Utility Deregulation: Policy Consequences And Opportunities

Issue Overview

After years of debate and discussion over the structure and regulation of the electric utility industry, legislative and regulatory initiatives at the local, state and federal levels have created momentum toward a less regulated, less monopolized utility market structure. Deregulation of the telecommunications and natural gas industries in recent years also spurred the nation's regulatory policy makers to focus attention on the potential benefits to electric utilities and utility rate payers of greater deregulation. In addition, dissatisfaction with electricity rates, principally on the part of large industrial consumers has further influenced policy interest toward more competitive, market driven mechanisms for establishing electric prices.

The outcome of these various uncoordinated actions is today's debate over what to do with an industry structure best characterized as part monopoly and part competitive. At the current pace of state and/or federal deregulation, no matter how piecemeal, there is no question that over the coming years the generation of electrical energy by utility enterprises will evolve to one where more competitive forces dominate. The policy implications of deregulated electrical utility industry for electrical, mechanical and sheet metal contractors, is the major focus addressed in the following report.

Historical Perspective

The electrical utility industry is the result of contradictory statutory decisions made over many decades. Initially an open and competitive industry, where any enterprise with adequate resources could receive permission to sell power, it evolved to today's tightly regulated sector where no electric power can be sold without the permission of state or federal authorities. After the open markets of the late 19th century, where unregulated activity led to franchise abuses and a unreliable and inadequate power supply, the public and the utility industry joined to support a system of exclusive franchises necessary for utility operations. In exchange for these exclusive franchises utilities agreed to limit rates of return and rate payer charges to those deemed "prudent and reasonable" in order to guarantee utility operators a "reasonable" rate of return on investment.

In 1992 Congress passed and the President signed the Energy Policy Act to encourage the electric utility industry to move toward a more competitive market system. A wide exemption was including for wholesale power generators to use the utility transmission grid to sell power at competitive rates. However, retail wheeling of power was prohibited if it would infringe upon decades old state laws granting utility franchises. This complex collection of state laws, seen by many federal policy makers as an impediment to more openly competitive utility markets, has brought the deregulation debate to the U.S. Congress.

In 1996 the Congress debated but did not pass wide ranging legislation which would have deregulated the industry. Opponents of the current utility regulatory structure, including many in the leadership of the Republican majority in Congress have advocated deregulation. The two restructuring bills given the most serious consideration and support in the 104th Congress would have given states six months to transition to retail competition. In either case the federal deadline for a deregulated electric utility industry would be December 15, 2000. Action on similar legislation is assured in the 105th Congress.

The trend toward and increasing interest in deregulation is also evidenced by the fact that California and Rhode Island both passed utility restructuring and deregulation bills in 1996. At present, at least 13 states have initiated legislative studies of restructuring (Arizona, Connecticut, Kansas, Illinois, Maine, Massachusetts, Nebraska, Nevada, New Hampshire, New Mexico, Oklahoma, Texas and Utah). Several states have initiated pilot programs, and nearly 40 states have legislative and/or regulatory activities underway.

Restructuring: a Definition

Before focusing on the specific role of HVAC firms in the restructuring policy debate it is important to briefly examine the restructuring concept.

Retail wheeling is one the most discussed restructuring options. Utilities, as owners of the power grids that transmit the electricity, would be paid a fee for "wheeling" the power, regardless of the source, over their transmission and distribution lines. Consumers to varying degrees could switch suppliers and purchase power from a seller of their choosing. There would no longer be exclusive franchise territories. Much of the demand for retail wheeling originated with electricity-intensive industries like aluminum, automobiles, refining and petrochemicals. However, many businesses especially in the industrial sector, are now examining ways to reduce their electric costs as part of their efforts to remain competitive.

An integral part of retail wheeling is the concept of "unbundling" prices for electric services. Currently, most customers receive a complete package of energy services that include generation, transmission and distribution. The customer pays a single rate for all of these services. Under a plan, these services could be unbundled, or separated. Thus, consumers could buy power from the least-cost provider and then pay another entity to transmit it. If, in addition, the individual components of the cost to deliver electricity are separately priced, customers could select the kind and quality of services that best suit their particular needs. Some policy observers maintain that, even if retail wheeling is not implemented, utilities should be required to unbundle at least a portion of their energy services.

Advantages And Disadvantages

The proponents of restructuring maintain are driven by their belief that restructuring will save them significant amounts on utility rates that the present system of production and distribution causes retail rates in excess of the cost of new generation, driving up consumer costs. They generally argue that:

Market forces would replace integrated resource planning thereby reducing industry costs and taxpayer involvement. For example, the Building Owners and managers Association (BOMA) International's Experience Exchange Report, electricity costs account for twenty seven percent of an average office building's operating expenses. More money is spend on electricity that is spend on building security, maintenance, cleaning, or administrative costs. Across the nation, commercial real estate professional spend more than $20 billion annually for electricity. Even a modest savings of 10-40 percent would equate to savings of $2-8 billion for the commercial real estate industry alone.

It would increase consumer choice by giving large and small customers access to multiple suppliers of electrical service, including DSM programs, at a lower cost.

It would reduce rate inequalities that currently exist within the same state and between adjoining regions. These differentials can amount to 50% to 100%.

More competition would promote greater product and service innovation.

Opponents maintain that restructuring will produce a number of detrimental effects, including the following:

For some utilities, restructuring could shift costs to small consumers who cannot effectively contract for alternative sources. Part of these costs include so-called stranded investment costs. Stranded costs are those unamortized costs of prior investments that are scheduled for recovery through regulated monopoly rates but would not be recovered under deregulation and unfiltered competition between utilities for the lowest rates. Stranded costs for the industry as a whole have been estimated at $135 billion - well over half the total equity value of all investor-owned utilities. Many of the vulnerable utilities would be threatened with bankruptcy if unrestricted wholesale and especially, retail competition were allowed without providing utilities allowance for covering stranded costs.

Stranded costs might ultimately be passed along to utility shareholders, despite the fact that, at the time of the original expenditure, such costs had been deemed prudent by the state regulators and thereby recoverable from customers through the electrical rates.

Restructuring could undermine integrated resource planning and encourage short-range decision making based predominantly on current price rather than future needs and environmental concerns, resulting in delayed development of new power plants or innovative technology.

Restructuring could result in the proliferation of smaller, financially weaker electrical producers. If these companies failed, the reliability of electric delivery would be threatened. Moreover, such small competitors would become takeover targets, ultimately creating oligopolies such as occurred in the airline industry after deregulation. A largely consolidated utility industry would be far less competitive than currently available through targeted deregulation on a more limited scale across hundreds of competing utilities. Opponents of federal deregulation propose that under a more aggressive state-driven deregulation effort more competition and less consolidation would result.

Deregulation And Private Industry

It has long been generally recognized that participation in unregulated markets by regulated entities, such as utilities, raise serious competition concerns, particularly with respect to the problem of cross-subsidies between regulated and unregulated ventures. Deregulation of the telecommunications industry was based, in large part, on the recognition that cross-subsidies between these regulated and unregulated businesses could not be eliminated through federal regulatory oversight. In recent years utility supply and installation programs marketed under the guise of energy conservation serve the same ends--to unfairly compete with private sector through cross-subsidization in many forms.

The ratepayer subsidized resources used by utilities to the disadvantage of private sector competitors include such factors as: access to capital, name recognition, advertising paid by ratepayers, credit information, existing billing mechanisms, direct mail, marketplace data, direct supply from manufacturers, consumer financing, administration and overhead paid by ratepayers, and selective referral and market allocation.

All of these advantages can be easily conferred upon the utility divisions, subsidiaries, or affiliates through which utilities can conduct their anti-competitive efforts. It is this transfer of assets, both tangible and intangible, all of which are paid for by utility ratepayers, which gives rise to the type of subsidies which make it difficult for private sector firms to compete with utilities on an equal footing.

As a result of deregulation a utility should not be allowed to recover from its ratepayers those costs associated with its non-utility operations unless specifically required to do so by law or where all ratepayers benefit equally as a result of such charges. Deregulation, if blind to these utility advantages, will serve to damage the economic position of private sector utility competitors.

If allowed, diversification by deregulated utilities into areas outside of their previously publicly regulated role as producers and suppliers of energy could result in significant harm to small, private section markets in energy service fields. Deregulation without competitive safeguards would allow utilities to dominate markets by calling upon their considerable monopoly advantages garnered under pre-deregulation economic conditions. A "level playing field" should be maintained in any deregulation scheme.

Contractor Recommendations For Deregulation

In order for deregulation to foster free and fair competition between utility enterprises and private sector firms as well as increase new business opportunities the following policy objectives should be considered:

Fair and open competition in the electricity and energy services market. This competitive environment must be maintained to ensure that the market place is not dominated by any one business entity (i.e. deregulated utility and/or subsidiaries).

No cross subsidization of non-utility operations from the utility's rate base will be allowed. A definition of cross subsidization should be included in any deregulation statute for use in potential legal and regulatory disputes. With utility requests to bundle new services and products with energy in the deregulated environment greater cross subsidization may occur unless prohibited.

Separation of utility and non-utility functions and operations. As utilities are restructured in a competitive environment, there will be a need to configure them in such a way as to assure that those functions, and only those functions, which are inherent to the utility franchise are not co-mingled with a utility's competitive operations. This is especially true at the distribution level which will lie partly within the regulated utility sector and partly within competitive, private sector markets.

Adoption of and adherence to, proper cost allocation rules. While most states do not have cost allocation rules, it should be a requirement that states adopt such rules (the FCC's telecommunications cost allocation formulae are an example) in order to prevent abuses such as cross-subsidization.

Protection of customer proprietary information and site data. This will become an increasing problem for all HVAC and electrical contractor competitors. It is a subset of the transfer of intangible assets at no charge-cross-subsidization issue. Customer generated information and site data should stay with the regulated utility and be used only for necessary non competitive utility functions. It should not be shared with a utility's subsidiary or affiliates in aggregate form unless and except it is made available to all competitors under non-discriminatory terms. With respect to specific customer sites, it should never be disclosed without the written, knowledgeable consent of the customer.

Equal, non-discriminatory access to new markets, business opportunities, incumbent architecture and systems. New and emerging markets for energy services should not be exclusively reserved for utilities either as a function of their utility franchise or as a result of unfair competitive advantages conferred by nature of the utility-subsidiary or affiliated relationship.

Conclusion

While much has changed since the decades old federal and state utility statutes were first enacted establishing today's utility industry, continued consideration of deregulation's impact on competitive markets must be given a priority by federal decision makers. Such a sweeping transformation of the electric utility sector if done appropriately holds potentially large benefits for the economy, new business opportunities for contractors and greater efficiency for utility operations.