Two Utilities are Better Than One

In Lubbock, Texas, two electric utilities are competing for people's business. How does it work? Could competition be the answer to rising electric bills?

Jan Bellamy from the October 1981 issue

(Page 6 of 7)

Yet there is reason to think that Primeaux was too cautious in his assessment of the reach of X-efficiency. Consider once again the example of Lubbock. Electricity rates there are 20 percent lower than in nearby Texas areas. Yet LP&L and SPS together produce over 1.5 billion kwh per year—far higher than Primeaux's cut-off point.

Lubbock was not one of the cities in Primeaux's data base, and when I told him that figure he was quite pleased. "I have every reason to believe that if Lubbock had been in the sample years of data the earlier results would have been even more impressive," he told me. In fact, he pointed out, only 3 of the 23 competitive cities he analyzed had power outputs exceeding 200,000 kwh, so the 222,000-kwh cutoff had been based on very limited data. If more large cities had competition, we might have a lot more evidence in support of X-efficiency.

Not being a whiz at math, I couldn't really assess Primeaux's statistical results. But a chart I picked up at SPS in Lubbock brought home to me what X-efficiency is all about. It showed SPS's cost of building a new coal-fired power plant in the late 1970s versus that for comparable plants in Wisconsin, Oregon, and Pennsylvania (based on calculations by the Electric Power Research Institute). The other three plants averaged $7.39 per installed kilowatt—fairly typical for modern 5()()-1,000 megawatt plants. But here was SPS able to build the same thing for only $296 per kilowatt!

If that's what X-efficiency means in practice, then I'm a believer. Those people really had figured out how to produce electricity cheaper! (In fact, SPS's installed cost per kilowatt is the lowest in the nation.)

There's one final nail in the coffin of the old economies-of-scale argument for regarding utilities as natural monopolies. It is that for large firms—the ones Primeaux tentatively excluded from eligibility for competition —economies of scale no longer exist. It turns out that the economics of producing electricity underwent a fundamental shift in the latter half of the 1960s.

What happened, notes utility analyst Ernst R. Habicht, Jr., was that rising costs of production began overtaking the pace of technological change. The result? Utilities shifted from being a declining-cost to an increasing-cost industry. Each new increment of generating capacity cost so much more to build that the net effect was to raise average costs instead of lowering them. In short—no more economies of scale.

Rate-of-Return Ruin

Conventional public utility regulation is a bad deal for consumers. By forcing a monopoly structure on electricity production, it has raised utility costs by promoting X-inefficiency, has led to higher utility rates, and has restricted consumer choice and the availability of good service. (In Sikeston, Missouri, the competing utilities provide the following customer services al no charge: cutting down trees, providing poles for TV antennas, providing free electrician services, and installing the wiring from the power pole to the building.) Ironically, though utilities fought for and benefited handsomely from regulation, today they are being strangled by it.

As noted earlier, the basic approach to pricing employed by public utility commissions is rate-of-return regulation. Because the system is designed to allow up to a specified return on the company's installed capital infrastructure—the rate base—it is in the company's interest to load everything possible into that rate base. The more it costs to build a power plant—and most coal-fired plants cost $700-$1,000 per installed kilowatt—the more the utility can make at its allowed 10 percent return on the rate base. The utilities have every incentive to build plants as inefficiently as possible—they're rewarded by the regulators for doing so. Without competition as a counteracting force, they've historically done just that, and the consumer takes it in the pocketbook.

This part of the rate-of-return gravy train is still in motion. Another part of it, though, has turned around and now threatens to ruin the utilities. That other part is regulatory lag.

During the 40-odd years when electric utilities were declining-cost firms, the purpose of regulatory rate hearings was to decide on the size of rate decreases. A11 during that period, technological improvements and economies of scale in going to larger power plants led to continuing declines in the cost and price of electricity. The average price dropped from 7.45¢/kwh in 1920 to 6.03¢ in 1930, 3.84¢ in 1940, and 2.88¢ in 1950 (measured in constant 1967 dollars).

Because of this downward cost trend, it was clearly in the utilities' interest to have rate-hearing procedures that were

thorough, complex, and time-consuming— the more time-consuming the better. The length of time between the initiation of a regulatory agency proceeding and its final resolution is referred to as regulatory lag. And for 40 years, regulatory lag worked in favor of the utilities, putting off the advent of rate decreases.

Then came the 1960s, and when utility economics changed, so did the significance of regulatory lag. Now the purpose of a regulatory proceeding was to obtain a rate increase. But the well-oiled gears of the regulatory machinery ground on at their accustomed snail's pace, aided and abetted by consumer and environmental groups who arose to challenge the wisdom of virtually every rate-increase request.

Regulatory lag began cutting off the utilities' access to capital, right when they needed it the most. Faced with skyrocketing prices of oil and natural gas, rising coal prices, and huge increases in construction costs, utilities desperately need the ability to make their own investment decisions in a timely fashion. But regulatory lag means they must spend two years arguing over what was needed two years ago instead of getting on with today's job.

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