## Restructuring or Deregulation?

Restructuring is not Synonymous with Deregulation

The almost-century old structur e of the American electric ut ility industry is in flux. Almost all interested parties accept the fact that technol ogical change and altered views of the nature of gov ernment intervention have ma de the idea of increased competition attractive. But just how should the competit ive market be structured? Some participants want co mplete deregulation so th ey can derive the fullest benefits of competition quickl y. Others argue that the unfettered free market, however, will cause har dship and inequities.

In California and elsewhere, lawmakers realized that new inst itutions--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 init iatives, and R&D on alternative technologies) formerly run by regulated utility companies. These programs are clearly desired by the public, but they mi ght hold little interest among competitive companies thatseek to minimize costs.

On one hand, restruct uring of the electricutility industry in the coming years means that deregulation ma y occur in terms of prices and entry of competitors into the market. On the other hand, governm ent intervention of some areas of the business are likely to co ntinue to ensure maintenance of socially desirable functions. Restructuring, therefore, is not syn onymous with complete deregulation.



### Problems with Traditional Regulation

As much as some ut ility executives may protest de regulation of prices, many parties agree that tr aditional regulation appears flawed. In t he golden years, when new construction of power plants reduced the average cost of electricity, regulation that set rates based on the value of th e new equipment worked fine, since rates generally decreas ed. But in the 1970s and la ter, utility construction became increasingly costly, and rates reflected those higher costs. Moreover, regulatory rules encouraged ut ilities 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 Electr ic Utility Companies

During the Golden Years Page 1 of 6 Powering A Generation: Understanding Deregulation #1

7 / 31 / 201 5 http://americanhi story.si.edu/powering/dereg/dereg1.htmDuring the years after World War II and unt il the 1970s, utility management focused on the major chore of building enough power pl ants and improving the transmission and distribution grid. Not surprisingly, most manage rs rose through utility ranks after getting college degrees in engineering. Mechanical and electrical engineers in particular, they knew how to solve problems relating to th e installation, coordination, and operation of huge generation units within an increasi ngly 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 fi rm. But a form of competition existed nevertheless, and it tells much about the prid e and spirit of utilit y 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 effici ent one. Beyond this type of competition, however, utility executives remained cooperative with their co lleagues in other firms, feeling that they belonged to a fraternity made up of like-minded managers.

On most political and regulatory issues d ealing with electric power, they held common views, which were often expressed by their trad e association, the Edison Electric Institute. And in 1972, they created an industry-wi de R&D organization, the Electric Power Research Institute which shar ed its fruits with all memb ers. Few secrets existed among utility executives. They employed similar bus iness 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 e ngineers, they frequently sought answers to problems by suggesting the introduction of ne w 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, custom ers became more active and complained to regulators, who hampered managers' abili ty to do whatever they wanted. Moreover, executives generally opposed the spread of f acilities qualified under the Public Utilities Regulatory Policy Act--unregul ated 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. Page 2 of 6 Powering A Generation: Understanding Deregulation #1

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### New Leadership

To deal better with the problems and chal lenges of the time, seve ral utility companies placed people with different backgrounds into leadership positions. Instead of only engineers, more utility deci sion-makers had training in law, accounting, public relations, and even environmental advocacy. Some new mana gerial recruits deliberately had little utility experience, coming instead from co mpetitive industries. Holding different perspectives on the business, they helped utility companies bett er address regulatory issues and work more effectively with increasingly powerful opponents of traditional utilities. They also l ooked 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 meeti ngs lost much of their fraternal fellowship. Utility executives wistfully noted that with competition on the horizon, the industry had become less friendly, with managers refraini ng from talking and socializing with each other as in earlier days.

While most executives did not look forwar d to an end to some regulation, others welcomed it, thinking that their companies (oft en low-cost companies) would thrive in the competitive environment. Additionally, the incr easingly divided industry lost its ability to speak with one voice, even through the Edis on Electric Institute, thus weakening its political clout on issues suchas how to reduce acid rain.



### New Strategies for Competition

The managers had reason to fear open dial og as companies in the mid-1990s tried to buttress themselves for a new era. In one appr oach 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 increa sed from one in 1994, to 30 in 1996.

At the same time, gas companies and el ectric 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 Page 3 of 6 Powering A Generation: Understanding Deregulation #1

7 / 31 / 201 5 http://americanhi story.si.edu/powering/dereg/dereg1.htmEven as states and the federal government debate bills for re structuring 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 gene rated 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, micr o-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 bus inesses to remove themselves from the electric power grid or connect with neighbors and other bus inesses to cr eate similar synergies that utilities obtained by interconn ecting their transmission systems. With the flourishing of smart electroni c technologies used for co mmunications, 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 ho tels, industrial companies, and other isolated businesses. But with the growth of alternating current, which allowed long-dist ance transmission of power, and growing economies of scale in ce ntral 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 industr y on the road to restructuring, by ending promotional rate structures, establishing unc onventional "Qualifying Facilities" (or QFs), and encouraging conservation. While hoping fo r 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 electri c power and the overall struct ure of the electric utility system.
Unintentionally, PURPA started the questioni ng process because it enabled non-utility generators to produce power for use by customer s 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 rene wable energy producer could sell electricity into the power grid, withregulated utilities help less to dictate terms.



### PURPA's Limits Page 4 of 6 Powering A Generation: Understanding Deregulation #1

7 / 31 / 201 5 http://americanhi story.si.edu/powering/dereg/dereg1.htmIn a sense, however, PURPA did not create a co mpetitive 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 ne w players represented a sourceof 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 Na tural 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 regulati on. In the theory accepted early in the 20th century, electric power pr oduction and distribution constituted a natural monopoly because, by dint of huge cap ital investment in expensiv e 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 li mited to using smalle r 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 smal l-scale technologies, such as gas turbines, that nonutility companies could produce power as cheapl y or more so than could regulated firms. In short, the existence and success of PU RPA 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 res ources, EPAct also contained measures for creating greater numbers of producers of power along more conventional means. For example, it created a new cl ass 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 cas e for PURPA QFs). The measure increased competitive pressure on existing generating comp anies and utilities in the same way as a new supermarket in town would force others to become more efficient and cost-conscious.



### Utilities Could Ex pand Outside their Franchise Areas Page 5 of 6 Powering A Generation: Understanding Deregulation #1

7 / 31 / 201 5 http://americanhi story.si.edu/powering/dereg/dereg1.htmUtility companies won some new rights under the Energy Policy Act as well. The law allowed utilities to own so me EWG facilities, even outside their franchise area. Conceivably, then, a utility on the west coast could own generating faci lities 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 l ong as customers of dom estic 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 comp anies that sought to wheel power over them, only wholesale transactions we re 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 companie s, municipal power systems, and rural electrification networks, which would then resell th e 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 acce ss" to transmission faci lities, and specified the use of "Open-Access Same-Time Inform ation Systems" (or OASIS) to prevent discriminatory practices. One impact of modern computer technology on the industry has been to make possible the control systems ne eded to oversee transmission reliability in this open environment. Another has been to permit OASIS to function as intended, as the system is designed to f unction via the Internet.



### Door Left Open for Reta il Competition in States

Though the federal law limited sales to wholes ale 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 elect ricity all customers-- whether they be big factories or small reside ntial households. Within a few years, several states began plans to pa ss through that open door. Page 6 of 6 Powering A Generation: Understanding Deregulation #1

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