Commentary

Lights Out on Electric Restructuring?

By Jerry Taylor and Peter Van Doren
This article appeared in the San Francisco Chronicle on June 25, 1998.

After a massive multiyear lobbying campaign, the business community finally achieved the unthinkable: the breakup of the mighty California electric utility monopoly. Utilities are now required to turn their private power lines into public electricity highways and must transmit power from anybody who wants to generate it to anyone who wants to buy it. Residential and business customers can now finally choose their electricity provider and, presumably, save money.

But after three months, California’s brave new world of “competition” is on life support. Despite months of intense advertising and promotional campaigns by third-party marketers, only 66,294 residential customers (or about 9 percent of California ratepayers) have opted to switch to a different electric company. Accordingly, nonutility competitors are preparing a massive retreat from the Golden State. What went wrong?

The short answer is that politicians rather than market forces designed the system. The net effect was to stifle the very market forces necessary to drive down California’s sky-high utility rates.

Utilities worried that, in a free market, most of their high-cost nuclear plants and renewable sources of electricity would prove so uncompetitive that bankruptcy could result. The California Legislature thus allowed utilities to impose a “transition charge” on customers who abandon their high-priced electricity for cheaper nonutility power generators.

Consumer activists, worried that prices might rise, lobbied successfully for a provision to freeze retail rates at 1996 levels. As a result, customers who switch from a traditional utility to a new power marketer pay the wholesale price for power, plus a delivery charge plus a variable transition charge: The sum cannot exceed the 1996 electric rate.

But since a rate freeze did not offer anything to consumers that they did not already have, the Legislature decided to mandate a 10 percent rate cut for all residential and small business customers. The reduction was purchased through selling 10-year bonds issued by an off-budget state agency. The bonds are essentially a device for shifting the costs of uneconomic nuclear and renewable power from the utilities to the ratepayers.

The upshot is that rates are artificially inflated by regulation and no one can significantly underprice anyone else. Ratepayers have thus chosen to stick with the devil they know.

The collapse of “managed competition” in electricity is not confined to California. Massachusetts and Rhode Island have both opened California-style electricity markets. In Massachusetts, more than 40 companies planned to enter the retail power market, but only three have. In Rhode Island, only a few of the state’s ratepayers have left their utilities since choice was afforded them last summer.

It should be clear by now that utility restructuring, as it’s currently conceived, is but a reshuffling of deck chairs on the regulatory Titanic. Why not try real deregulation? The elimination of governmentally imposed restrictions on entry and prices is all that is necessary.

Without regulatory protection, some utilities would undoubtedly face competition, as they currently do in those parts of the country where such things are allowed. Utilities that escape direct competition would encounter rivalry from natural-gas-fired electricity generators or even natural gas firms themselves. Moreover, simply removing subsidies and allowing ratepayers the choice of abandoning high-cost power would slice a lot off of utility bills.

The mere threat of competition would likely tame even the most aggressive utility company, particularly since studies show those companies are already charging more than the optimum rate. Bills have nowhere to go but down. It’s the regulators and legislators — the advocates of restructuring — that stand in the way of real rate savings for California consumers.

Jerry Taylor is director of natural resource studies at the Cato Institute. Peter VanDoren is editor-in-chief of Regulation magazine.