Electricity Deregulation - The Myth of the Free Market
by David Bacon
BERKELEY, CA (7/1/98) -- The prevailing mythology of deregulation tells us that the bloated, inefficient, monopoly industries of the past are being dragged into a new era, kicking and screaming. Now they will be faced, goes the story, with unwelcome competition from the lean and mean companies of the future. New competitors will out-perform the behemoths -- they will cut costs to the bone and deliver their products at ever-cheaper prices. Consumers will rejoice.
This mythology justifies unchaining market forces in one of the most essential industries of modern life - electricity. Electrical deregulation, first proposed in California, is being implemented in a growing number of other states. The free-market philosophy behind it, however, is not a California phenomenon. It is an almost-unchallenged set of assumptions held by politicians and regulators throughout the country.
Deregulation's proponents would have consumers believe that, in the words of California Public Utility Commission staff member Tom Thompson, "the prospect of competition scares the big utilities to death." In truth, instead of opposing deregulation, the nation's giant electric utilities, allied with their largest industrial customers, support it. Behind the scenes, they're fashioning the rules for this new "competitive" era because they've become their own competition.
In the process, they're dismantling the old system which has governed one of the world's largest industries for almost a hundred years. The new system erected in its place will have profound effects on electrical consumers, the environment, low-income communities, and the workers and unions who make the system function.
In the trust-busting Progressive Era prior to World War One, the consumption of electricity was recognized for the first time as a basic necessity of modern life. In some areas, electrical generation and distribution facilities were made public property, usually by cities. Elsewhere, private investor-owned utilities were allowed to maintain a monopoly, but regulatory agencies were established to set rates and ensure the public wasn't gouged.
Whether public or private, utilities were vertical monopolies, controlling the three main components of electrical power:
- power generation by turbines, run by steam in huge plants, water pressure in dams, or more recently, by wind or other renewable resources;
- power transmission, sending electricity from power stations throughout the country on a grid of high-voltage transmission lines; and
- power distribution, which takes electricity from the grid, converts it to 120-volt power, and distributes it to residences and businesses.
Monopolies had some advantages. It made sense to have just one system to distribute electricity to consumers. A monopoly system was able to plan -- growth in power usage could be estimated, and new plants built to accommodate it. The system provided a predictable return on the long-term investment required for constructing huge, enormously expensive generating stations.
According to utility union lawyer Mark Joseph, planning made it possible "to ensure that there's enough, but not too much, capacity. Pure market forces would give us overbuilding and spikes of high prices during shortages, and lots of bankruptcies when prices fall. We don't need a business cycle, and this kind of unreliability, in our electrical supply."
The old monopoly system, however had increasingly-evident disadvantages as well. Since investor-owned utilities earn profits which rise as they sell more power, they have little incentive to encourage conservation. Regulations guaranteeing a set return on investment gave them a big reason to spend enormous sums on huge facilities, especially nuclear plants, regardless of their environmental danger.
In state after state, public utilities commissions responsible for regulating the industry were won over by the utilities themselves, and allowed the monopolies to increase rates and pass on excessive costs to consumers. Consumer and environmental groups, nevertheless, were able to win important concessions, including subsidized rates for low-income consumers, and requirements mandating that utilities supply a rising percentage of power from environmentally-sustainable sources.
But in many areas, particularly in California where the deregulation movement started, electricity rates have skyrocketed. Large industrial consumers in particular have threatened to opt out of the system, and supply their own power needs for themselves. New technology makes it possible for them to generate electricity in small, less expensive plants, at a cost often below that of older, larger facilities.
In 1978, Congress passed the Public Utilities Regulatory Policy Act, whose stated objective was creating competition to the established, monopoly power companies. Henceforward, independent energy producers could generate electricity, and utilities were required to buy it. Some of those independent producers invested in environmentally-friendly generation technologies, like wind power. Others simply built smaller, cheaper plants burning a variety of fuels.
PURPA turned out to be just the beginning. Eventually proposals were made for deregulating the industry much more radically, including, ultimately, the breakup of the vertical monopolies themselves.
Today, the heart of electric utility deregulation is retail wheeling, the core principle embodied in legislation already adopted in twelve states, including California, Nevada, Maine, Montana, New Hampshire, Oklahoma, Pennsylvania, Rhode Island, Illinois, New York, Wisconsin and Massachusetts. It is likely to pass in at least another four this year -- Vermont, Connecticut, Ohio and Texas.
Retail wheeling creates an open market for electric power, in which consumers, in theory, can purchase electricity from any supplier. Existing utilities still maintain a monopoly on delivering the power and, usually, billing customers. In most cases, they have to divest themselves of their power-generating business. The power itself comes from independent producers, who "wheel" it onto the grid, and thence to the buyer. If consumers don't specify a new supplier, the existing utility usually supplies them by default.
Some systems, like California's, set up a pool buying program, called a power exchange or independent service operator (ISO), which buys power nationally at the cheapest wholesale rates and sends it out over the transmission lines. In California, those transmission lines will continue to belong to the current utilities, but will be operated by the ISO. In other states, like Illinois, the legislation deregulating electricity envisions the creation of an ISO, but doesn't require that to happen immediately. "Our law doesn't clearly define what will and will not be regulated," explains Chris Hahs of the Center for Neighborhood Technology.
Retail wheeling, however, doesn't treat all consumers as equals. Large industrial and agricultural consumers enter the market first in almost every state, while small consumers remain tied to the old utility supplier. Consumer groups criticize the difference in treatment because they believe that once large users leave the system, small rate payers will wind up paying the costs of maintaining the utilities' existing infrastructure. This could cause residential electric rates to rise sharply, especially if few or no new providers enter the market.
In Illinois, for example, industrial users will be able to choose new suppliers in October, 1999. Other non-residential customers will gain that ability in January, 2001. Residential users will be tied to their existing providers until May, 2002.
Joel Eisenberg, a senior analyst for public policy at the Oakridge National Laboratory, believes that it will be difficult to protect access by low-income consumers to cheap electrical power. "The marketplace is likely to serve small and low-income consumers with less interest," he explains, "Because they make up a lower demand [than large-volume industrial consumers], there will be a disinclination to serve them, which will lead to a lower supply, and therefore higher prices. In the residential market, consumers may see fewer choices, and worse service."
Meg Power, executive director of the Economic Opportunity Research Institute, concludes that "clearly, retail competition is not to the advantage of small consumers. The question is, can it do us no harm?"
One way consumers have sought to increase their power is through aggregation -- joining together to try to get reduced rates in return for buying in larger volume. In Massachusetts, residents of 15 towns on Cape Cod voted at town meetings in 1994 to form the Cape Light Compact. Their experience was instrumental in winning the inclusion of an "opt out" provision in Massachusetts electrical deregulation law, called "community choice."
In many states, aggregation is hampered by provisions that require the individual recruitment of consumers, who must each "opt in" to a pool-buying arrangement. Those who don't remain with their default provider - the old utility. In some states, there's no clear way to aggregate residential consumers at all.
In Massachusetts, local communities can make the decision to aggregate the residents within their jurisdictions. Those who don't wish to be included must "opt out."
Large industrial consumers, however, have been the real driving forces behind the restructuring of the electrical industry, and in many states, they have formed an alliance with the utilities themselves.
In California, the original proposal for retail wheeling was written in 1994 by the state's Public Utilities Commission, responsible for regulating the industry. But it was immediately supported by a coalition between the state's (and the nation's) largest utility, Pacific Gas and Electric Company, and its largest industrial customers. This coalition, called Californians for Competitive Electricity. CCE, includes the California League of Food Processors, the California Manufacturers Association, the California Large Energy Consumers Association, the California Independent Energy Producers Association, and PG&E.
For additional leverage, PG&E itself filed its own retail wheeling proposal before the commission, calling for an even longer period between the time when large customers can buy power from independent producers, and when residential users can do so.
PG&E had been preparing for retail wheeling for some time before the PUC's formal proposal. Starting in 1988, PG&E persuaded the PUC to equalize the electric rates of all consumers. Previously, large industrial and agricultural users paid higher rates, in order to subsidize lower rates for residential customers. According to the New York Times, leveling rates lowered payments for the company's hundred largest customers $100 million per year. Industry observers viewed this as an effort by the company to buy the loyalty of its largest customers, preparing for the day when they might be able to choose another supplier.
In another move to prepare for deregulation, PG&E stopped building power plants in its own service area in 1993, and even bought up five plants belonging to independent power producers and shut them down. When AB 1890 passed, California's enabling legislation for electrical deregulation, it mandated the divestiture by the utilities of their generation plants. Since then, PG&E has sold off most of its fossil-fuel plants, and is getting ready to sell its hydroelectric plants. Southern California Edison has sold all its fossil-fuel plants in the state.
While it might appear that PG&E and SCE are leaving the power generation business in the face of impending competition, nothing could be further from the truth.
Instead, PG&E has become one of the largest, unregulated, independent power producers in the country. In 1989 the corporation set up a subsidiary, which it jointly owns with the huge Bechtel construction firm, to build and operate power plants. This subsidiary, U.S. Generating Company, is headquartered in Maryland.
By 1995, it was already operating 22 power stations, from coast to coast, with a combined capacity of 4800 megawatts. Company reports document that thirteen of the facilities alone represent an investment of $4.2 billion.
Because USGen is unregulated, and operates outside of California, it can do things which PG&E can't. It operates numerous coal-fired plants, which cannot be built or operated in California because coal pollutes the atmosphere more than any other fuel. They are the cheapest plants to operate, however, except for hydroelectric facilities, because of coal's low price.
In 1997, USGen moved into Massachusetts, then debating its own retail wheeling proposal, and now owns most of the state's power plants. One of them, the coal-burning Brayton Point Somerset plant, is Massachusetts' dirtiest, responsible alone for 20% of its air pollution. USGen also purchased Salem Harbor, the second-dirtiest, along with half-a-dozen hydro plants as well. Another large Massachusetts power station was bought by the Southern Company, the largest energy holding company in the U.S., and parent of Georgia Power.
"In Massachusetts," says Rob Sargent, energy program director for the Massachusetts Public Interest Research Group (MASSPIRG), "we've given away the store."
Southern California Edison also created its own unregulated subsidiary, Mission Energy. In the late-1980s, a union steward at Edison suspected that the company was using Mission Energy to sell power to itself, supposedly as an independent producer. After getting stonewalled by the commission, the Utility Workers Union went to the media. After public pressure forced a PUC investigation, Mission had to sign an agreement that it would not operate in California.
Other giant utilities like Duke Power, PECO and Consolidated Edison are also maneuvering to become survivors. Chicago's Commonwealth Edison has its unregulated subsidiary, UNICOM, which is already the nation's third-largest. This year, the American Electrical Power Service Corporation joined with the Central and Southwestern Corporation in a gargantuan merger of two major power generators.
A few companies will eventually become members of an increasingly small club of giant electricity producers nationwide. These unregulated behemoths are set to monopolize power generation as deregulation breaks down barriers in state after state.
"The eventual outcome," says Carl Wood, an international representative of the Utility Workers responsible for deregulation issues, "is the creation of 8-10 huge generating companies in the U.S. Most investor-owned utilities," he concludes, "will be driven out of the generation business. Only the largest will survive."
Eisenberg says that in principle, he supports the idea of competition and a free market in the power industry. Nevertheless, "the concern about concentration is very legitimate," he says. "There's been a significant level of concentration so far. I suspect that barring an intensive effort to make the market work, including forcibly breaking up utility concentration in the marketplace, there won't be a lot of competition."
The new system is creating, however, a commodity market in power, with some disturbing consequences. Although the average wholesale price of electricity is between 3 and 4¢ per kilowatt hour nationwide, demand during the recent Midwestern heat wave has driven up peak prices to record levels. According to the Cleveland Plain Dealer, on June 25 and 26, spot prices rose to $3 to $5 per kilowatt hour.
On the surface, retail wheeling only affects privately-owned utilities. But the new system will determine the rules of the game in power generation. Even cities like Los Angeles, Sacramento, Burbank and others, where utilities were municipalized years ago in the same progressive wave which established the commission itself, may find themselves swept along by the economic forces deregulation is unleashing.
Although Los Angeles' Department of Water and Power's electric rates, for instance, are significantly below those of Southern California Edison and PG&E, its cost to produce power is still higher than USGen's coal-fired plants. "DWP's in-basin generation is relatively expensive," according to Brian d'Arcy, treasurer of Local 18 of the International Brotherhood of Electrical Workers, which represents DWP employees. "It's possible to get a lot of cheap, dirty power in the southwest." If DWP power stations close, "huge number of jobs could be lost," d'Arcy says.
Maneuvering by utilities to prepare for competition threatened the poor even before retail wheeling was adopted. Audrey Krause, past director of Towards Utility Rate Normalization, a California rate payers' advocacy organization, cited a 1994 application by Southern California Edison to eliminate $9 million from low income assistance programs, along with another $87 million to promote energy efficiency. The utility wanted the cuts, she believed, as it was trying to trim costs to meet a new competitive environment.
The national commitment to funding for low-income families, represented in the budget for the federal Low-Income Household Emergency Assistance Program, has declined every year. In 1994, it received $1.437 billion, and served 6.6 million households. In 1998, it's budgeted for $1 billion, and last year only served 4.3 million homes.
Timothea Howard, lead organizer of the Columbia Heights/Shaw Family Support Collaborative in Washington DC, told a hearing of the House and Senate Appropriations Committees this year that "for a significant number of households loss of utility service is a contributing factor to children going into foster care." Child protective services often interpret utility disconnection as child neglect, resulting in the removal of children.
Yet in East St. Louis, for instance, utilities increasingly disconnect poor customers as a method of bill collection. Of 731,000 households that lost LIHEAP assistance for paying electric bills between 1995 and 1997, it is likely that 43%, or 314,000, included children, according to a survey by the National Energy Assistance Directors Association.
Most states implementing retail wheeling have included some form of continued assistance for low-income households, usually financed by a surcharge by the distribution utilities. According to Meg Power, in a few states like Pennsylvania and Massachusetts, money available for assisting low-income households has increased. In Illinois, deregulation legislation included contributions to a low income energy assistance program which didn't exist before.
The National Clergy and Laity Concerned advocates a model program for states restructuring the electric industry. It includes rate reductions of at least 15%, a guarantee that electric service will be universally available to all households, that default service be available to all consumers, and that the reliability and quality of service be maintained at current levels, with new safeguards and no dilution in existing consumer protection.
When USGen begins to operate its newly-purchased coal-burning plants in Massachusetts, they will undoubtedly operate around the clock, In an unregulated environment, the company's profits depend entirely on producing and selling as much power as quickly as possible. That's not good news for the state's air quality.
In San Francisco, USGen's parent, PG&E, is selling off two of its oldest, dirtiest plants, located in the African-American communities of Bayview and Hunters Point. The city, fearing that a new private owner would also seek to run the plants at maximum capacity, tried to buy the plants at a low price. Both, after all, were fully depreciated decades ago. PG&E, however, refused to give the city a special deal, and instead held an auction to solicit the highest bidder.
Retail wheeling as a system starts economic wheels into motion which will reward companies for building dirty plants in states with few environmental protections, where power can be produced cheaply. Much as other industries do, power producers will pit states against each other, seeking to ratchet down environmental safeguards with the carrot of construction and jobs.
The retail wheeling system, however, based on using free market competition to lower rates, will inevitably produce pressure to reward the cheapest producers, regardless of the environmental damage they inflict.
Some states have included regulatory provisions which mandate the sale of a set percentage of total power generated by renewable resources, ranging from Nevada, which starts at 1/10 of 1%, and rises to 1% after 5 years, to Maine, which requires 30%. Other states require a fund to pay for research and development of renewable resources.
In California, environmentalists won the inclusion in AB 1890 of $500 million in funding over 10 years for environmental programs. In Illinois, two funds were established. One provides $3 million a year for assistance to residences. The Renewable Energy Resources Trust Fund sets aside $100 million over 10 years, but requires the 50% of the funding be spent on research into cleaner-burning coal. "These are all minuscule, however, compared to what they should be," says Chris Hahs.
Retail wheeling is already having a significant impact on workers in the plants themselves. As a result the divestiture by California utilities of their power plants, the unions for the workers in those plants will cease to exist. Unions will have to be reorganized from scratch, and win recognition from the new owners. In today's union-hostile environment, in which one in ten workers involved in a union-organizing drive loses their job, that will undoubtedly prove to be very difficult.
That was one reason why unions opposed the divestiture provisions of California's AB 1890. "But once it became apparent we had lost that fight, we had to sign on and save what we could," Wood says. Unions were able to include provisions protecting pensions and providing money for retraining laid-off workers. Unions also fought for language protecting the reliability of the distribution system. Since reliability depends largely on maintaining an experienced workforce, the provision protected some jobs.
In general, workers for the new independent power producers have no unions. Their wages, conditions and rights on the job are below those at the old utilities, where unions were usually organized in the labor upsurge of the 1930s and 40s.
All PG&E facilities in California, for instance, have unions. But the company's subsidiary, USGen, while it uses union labor in building new plants, historically has had no unions in the workforce which operates them. Nor does it intend to, according to USGen spokesperson Jack Hawks. As a consequence, unions say, wages paid by USGen are considerably below those at PG&E.
When USGen took over power plants in Massachusetts, the strength of the existing unions was able to save their existing contracts and employment levels. But the new relationship with the company had its price. The unions went to bat for the utility, opposing amendments to the deregulation legislation which would have increased standards on burning fossil fuels, and supporting utility proposals for recovering the costs of stranded assets.
Carl Wood admits that the union workers "have been used to a protected environment. The bottom line for our employers was never affected by how much they could squeeze us, because they were guaranteed a profit on top of their costs. Now, their profits will be directly affected by how much they squeeze our wages and benefits."
The most controversial element of deregulation legislation has been the proposals by utilities for recovering their investments in facilities which can't generate electricity at competitive prices. These older plants are called stranded assets.
Utilities propose that rate payers pay the stockholders for writing them off. Many of the most expensive of these facilities are the utilities' nuclear plants. In California, stranded assets include the Diablo Canyon and San Onofre nuclear power plants. When the amortization of the bonds used in their construction is included in the cost of power production, the electricity they produce has a comparatively high cost.
The public utilities commission gave PG&E and Southern California Edison the right to add their profit margin onto those costs. As a result, the plants have been a significant factor in California's high electric rates for years. In 1995, Diablo Canyon alone accounted for 40-60% of PG&E's profits, according to utility union attorney Mark Joseph. The New York Times calculates that closing the plant would eliminate revenue of $6 million a day.
If the cost of amortization isn't included, the actual cost of electricity production in the San Onofre nuclear plant, for instance, is about 3¢/kwh, compared to the national average cost of generation, which runs 4-5¢, according to Wood. As a result, there's now suddenly a market in used nuclear plants, once they've been written off by the utilities which built them.
California has comparatively few nukes compared to Illinois' Commonwealth Edison, which has thirteen, and just sold one. Illinois' deregulation law compensates the utility for the uncompetitive operation of those plants by adding a surcharge onto the bills of consumers through 2006, with a possible extension for two more years.
The recovery provisions for stranded assets have created an obstacle for other companies, who otherwise might consider selling electricity in these newly-opening markets. They have to produce electricity cheaply enough so that, even with the surcharge for stranded assets, they can undersell the existing utilities. Some states mandate a rate rollback of 10-15%, which forces them to produce at an even lower cost. Utilities, on the other hand, can subsidize their prices using the money received in compensation for stranded assets.
Nukes aren't the only stranded assets. Many older plants are also included. In California, where utilities signed contracts with independent producers to buy electricity at high prices, stranded assets provisions covers those agreements as well. Southern California Edison is even being compensated for high-cost contracts it signed with its alter-ego, Mission Energy.
As a result, in the states where retail wheeling has been implemented, there's been very little new competition. Enron Corp., a major independent producer, just pulled out of California and downstate Illinois within the last few months. "I don't think anyone is going to be able to get in under Com Ed," Hahs says bitterly. When the market in Massachusetts opened up on March first, no one new company offered to sell electricity to the state's 2.5 million residential consumers. "Meanwhile, large customers got a rate reduction, and utilities got a bailout," says MASSPIRG's Rob Sargent.
In California, TURN's director Nettie Hoge admits that the organization made a mistake in not opposing the original legislation. "It happened so quickly," she says, "and when it was over, the utilities were walking away with the store." TURN has cosponsored an initiative on the state's ballot which would eliminate the stranded assets provisions affecting nuclear plants, and the use of bonds to finance the state's rate reduction. "The utilities have more than recovered their costs," she says. "What's happening now is that we're guaranteeing their profits."
TURN is being assisted by a statewide organization, Californians Against Utility Taxes, and a newly-formed national network, Rate payers for Affordable Green Electricity. "What California does has repercussions across the country," Hoge declares, hoping that other states too will move to rescind stranded assets provisions.
While Hoge feels confident that the initiative will not affect other parts of AB 1890, won by unions, environmentalists and advocates of low-income communities, others are not so sure. "The bill included money for stranded employees as well as stranded assets," worries Ben Hudnall, business manager for Engineers and Scientists of California. "While the drafters of the initiative didn't set out to kill this, we think it might have that effect.
As reaction to deregulation begins to build, it's not clear what alternative exists to the present direction. TURN's past director Audrey Krause didn't want to alter the original regulatory structure to begin with. "It's not broke, so don't fix it," she declared, arguing that the public utilities commission simply didn't want to do its job. "If it wants lower rates, all it has to do is order them. Commissioners have to cut the profits and dividends of the utilities, which they've never had the guts to do."
Meg Power thinks that, while retail wheeling doesn't serve consumers well, "wholesale competition would allow consumers to get a good price on energy. At the same time, those benefits would be captured for low-income residents."
Chris Hahs believes that changing the rate structure might provide an alternative. Instead of being guaranteed a set profit above costs, he thinks utilities should be given a set rate, and forced to reduce costs below that to make a profit.
In California, however, moves towards performance-based rate setting led PG&E to make massive layoffs. Then, when winter storms hit, it had far too few emergency crews to restore power to communities that lost it for days at a stretch. "It would have to be the responsibility of state regulators to ensure that the costs the utilities cut doesn't affect service," Hahs responds.
Public ownership and municipalization was the answer of trustbusters of the Progressive Era, and there are still a number of communities around the country which are interested in pursuing that alternative. In the Central Valley university town of Davis, California, the Davis Coalition for Local Power is going after PG&E distribution system. Palm Springs, where affluent residents have high bills for the cost of running air conditioners in the extreme desert heat, made one attempt to set up a duplicate metering program, as was done in Cleveland, but was refused permission by the Federal Energy Regulatory Commission.
"Public ownership is a really cool alternative," Hahs says. "Everyone looks at the Sacramento Municipal Utility District, and thinks they could do it too." But Hahs also worries that publicly-owned utilities don't necessarily have an incentive to develop the new technology for more efficient power generation, which is an important motive force behind the move towards deregulation. "There's lots of new ways to do things out there now," he says. "And the old rate structure really kept them from being developed."
In the end, it is as much a question of power as one of technology or system. The development of retail wheeling is leading to enormous monopolization and concentration of economic and political clout in the electricity industry. Those monopolies have a great stake in the continuation of deregulation. Without organized alliances between consumers, environmentalists, unions and advocates for low-income communities, it is difficult to imagine where the political power would come from to defeat them and change the system.
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