional candidate John O’Connor and consumer advocate Ralph Nader, led the effort to repeal the law, calling it “the biggest consumer rip-off in Massachusetts history”. The big issue involved in the attempted repeal was lawmaker reneging on their promise to protect consumers by allowing utilities to recover 100% of their bad investments. Because deregulation will cause some utilities to lose money on investments in power plants or on contracts they made when they expected to keep selling power at a regulated price, the question becomes do they deserve compensation for these “stranded costs”, which may approach $200 billion nationally?
For instance, utilities spent more than $5 billion building the Seabrook nuclear plant in New Hampshire, which produces 1,150 megawatts. In contrast, private developers have proposed more than 50 new plants, which combined would produce 30,000 megawatts, and the cost of these projects is estimated at slightly more than $15 billion. The utilities argue that public regulators approved those expenses and that the state can not back out on them now, stating that many plants have already begun to implement the new law, including selling most of their power plants. Repealing the law now, they argue, would create utter chaos. Therefore, a provision was written into the law allowing for utilities to recover all of their stranded costs over a 10-year transition period. While proponents of the law were hoping for a 30% rate reduction, of which two-thirds would have come from consumers not having to pay for most of the utilities stranded investments, they will now have to settle for a guaranteed 15% rate cut, hopefully with more to come through competition.
The question now on everyone’s mind is: has the law served its purpose and reduced electric rates? In a study done by Standard and Poor’s DRI entitled “Economic and Environmental Analysis of the New Massachusetts Electricity Law”, and released on September 2, 1998, it found that the new has triggered “substantial economic and environmental benefits”. According to the study, electric rates will decline by almost 28% by the year 2010 as a direct result of retail competition and industry restructuring. The DRI, a conservative report when compared to others, predicts that consumers will save $470 million in 1998 alone, and increases that estimate to at least $550 million per year in future years as a result of the new law. Also, the study predicts the Commonwealth to achieve higher economic output and employment growth triggered by the estimated $10 billion consumers and businesses will save on electricity costs. By 2010, there will be over 60,000 more jobs, a $19.6 billion gain in consumers’ cumulative real discretionary income, and lower price inflation. All of this forecasting appears to put the law in a favorable light, but many want to know how it’s working now.
According to the Massachusetts Electric Company, its 970,000 customers have saved a total of $67 million on their electricity bills in the first six months of the new electricity law. On September 1, savings for the company’s customers increased to more than 15%, or a total savings of $25 million per month, one full year ahead of the required rate cut. This was due to the company’s affiliates selling their power plants. Therefore, by examining the early results of the new law, along with projections such as the ones provided by Standard and Poor, one can determine that the deregulation of the electric industry has been long overdue.