Disasterous Deregulation

by Charlie Higley

December 2000

Background

The electric power industry, one of the oldest, largest, most complex, most polluting, and heavily regulated industries of the American economy, is undergoing tremendous change. State and federal lawmakers are dismantling the laws and regulations that have controlled the industry and protected electricity consumers for the better part of 100 years.

Currently, most electric utilities have a legal monopoly to be the only supplier of electricity to customers and businesses located in the utility s service territory. As a customer, you have to buy electricity from your local electric utility. In contrast, electricity deregulation (also called "restructuring") allows a consumer to shop for power, instead of having to buy electricity from the local monopoly utility. It also allows non-utilities, or "independent power producers," to own power plants and sell electricity.

The United States is home to about 3,200 distinct electric utilities, of which there are three basic ownership types: investor-owned utilities, which own 78 percent of the assets used to provide electricity; publicly-owned utilities (including municipal utilities and federal utilities), which own about 14 percent of electric power assets; and cooperative utilities, which own about 8 percent of electric power assets.

Since electric utilities are monopolies, state and federal agencies must regulate electricity rates and terms of service, otherwise utility owners would charge whatever rates they pleased, or would provide service to only the most profitable customers. In contrast, non-regulated companies produce goods and services the prices of which are determined by the presence of many competing companies pursuing the dollars held by consumers free to chose the best deal.

In exchange for their state-granted monopolies, investor-owned utilities are allowed an opportunity (but not a legal guarantee) to recover in rates the costs of doing business (for example, the costs of the power plants, fuel, buildings, wages, depreciation, interest payments, taxes, etc.) plus an opportunity (but not a legal guarantee) to earn a profit on invested capital. Municipal and cooperative utilities also recover their costs through rates, but as non-profit organizations, they do not harvest profits from their customers. Under regulation, all utilities are required to serve all customers living in their service territories, and utilities must ensure that they will have enough power on hand to meet the needs of their customers for at least the next 10 years or so.

Why Deregulate?

For many technical and economic reasons that are beyond the scope of this review, industry analysts have long believed that, for a given area, one utility could produce, transmit, and distribute electricity more cheaply than several.

In the early 1970s, the belief that one utility could provide the least expensive electricity began changing. New technologies, such as turbines powered by natural gas, were developed that produced electricity less expensively than large coal-fired power plants or nuclear reactors. A federal law passed in 1978 encouraged utilities to build or purchase power from "cogeneration plants," which are more efficient and cost-effective than traditional plants because cogeneration produces useable steam or hot water as well as electricity. However, the old monopoly utilities were slow to adopt the new technologies. During the 1970s and 80s, many electric utilities foolishly built large nuclear power plants costing billions of dollars. Nuclear utilities had to raise their rates in order to pay off the huge debts incurred while building the reactors. Other utilities that wisely avoided nuclear power were able to keep their electric rates much lower.

Starting in the late 1970s, large industrial corporations began calling for deregulation. These corporations, such as steel mills, car manufacturers, and oil refineries, noticed the huge differences in rates charged by different utilities; one factory could pay rates more than twice as high as a similar factory served by a different utility. Always looking to cut costs, many large industrial corporations, which use tremendous amounts of electricity, began complaining about the differences in rates, as well as having to buy electricity from their local monopoly utility. Instead, these large customers wanted to shop for the cheapest power available. They also argued that new companies should be allowed to generate and sell electricity, which would put competitive pressure on the utilities to reduce their rates.

Calls by large industries for utility deregulation found a ready chorus in academics, analysts, and politicians who believed that competition could produce lower prices, better service, and more innovation than government regulation. The free-marketeers pointed at other industries that had been deregulated during the 1980s, such as airlines and telecommunications, claiming that deregulation helped lower the cost of airplane tickets and long-distance telephone rates (Public Citizen disputes many of these claims; deregulation helped lower prices for some, but others have seen price increases and reduced service). The free market proponents argued that since deregulation worked for the airlines and telecommunications (which Public Citizen disputes), why not the electric power industry?

Electric utilities strenuously opposed attempts to end their monopolies. The utilities worried that they would be unable to pay off the debt owed on their nuclear power plants if their customers, especially large ones, were allowed to shop for power. Nevertheless, the tide of free-market hysteria reached a fever-pitch in the early 1990s, and several states began exploring ways to deregulate their electric utilities.

With the threat of not getting their billion dollar investments in nuclear power paid off, utilities lobbied state legislatures to get ratepayers to pay for their power plants before deregulation could take effect. Given their huge lobbying staffs and fat campaign contributions, nuclear utilities were able to convince every state government considering deregulation to force ratepayers to pay off the utilities in exchange for deregulation.

For example, the deregulation bills enacted in the mid-to-late 1990s in California, Illinois, Massachusetts, New York, Ohio, Pennsylvania, Texas, and other states include multi-billion dollar bailouts of the utilities for their bad investments in nuclear power. California utilities will get more than $20 billion from the backs of hardworking families to pay for their poor decisions to build nuclear power plants. In Massachusetts the utilities are receiving about $7 billion; in Illinois $14 billion; in New York nearly $17 billion; in Ohio $11 billion; in Pennsylvania about $10 billion; and in Texas nearly $5 billion. Nationwide, the utility bailout could total over $200 billion, making it one of the largest corporate bailouts in history.

So far, all of the movement toward deregulation has taken place in the states, with 24 already acting. However, not one state has restructured their electric industry in a way that will truly benefit consumers or protect our natural environment. Instead, large industrial customers and utilities have used campaign contributions and strong-arm lobbying to get lawmakers to enact legislation that will benefit corporate interests at the expense of the consumer s interest.

California was one of the first states to implement its deregulation law; California opened its electricity markets to so-called competition in April 1998. Because the California deregulation scheme is so poorly thought out, less than 3 percent of all California customers, including large industrial customers, have switched suppliers. Almost no residential customers have switched. Thus, almost three years after the law took effect, nearly everyone in California is now being served by an unregulated monopoly.

Ratepayers May Never See Lower Electricity Prices

Many state deregulation laws have a "transition period," during which residential consumers receive a discount on their electricity rates, usually about 10 percent. However, once the transition period expires (usually about four years), there is no assurance that small consumers will ever see lower electricity prices.

Indeed, deregulation has already led to huge volatility in electricity prices, which have spiked at prices more than 100 times normal in many parts of the country over the past several years. For example, during the summer and fall of 2000, wholesale prices for electricity in California were, on average, more than four times as high as prices during the previous year, with occasional price spikes of 50 times normal prices. Californians watched helplessly as deregulated power suppliers took an extra $6 billion out of the state s economy, or more than $200 out of the pocket of every person living in the Golden State.

Utility Workers Are Losing Their Jobs

In the wake of utility deregulation, more than 150,000 utility workers have lost their jobs (about 30 percent of the 1990 utility workforce). Not only have these layoffs affected the well-being of displaced workers, the layoffs mean fewer high-paying jobs in many communities. Utility layoffs also affect the safety and reliability of electric service: with fewer workers on the job, power outages take longer to restore. Consumers reporting outages here nothing but busy signals and answering machines when calling their utility.

For example, blackouts in New York City and downtown Chicago during the summer of 1999 were the direct result of cost-cutting by the utilities. They delayed performing maintenance on power lines and transformers. During a heat spell, when everyone needed electricity the most, poorly-maintained power lines and transformers over-heated and failed, plunging thousands of residents and businesses into stifling heat and total darkness. Imagine sitting in a New York or Chicago skyscraper with no lights, air conditioning, or elevators.

Are consumers in New York and Chicago seeing lower rates because of utility cost-cutting? No the utilities are keeping the money to pay for their bad investments in nuclear power.

Deregulation is Producing More Pollution

Except for Texas, no state deregulation scheme addresses the toxic pollution produced by the 500 coal-fired power plants that, in 1977, became exempt from provisions of the federal Clean Air Act. These "grandfathered" power plants alone are responsible for producing one-third of the nation s pollution that causes smog. When breathed, smog (also called "ozone") literally burns through lung tissue, and can send to the emergency room those who are very young, very old, or have respiratory problems. According to the American Lung Association, 117 million people are breathing unsafe, smog-contaminated air. Smog also reduces the health and productivity of farmlands, forests, lakes, and rivers.

Soot (also called fine particulate matter) is perhaps the most visible type of pollution from coal-burning power plants, which produce far more soot than any other source. Although soot is ruining the vistas in many National Parks and scenic areas, the American Lung Association estimates that 70 million people live in areas where soot has made the air unsafe to breath. Like smog, soot damages the lungs, causing bronchitis, chronic coughs, and premature death for thousands.

Pollution from coal-fired power plants creates one-third of the pollution that leads to global warming, which is likely influencing much of the extreme weather we ve been having lately, such as stronger floods, droughts, tornadoes, and hurricanes.

Coal-burning power plants also produce about two-thirds of the nation s pollution that causes acid rain, which has ruined lakes, forests, and farmlands in the eastern United States.

Mercury pollution from coal power plants, which produce about a third of all mercury emissions, causes serious neurological damage to developing fetuses, infants, and children, causing irreversible disabilities such as mental retardation, cerebral palsy, and liver damage. Mercury pollution from coal power plants is a large part of the reason why health agencies in 40 states warn people about eating fish from over 50,000 bodies of water.

Each year in the U.S., air pollution kills more than 60,000 people a death toll higher than that caused by traffic accidents. Because these grandfathered coal plants produce significant amounts of air pollution, the grandfathered coal plants are literally killing thousands of people each year.

Since these grandfathered coal plants, which produce over half of the nation s electricity, do not have to use modern technologies to reduce pollution, they can produce electricity more cheaply than cleaner technologies, such as wind machines or solar cells. With large industrial customers scrambling to get the cheapest power, deregulation has caused these old, dirty coal plants to run even longer, producing annually an extra 750,000 tons of smog-forming nitrogen oxides and nearly 300 million tons of carbon dioxide beyond the amounts produced in 1992. So far, electricity deregulation has increased pollution from power plants. So far, electricity deregulation is literally killing more and more Americans each year.

Deregulation: The Return of Utility Holding Companies

Electricity deregulation is encouraging utilities to rebuild the ruinous holding company empires that abused shareholders and ratepayers during the 1920s and 1930s. Distressingly, many of the industry reforms enacted during the early years of the New Deal, which successfully brought the utility holding companies under control, are now being repealed, undermined, and ignored. Deregulation proponents are repeating the mistakes of the past, and nothing signifies this backward, ignorant, greed-driven trend better than the return of the anti-consumer, anti-shareholder utility holding company.

A holding company is a corporation that owns the stock of another company, giving the holding company the authority to control the board of directors and the budgets of the acquired companies, which become known as subsidiaries. The goal of a holding company is to acquire other profitable businesses in order to increase profits for the managers and shareholders of the holding company itself. Holding companies have been part of American business since the mid-1800s, and have been the preferred corporate structure for robber barons ever since from John D. Rockefeller s Standard Oil, to most of today s major corporations.

Electric utilities quickly learned how to exploit ratepayers and shareholders through the use of holding companies. During the Roaring Twenties, a period of unprecedented economic boom, electricity use grew rapidly, and utility holding companies began merging and consolidating into empires that stretched across state and national borders. Most of these mergers were done to increase profits and to escape state regulation; state regulatory commissions were and remain powerless from controlling the operations of holding companies or utility subsidiaries organized in other states. Prior to 1935 there was no federal regulation of electric utilities, so for most purposes the holding companies were unregulated monopolies. With completely ineffective state regulation, utility holding companies forced ratepayers to pay excessive rates while selling worthless stock to shareholders. Meanwhile, rural areas of the U.S. remained without power, as the holding companies considered rural areas unprofitable to serve; in 1935, only 10 percent of farms had electric power.

President Franklin D. Roosevelt had deep enmity for utility holding companies. In a letter to Congress, Roosevelt wrote:

[The holding company] is a corporate invention which can give a few corporate insiders unwarranted and intolerable powers over other people s money. In its destruction of local control and its substitution of absentee management, it has built up in the public-utility field what has justly been called a system of private socialism which is inimical to the welfare of a free people.

& . It is time to make an effort to reverse that process of the concentration of power which has made most American citizens, once traditionally independent owners of their own businesses, helplessly dependent for their daily bread upon the favor of a very few, who, by devices such as holding companies, have taken for themselves unwarranted economic power.

Along with the support of other progressive leaders, Roosevelt led a massive restructuring of the power industry through the creation of the New York State Power Authority in 1931 and the federal Public Works Administration in 1933; the enactment of the Tennessee Valley Act of 1933, the Public Utility Holding Company Act of 1935, the Federal Power Act of 1935, and the Rural Electrification Act of 1936; the creation of the Bonneville Power Administration in 1937 (followed by the development other federal and state systems), and the consumer takeover of all investor-owned electric utilities in Nebraska by 1950.

In particular, Roosevelt s Public Utility Holding Company Act of 1935 (PUHCA) brought under federal regulation the utility holding company empires so detrimental to ratepayers and shareholders alike. PUHCA forced holding companies into owning adjacent utilities that can be operated as single electrical systems, allowing for lower cost electricity and greater reliability through integrated and coordinated operation; holding companies had to sell any utility that could not be integrated with its other utilities. PUHCA also forced the holding companies to simplify their corporate structures by prohibiting the abusive pyramiding of holding companies on top of holding companies, and by eliminating minority controlling interests, which greatly complicated utility ownership and regulation.

Due to the enactment of PUHCA, ratepayers saw their electric bills drop by 14 percent between 1938 and 1951. Shareholders, who had been sold worthless stock, saw their holdings increase in value after PUHCA was enacted, due to the numerous shareholder protections contained in the law.

Although most utilities prospered in the decades after PUHCA was enacted, the utilities have always hated the law, and have been working ever since to weaken it through amendments or outright repeal. As deregulation fervor spread during the 1980s and 1990s, enforcement of PUHCA by the Securities & Exchange Commission (SEC) became weaker and weaker, to the point where the SEC is now allowing utilities to recreate holding companies that completely violate PUHCA s provisions. For example, 54 utility holding companies have been created since the first amendments to PUHCA were passed in 1978. The same period has seen over 120 mergers of electric and gas utilities, with over 75 occurring in 1999 and 2000. Little of this activity would have occurred with stronger enforcement of PUHCA.

Most analysts believe PUHCA repeal is inevitable, while some also believe that, within a few years, between five and ten super holding companies will own and control most of the nation s electric power industry, just as they did in 1930. If so, we can all look forward to paying the outrageous rates currently being inflicted on the ratepayers of California, the first state to feel the brunt of utility holding companies run amok.

What Should Be Done?

Given the incredible importance that affordable, reliable electricity plays in our modern society, should we tolerate electricity deregulation when all it is creating are higher prices, less reliable service, fewer jobs, a more polluted environment, and unregulated monopolies?

The answer is no. Instead, consumers should take control of this industry so that we are no longer at the mercy of utility holding companies and other for-profit suppliers. Consumers can take charge by creating new, nonprofit cooperative or municipal utilities, which could purchase the electric power system using low-cost debt. Municipal utilities are owned and controlled by a community and its citizens municipal utilities have been a part of the electric power industry since its beginnings in the 1880s. Cooperative utilities are owned by their members. Since municipal and cooperative utilities are owned by their customers as nonprofit utilities, they have no incentive to charge high rates.

Regarding investor-owned utilities, unless they are regulated, they will always take advantage of consumers. Regulation is needed to keep power suppliers from charging the highest prices they can get away with. Regulation is also needed to ensure that the utilities build enough power plants to meet the demands of their customers for the foreseeable future.

States that have deregulated their investor-owned utilities should reregulate them. States that haven t deregulated their utilities shouldn t. Efforts to deregulate federal utility law should cease; the Federal Energy Regulatory Commission should return to cost-of-service rates, and the Securities and Exchange Commission should return to enforcing PUHCA.

Instead of focusing on the profits of the next quarter, nonprofit consumer-owned utilities can plan their needs well into the future, making sure affordable, reliable, environmentally-responsible power is available to everyone. Regulation can help control the abuses of consumers at the hands of investor-owned utilities.

Putting consumers and the public in charge is the best way to ensure that our electricity industry is owned, operated, maintained, and planned in ways that minimize costs to consumers and damage to the environment, instead of maximizing the money harvest of for-profit suppliers.

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-- Cherri (jessam5@home.com), January 29, 2002