Restructuring or Deregulation?

Restructuring is not Synonymous with Deregulation

The almost-century old structure of the American electric utility industry is in flux. 

Almost all interested parties accept the fact that technological change and altered 

views of the nature of government intervention have made the idea of increased 

competition attractive. But just how should the competitive market be structured? 

Some participants want complete deregulation so they can derive the fullest 

benefits of competition quickly. Others argue that the unfettered free market, 

however, will cause hardship and inequities.

In California and elsewhere, lawmakers realized that new institutions--overseen 

by government--had to be created to ensure fair play by all parties. Moreover, 

regulation needs to remain in place to safeguard the environment and to maintain 

programs (such as low-income programs, energy-efficiency initiatives, and R&D 

on alternative technologies) formerly run by regulated utility companies. These 

programs are clearly desired by the public, but they might hold little interest 

among competitive companies that seek to minimize costs.

On one hand, restructuring of the electric utility industry in the coming years 

means that deregulation may occur in terms of prices and entry of competitors 

into the market. On the other hand, government intervention of some areas of the 

business are likely to continue to ensure maintenance of socially desirable 

functions. Restructuring, therefore, is not synonymous with complete 

deregulation.

Problems with Traditional Regulation

As much as some utility executives may protest deregulation of prices, many 

parties agree that traditional regulation appears flawed. In the golden years, when 

new construction of power plants reduced the average cost of electricity, 

regulation that set rates based on the value of the new equipment worked fine, 

since rates generally decreased. But in the 1970s and later, utility construction 

became increasingly costly, and rates reflected those higher costs. Moreover, 

regulatory rules encouraged utilities to complete long-delayed power plants even 

if the demand for power was not likely to warrant such a big plants or because 

poor management caused costs to escalate.

Management of Electric Utility Companies

During the Golden Years

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During the years after World War II and until the 1970s, utility management focused on 

the major chore of building enough power plants and improving the transmission and 

distribution grid. Not surprisingly, most managers rose through utility ranks after getting 

college degrees in engineering. Mechanical and electrical engineers in particular, they 

knew how to solve problems relating to the installation, coordination, and operation of 

huge generation units within an increasingly complex grid of power plants and 

transmission lines. As nuclear power appeared in the 1960s to be the technology of the 

future, more engineers trained in the esoteric and challenging field also entered utility 

management.

Good Natured Competition

Competition between utility companies could not exist on the retail level, since regulation 

parceled out monopoly franchises to each firm. But a form of competition existed 

nevertheless, and it tells much about the pride and spirit of utility managers. Reflecting 

their engineering backgrounds, many executives competed against others by trying to 

install the largest power unit of the day (with the company president's name adorning it), 

or the most thermally efficient one. Beyond this type of competition, however, utility 

executives remained cooperative with their colleagues in other firms, feeling that they 

belonged to a fraternity made up of like-minded managers.

On most political and regulatory issues dealing with electric power, they held common 

views, which were often expressed by their trade association, the Edison Electric Institute. 

And in 1972, they created an industry-wide R&D organization, the Electric Power 

Research Institute which shared its fruits with all members. Few secrets existed among 

utility executives. They employed similar business and technological strategies, and they 

enjoyed seeing their work yield social and economic benefits.

Troubled Times and Competition

The 1970s signaled the beginning of the end of the clubby attitude of managers as they 

tried to cope with myriad challenges. As engineers, they frequently sought answers to 

problems by suggesting the introduction of new or more technology. Hence, the solution 

to the energy crisis would be to build more nuclear power plants, despite the fact that 

vocal opponents and the public increasingly disapproved of them.

As rate increases became commonplace, customers became more active and complained 

to regulators, who hampered managers' ability to do whatever they wanted. Moreover, 

executives generally opposed the spread of facilities qualified under the Public Utilities 

Regulatory Policy Act--unregulated generators who quickly entered the business in the 

early 1980s--because they could not be controlled by utility companies. All in all, power 

company officials lamented the erosion of their authority over an industry that once 

brought near-universal benefits.

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New Leadership

To deal better with the problems and challenges of the time, several utility companies 

placed people with different backgrounds into leadership positions. Instead of only 

engineers, more utility decision-makers had training in law, accounting, public relations, 

and even environmental advocacy. Some new managerial recruits deliberately had little 

utility experience, coming instead from competitive industries. Holding different 

perspectives on the business, they helped utility companies better address regulatory 

issues and work more effectively with increasingly powerful opponents of traditional 

utilities. They also looked forward to the potential of more competition.

An End to Business As Usual

Splits in the Ranks

By 1990, that potential for a less-regulated market in electricity appeared ever more 

ominous. In fact, some managers believed that their firms would soon be rivals with other 

power companies. As a result, industry meetings lost much of their fraternal fellowship. 

Utility executives wistfully noted that with competition on the horizon, the industry had 

become less friendly, with managers refraining from talking and socializing with each 

other as in earlier days.

While most executives did not look forward to an end to some regulation, others 

welcomed it, thinking that their companies (often low-cost companies) would thrive in the 

competitive environment. Additionally, the increasingly divided industry lost its ability to 

speak with one voice, even through the Edison Electric Institute, thus weakening its 

political clout on issues such as how to reduce acid rain.

New Strategies for Competition

The managers had reason to fear open dialog as companies in the mid-1990s tried to 

buttress themselves for a new era. In one approach to make themselves more competitive, 

many utilities slashed payrolls and cut costly "social" programs, such as energy efficiency, 

that may have been popular. Additionally, many utilities began merging with others in 

attempts to reduce administrative costs and create synergies that would help them deal 

with new rivals. Mergers increased from one in 1994, to 30 in 1996.

At the same time, gas companies and electric companies started forming new 

relationships. Even more unusual, some energy firms foresee offering electric, gas, water, 

and telecommunications services to customers, who would then need to make only one 

phone call to obtain all their utility needs. In such an environment, it is no wonder 

managers didn't talk to each other as openly as in the 1960s!

New Technologies Can Change Everything

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Even as states and the federal government debate bills for restructuring the utility industry, 

technological innovation could change the entire nature of the electric supply business. 

For nearly a century, the accepted structure of the regulated industry has included large, 

central power-plants that generated electricity for distribution to homes and businesses, 

with customers linked to utility companies through a network of wires. That structure may 

soon change as new technologies allow decentralized and disconnected users.

Fuel cells making electricity and water, micro-turbines using natural gas, photovoltaic 

cells and energy storage systems which allow people to obtain electricity from the sun. 

These new technologies may allow homes and businesses to remove themselves from the 

electric power grid or connect with neighbors and other businesses to create similar 

synergies that utilities obtained by interconnecting their transmission systems. With the 

flourishing of smart electronic technologies used for communications, monitoring, and 

energy efficiency, this scenario becomes more feasible.

Coming Full Circle?

Actually, the new scenario is a throwback to the 1880s, when Edison sold small directcurrent generating systems to hotels, industrial companies, and other isolated businesses. 

But with the growth of alternating current, which allowed long-distance transmission of 

power, and growing economies of scale in central generation power plants, isolated 

generation diminished. Today, traditional economies of scale no longer exist, though 

economies of small scale seem to be thriving. In a very real sense, the enterprise of 

electricity supply could be returning to its roots of more than 100 years ago.

The Public Utilities Regulatory Policy Act of 1978

(Public Law 95-617)

PURPA's Impact

The enactment of PURPA started the industry on the road to restructuring, by ending 

promotional rate structures, establishing unconventional "Qualifying Facilities" (or QFs), 

and encouraging conservation. While hoping for non-conventional sources of power to 

come on line as a result of PURPA, no one anticipated the changes that the law would 

have on the regulation of electric power and the overall structure of the electric utility 

system.

Unintentionally, PURPA started the questioning process because it enabled non-utility 

generators to produce power for use by customers attached to a utility's grid. In other 

words, the law broke the stranglehold on power companies' previous monopoly in the 

generation function. Now, any unregulated cogenerator or renewable energy producer 

could sell electricity into the power grid, with regulated utilities helpless to dictate terms.

PURPA's Limits

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In a sense, however, PURPA did not create a competitive market for power yet. After all, 

the PURPA QFs did not literally compete with regulated utilities since those companies 

were required by law to purchase whatever power came their way from the cogenerators 

and alternative power generators. Still, the PURPA producers caused real grief to many 

utility managers, since the new players represented a source of power they could not 

control. The QFs sold power into the grid whenever they wanted, or whenever they had 

excess power remaining in a cogeneration plant, and utility managers had to find ways to 

limit their own production, or boost it, to ensure that customers obtained the power they 

needed without interruption.

Questioning the Rationale of Natural Monopoly for Regulation

These realities of electricity production made many people within and outside the industry 

question one of the rationales for acceptance of utilities at natural monopolies and, 

consequently, the justification for regulation. In the theory accepted early in the 20th 

century, electric power production and distribution constituted a natural monopoly 

because, by dint of huge capital investment in expensive generating equipment and 

associated facilities, one company could produce power more economically than could 

competitive firms. Many companies in the same market would not enjoy the large market 

of diverse customers, and they would be limited to using smaller and less-efficient 

equipment. All customers, therefore, would be deprived of the benefits that could be 

accrued if only one company produced power for an entire market.

But the end of technological progress combined with the economic woes of the 1970s and 

1980s turned this argument upside down. It now appeared, thanks to incentives provided 

by PURPA and innovation in small-scale technologies, such as gas turbines, that nonutility companies could produce power as cheaply or more so than could regulated firms. 

In short, the existence and success of PURPA QFs appeared to destroy one important 

justification for regulation of utilities.

The Energy Policy Act of 1992

Exempt Wholesale Generators

Containing measures that would help spur production of domestic energy resources, such 

as a credit for electricity generated from renewable resources, EPAct also contained 

measures for creating greater numbers of producers of power along more conventional 

means. For example, it created a new class of producers called Exempt Wholesale 

Generators, which could generate power any way they saw fit and without regard to 

energy efficiency concerns (as was the case for PURPA QFs). The measure increased 

competitive pressure on existing generating companies and utilities in the same way as a 

new supermarket in town would force others to become more efficient and cost-conscious.

Utilities Could Expand Outside their Franchise Areas

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Utility companies won some new rights under the Energy Policy Act as well. The law 

allowed utilities to own some EWG facilities, even outside their franchise area. 

Conceivably, then, a utility on the west coast could own generating facilities on the east 

coast if it believed the practice made good financial sense. Moreover, utilities did not even 

have to keep all their business in the United States. If they saw profit opportunities abroad, 

they could purchase companies there, so long as customers of domestic operations were 

not disadvantaged.

Wholesale Competition Only

On another front, utilities also won a major concession. While the law required utilities to 

open their transmission systems to other companies that sought to wheel power over them, 

only wholesale transactions were permitted. While some lobbyists for large industrial 

electricity users sought to permit sales to retail customers, so they could take advantage of 

cheap power wherever it came from, the law limited sales to wholesale customers. These 

included other utility companies, municipal power systems, and rural electrification 

networks, which would then resell the electricity to ultimate customers.

In accordance with EPAct requirements, the FERC issued Orders 888 and 889 in 1996. 

The Orders outlined the process of "open access" to transmission facilities, and specified 

the use of "Open-Access Same-Time Information Systems" (or OASIS) to prevent 

discriminatory practices. One impact of modern computer technology on the industry has 

been to make possible the control systems needed to oversee transmission reliability in 

this open environment. Another has been to permit OASIS to function as intended, as the 

system is designed to function via the Internet.

Door Left Open for Retail Competition in States

Though the federal law limited sales to wholesale customers, it left the door open for 

competition on the retail level. It did so by allowing state legislatures and regulatory 

commissions to take the final step by allowing suppliers to sell electricity all customers--

whether they be big factories or small residential households. Within a few years, several 

states began plans to pass through that open door.

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