Electric Power Industry
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 int
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.