The Cato Review of Business & Government
The Cato Review of Business & Government
William A. Niskanen is the Chairman at the Cato Institute.
A controversy has developed about the potential deregulation of electricity-a controversy, I suggest, in which both parties are wrong for different reasons. Most of the electric utilities have acknowledged the growing demands for deregulation, but have insisted on pricing rules that cover the "stranded costs" of investments made under current regulations. Most of the advocates of increased competition in the markets for electricity, in turn, have been quick to endorse mandatory access to a utility's transmission and local distribution system. Each of these profoundly nonmarket positions, moreover, has been endorsed by leading regulatory specialists.
A reminder about the nature of property rights is necessary to sort out this issue. One's property consists of the bundle of rights that are recognized and protected by the law-the rights to use, exclude, partition, and sell. Any nonconsensual restriction on this bundle of rights constitutes a taking and should be compensated. A person or firm, however, does not have a right to the value of these rights.
The position of the utilities is wrong because it is based on the premise that some implicit "regulatory compact" protects the value of investments made under current regulations. In the absence of a prior agreement between a utility and its customers, however, the campaign to seek regulatory protection for the value of "stranded investments" represents a unilateral effort by the utilities to broaden their property rights. As the review article by Robert Michaels in this issue documents, even the terms "regulatory compact" and "stranded investment" are of recent origin. There never was a "regulatory compact"-consumers would never have agreed to guarantee the value of investments against major changes in technology or the market. The case for protecting the value of "stranded costs" is without merit.
The position of the competitiveness advocates is wrong because they would restrict the right of a utility to exclude other generators from using its transmission and local distribution system. Indeed, this has already happened. The Energy Policy Act of 1992 authorizes the Federal Energy Regulatory Commission to order a "transmitting utility to provide transmission services. . . to the applicant." A final rule defining the conditions under which a utility would be required to provide transmission services to other power generators is expected in April 1996. Moreover, several states are considering mandatory retail wheeling, which would require a utility to provide transmission and distribution services for a retail consumer to buy power from some provider other than the local utility. The potential benefits of a competitive market for electric power are substantial, but they have unfortunately made the competitiveness advocates too casual about the means to achieve early, effective competition. Mandatory wheeling, whether at the wholesale or retail level, should be recognized as a restriction, a taking, of the property rights of a utility.
The alternative, which sounds radical only because electricity has been regulated for over 80 years, is to reject both the recovery of stranded investments and mandated access to a utility's transmission and distribution system. Utilities would be allowed to charge what the market will bear for transmission and distribution services, including the right to exclude any party from access to those services. The primary government role would be to provide the same access to public rights of way that have been granted to the utilities. Other private firms, such as railroads and pipeline companies, should be allowed to offer competitive transmission services over their own rights of way.
Only the direction of the effects of these alternative rules can be forecast with any confidence. Pricing to protect the value of stranded investments, even with mandatory access, would protect utility profits at the expense of consumers; effective competition among power services would be delayed until the stranded investments were recovered. Mandatory access without protecting stranded investments would benefit most consumers at the expense of the probable bankruptcy of numerous utilities; competition among power sources would be accelerated and cross-subsidies among consumers would be eliminated. In both of the above cases, utilities would maintain a monopoly of transmission and distribution services but would be subject to continued regulation of the price of these services.
The third rule-no protection of stranded investments and no mandatory access-would lead to an intermediate near-term outcome and a superior long-term outcome. Utilities that are good managers of their transmission and distribution systems would profit relative to those with substantial stranded investments. Effective competition among power sources would be delayed until there is credible potential or actual competition in transmission services. The first consumers to benefit would be those large power users that now face discriminatory prices and have the lowest-cost access to alternative power sources. In the long term, this third rule is the only rule that leads to increased competition among both power sources and transmission services.
A comparison of probable outcomes, however, is not a sufficient basis for evaluating rules. A fair game, for example, is defined by whether both parties agree to the rules and play by the rules, not by the outcome of the game. In this sense, neither stranded cost recovery nor mandatory access is a fair rule; consumers would not agree to protecting the value of a utility's prior investments, and utilities would not agree to mandatory access to their most valuable assets. The rejection of both stranded cost recovery and mandatory access is the only rule consistent with the current property rights of both parties-the only fair rule. All parties to this controversy about the potential deregulation of electricity are best advised to be principled rather than clever.
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