The Cato Review of Business & Government
The Cato Review of Business & Government
Washington International Energy Group
If one were asked to pinpoint a date when the U.S. electric utility industry "hit bottom," it probably would be February 11, 1985, when Forbes' cover story, "Nuclear Follies," compared the U.S. utility industry's $125 billion investment in nuclear power plants to the total cost of the Vietnam War ($111 billion) and called the country's discredited nuclear power program "a defeat for the U.S. consumer and for the competitiveness of U.S. industry."
For years, America's electric power industry hummed along as one big, happy fraternity of monopolies, to which senior citizens could turn for steady dividends. But the days of such security began to vanish exponentially with the erection of huge cooling towers beside the nuclear power plants, whose construction costs were rapidly going out of control. While antinuclear activists demonstrated at power plant construction sites, business customers of the utilities began to protest that the growth of electric power rates was increasing their own cost of doing business. Executives from auto, steel, chemical, and other industries joined antinuclear activists in regulatory proceedings to deny utilities the compensation they needed to pay off the rising debt incurred by the construction cost overruns.
Nuclear power was not the sole source of the electric utility industry's declining credibility. Construction cost overruns also plagued coal-fired plants. In addition, utilities that also sold natural gas had to pass through to their customers the higher-than-expected costs of rising natural gas prices from the energy crunch of the late l970s and early 1980s.
Congressional inquiries into the economic disasters confronting the nation's utilities became commonplace in the early 1980s. Politicians conducted inquiries into how the public trust was being betrayed by sloppy corporate management, inattentive regulators, and incompetent contractors. The "hit list" of consumer wrath included such nuclear plants as Shoreham in New York, Marble Hill in Indiana, Zimmer in Ohio, Midland in Michigan, Seabrook in New Hampshire, and Three Mile Island in Pennsylvania.
The situation was ripe for a revolution in the way the utility business was being run. The seed for such a revolution was planted by a utility industry executive, William Berry, president of Virginia Power Company, who suggested that a less monopolized, more competitive industry might be a better answer. In 1982 Forbes described Berry's dismay at the economic inefficiency of plants sitting idle because they could only deliver power when it was needed by the utility that owned the plant. New generating capacity, he said, was not being constructed where and by whom it could be built most cheaply.
Berry proposed breaking up the industry's traditional, vertically integrated structure of generators, transmission lines, and distribution facilities into separate entities with generators competing for sales across common transmission lines to local distribution outlets. Under such a system, Berry thought, generators would be in competition with each other to serve more than one utility distributor. Thus, the generators selling electricity at the lowest cost would have the most utility customers. The days of utility generators' enjoying monopoly status would be over.
Although most of Berry's colleagues dismissed his proposal, a number of key staffers at the Department of Energy thought that his suggestion was consistent with the notion of deregulating monopolies-a centerpiece of Reagan administration thinking.
In 1986 President Reagan nominated Martha Hesse to be chairman of the Federal Energy Regulatory Commission (FERC), the agency with responsibility for regulating the wholesale electric power business. Together with two other commissioners-Charles Stalon, an economist, and C. M. Naeve, an attorney-Hesse laid the political groundwork for bringing more competition into the electric power industry. Her staffers held a series of public inquiries into issues concerning the generation and transmission of wholesale electric power.
Almost immediately, the electric power industry was thrown into turmoil. On one side was the traditional, vertically integrated utility industry, which was determined to preserve the way it had been doing business for more than fifty years. On the other side were large industrial consumers of electricity, who were eagerly searching for new ways to discipline what they saw as an industry out of control, and a new class of nonutility generating companies whose existence was spawned by the controversial Public Utility Regulatory Policies Act of 1978 (PURPA). That act established a favored regulatory environment to stimulate development of solar, wind, geothermal, waste-to-energy and cogeneration power production facilities as alternatives to traditional utility plants. Ever since PURPA was enacted, utilities fought the efforts of those power producers to gain access to their transmission systems.
Recognizing that consumer unrest with past utility practices was strong, particularly among industrial consumers, and that policymakers and politicians intended to question the way their business was run, a number of utility executives allied with Berry. On September 4, 1987, twelve electric utility chief executive officers sent a letter to all five FERC commissioners to endorse Hesse's effort to craft rules bringing more competition into the wholesale electric power industry The utilities joining Berry included Consumers Power Company Duke Power, Baltimore Gas and Electric, General Public Utilities, New England Electric, Eastern Utilities Associates, Boston Edison, Nevada Power, Public Service of New Mexico, Arizona Public Service, and Entergy.
Within a few weeks, the utilities that signed that letter formed an ad hoc coalition called the Utility Working Group. They were subsequently joined by Pacific Gas and Electric Company, the nation's largest utility. Their activities in support of FERC's efforts shocked the rest of the industry.
Under Hesse's leadership, FERC issued notices of proposed rulemakings that-if finalized-would encourage the restructuring of the electric power industry into the more competitive regime that Berry and others had envisioned in the early 1980s. To lobby against the proposed changes a number of other utilities formed the Electric Reliability Coalition.
The activities of the two groups split the Edison Electric Institute into warring factions. The fundamental cause of the split was not over the issue of competition itself, but over what such competition might cause. If laws and regulations were to be changed to encourage greater competition in the generation sector of the industry, just how was that generation supposed to reach the market where the power was most needed? More important, what would happen to the expensive sources of generation that might be displaced on an open market by power from less expensive generators? For example, if an independent power producer located in the service territory of a utility that needed new capacity contracted to deliver the power, the utility could simply agree to make room on its system to accommodate the transaction. But if the independent power producer and the utility were located on either side of another utility that did not want to transmit-or "wheel"-the power over its system because the second utility wanted to sell excess generation from its own system to the first utility, the second utility could traditionally refuse to cooperate in the transaction. In most cases utilities that would refuse to accommodate such wheeling transactions were concerned about protecting their own assets from being "stranded" if their customers were buying generation from other sources. Indeed, lost revenue resulting from a shrinking customer base would prevent them from servicing the debt used to build their generators. Those utilities feared that they would not be able to compete in an open generation market.
For the Utility Working Group the real issue was how best to increase the number of generators in the marketplace. Forcing all utilities into an open access regime would not work. To focus the debate on generation rather than on transmission, the Utility Working Group urged Congress and the administration to support a change to the Public Utility Holding Company Act of 1935 (PUHCA) to lift restrictions on the ability of utilities and independent power producers to locate their facilities where they might be most needed, either in other states or even in other countries.
PUHCA prevented utilities and independent power producers from issuing securities to build plants beyond their original geographic boundaries. Originally, that restriction was intended to prevent the growth of mammoth monopolies that might abuse their privileges of size. In passing PURPA, Congress partially lifted the lid PUHCA imposed on competition. PURPA said that such geographic boundaries would not have to apply to certain small power and cogeneration technologies. In addition, PURPA gave regulators the power to "force" unwilling utilities to wheel power from PURPA facilities across their systems. Although utilities fought PURPA with all the political power they could muster, Congress ultimately ignored their opposition. Subsequently, some utilities viewed PURPA as an asset. They profited from forming subsidiaries to enter the small power and cogeneration business themselves.
In 1989 executives from the Utility Working Group began to meet with counterparts from the nonutility, independent power industry and from large industrial consumers to see whether they could jointly support legislation before Congress. The discussions were agonizingly difficult at first. The independents and industrials said that they were willing to support legislation to lift PUHCA's restrictions, but they wanted legislation to mandate open transmission access and to limit a utility's participation in such broader wholesale ventures to 50 percent. (PURPA already had imposed a 50 percent ownership limitation on their participation in ventures that qualified for the special regulatory treatment in the law.) The Utility Working Group executives rejected that proposal.
In the meantime Edison Electric Institute executives were going through internal debate as well. Where some utility executives (notably those in the Utility Working Group) said that advocating legislation to change PUHCA would allow the industry to "get in the door first" and help define the debate, others (notably those in the Electric Reliability Coalition) said that such a step would lead to a breakup in the industry and more problems than any chief executive officer could possibly handle. Ultimately, the Edison Electric Institute executives negotiated a position statement saying that they did not advocate any legislation, but that if Congress did pass new legislation, it should conform to certain principles preserving the voluntary nature of such competition.
Sen. Bennett Johnston, chairman of the Senate Energy and Natural Resources Committee, introduced legislation to change PUHCA to enable anyone (utilities and independents alike) to build "exempt" wholesale generators (to signify their exemption from PUHCA) anywhere. The legislation was voluntary in nature; utilities did not have to buy power from exempt wholesale generators, nor would they have to open their transmission systems for mandatory access by exempt wholesale generators. Electric Reliability Coalition executives contended that the Johnston bill would wreak havoc on an industry that had served the nation well for more than fifty years.
When the Bush administration began holding inquiries into the development of a new national energy strategy proposal and announced that changing PUHCA was among options it was considering, the Electric Reliability Coalition went into high gear. The chairman of Carolina Power and Light Company informed Secretary of Energy James Watkins that a PUHCA amendment would lead to legislation to enhance transmission and to allow independent power producers to engage in direct sales to industrial customers. He also expressed concern that independent power producers often are permitted to use a higher percentage of debt to finance construction than are utilities. The chairman asserted, "As a utility increases its dependence on independent power producer power, credit rating agencies will treat its IPP-related contract obligations as debt, resulting in higher cost to finance the utility's other capital requirements."
A new coalition, formed in September 1990, urged congress to amend PUHCA. That coalition included the Utility Working Group, the IPP Working Group (an ad hoc coalition of independent power producers and contractors), the Cogeneration and Independent Power Producers Coalition of America (power producers primarily developed as a result of PURPA), the Natural Gas Alliance for the Generation of Electricity (mainly natural gas pipelines and producers that saw independent power growth as a growing market for natural gas use), the National Independent Energy Producers, and the Ad Hoc Committee for a Competitive Electric Supply System (a group of industrial consumers). The group called for modifications to PUHCA that would allow for independent power plants to be built along with qualifying facilities and traditional rate-based plants to give consumers the benefits of a more competitive system. The group could not agree on whether PUHCA legislation should include transmission.
On one side of the PUHCA debate were traditional utilities fighting hard to preserve their vertically integrated monopolies. On the other side was the coalition of independent power producers, fuel suppliers, industrial consumers, and "progressive" utilities that were convinced that change in the industry was inevitable and that helping to define the change was better than becoming victims of the change.
Encouraged by the coalition supporting PUHCA reform, a number of key politicians including Sens. Johnston and Malcolm Wallop and Reps. Philip Sharp, Billy Tauzin, Thomas Bliley, and Edward Markey began sponsoring their own versions of legislation to amend PUHCA to encourage more competition in the wholesale generation business. Sens. Johnston and Wallop sought to limit their legislation only to the voluntary nature of wholesale generation competition. Reps. Sharp, Tauzin, Bliley, and Markey, on the other hand, insisted that language be included giving FERC authority to mandate access on utility transmission systems to facilitate sales of power from independent power producers to other utilities.
Consumer and environmental groups-led by the Consumer Federation of America-joined the fray. They persuaded Rep. Sharp and his colleagues to include language in PUHCA legislation mandating transmission access, a ban on deals between utilities and their own nonregulated affiliates, and regulatory access to all books and records of utilities and their affiliates to guard against hidden cross subsidies.
While it is not possible to predict whether Congress will pass any PUHCA legislation, one statistic stands out: 1990 was the first year that the amount of new wholesale generation capacity owned by independent producers brought into commercial service (5,000 megawatts) exceeded by 300 megawatts that brought into commercial service through traditional utility rate base construction programs. In addition, the number of utilities voluntarily opening their transmission systems for greater access by off-system sellers and buyers was increasing. The push to amend PUHCA represents congressional recognition that it is time to reform the electric power industry so that it can operate efficiently in the 21st century.
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