Deregul;Ation Of The Electrical Industry Essay

Deregulation of the Electrical 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.

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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 input 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.
Summary
By examining the early results of the Massachusetts Electricity 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. The deregulation of the electrical industry proves that
any industry can and should be deregulated. It also proves that
competition of the utility company’s is in the best interest of society as a
whole and that no industry should be allowed to exist without it.


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