Electric Visions

Unleashing the market for power.

Ryan Oprea from the January 2000 issue

Electricity isn't just one of thenation's largest industries. It's one of the most heavily regulated. More than a century's worth of federal, state, and local laws have straitjacketed it, stifling innovation, raising prices, and wasting resources. The industry that fuels the rest of American industry is in dire need of reform.

Congress recognizes this. But a lot of special interests are at work in Washington, pushing different ideas about what that reform should look like. Under America's complex regulatory regime, electricity has become a labyrinth of public and private sub-industries, each governed by different rules, each with its own interests--and each with its own lobby.

Outside the industry, several more lobbies have joined the debate, from environmentalists to retirees. The North American Electric Reliability Council, for instance, creates voluntary rules for the industry, and would like to make them mandatory. There's even a National Alliance for Regulatory Utility Commissioners, to represent state regulators' interests.

With so many voices, it can be difficult to discern the real issues at stake. But there is general agreement on--or reluctant acceptance of--one point: Like it or not, competition is already coming to the industry.

Small, entrepreneurial companies have found tiny cracks in the regulations where they can innovate and compete. Plug Power, for instance, is developing a fuel cell technology that could allow homes and small businesses to produce their own energy. Trigen Energy has found ways to dramatically improve efficiency in power production--and claims a competitive industry would have every incentive to follow its lead. Such enterprises represent the possibilities of a dynamic, less regulated marketplace. It's unclear, though, whether there is room in Washington for a bill that would unleash all the creativity of companies like Trigen and Plug.

It's not as though the electricity market has never been competitive before. For a long time, policy makers assumed that it was a natural monopoly--that only one firm could operate profitably in each market. But over the last two decades, Burton Behling, Harold Demsetz, and other economists have discovered that the early industry was remarkably competitive. In the first 10 years of the century, in cities across America, consumers could choose from more than one electric company. In that environment, production quadrupled and prices fell 26 percent.

In 1907, with competition eating into their profits, the oldest firms began lobbying to consolidate the industry. States passed laws guaranteeing exclusive franchises to those utilities and propping up their prices. Unnaturally large holding companies began to develop, channeling their monopoly profits (as high as 2,000 and 3,000 percent in exceptional cases) into other industries and spreading into other states (thus partially shielding themselves from state takeovers).

The federal government responded by passing interstate legislation. In 1935, the Public Utility Holding Company Act prevented utilities from entering other energy-related businesses and severely restricted their capacity for growth. (A 1995 study by Paul Carpenter and Frank Groves of the Central and South West Corporation estimated that this law costs the industry $3 billion to $12 billion each year.) Also in 1935, Congress established the Federal Power Commission, later reorganized as the Federal Energy Regulatory Commission; to this day, its complex rate and merger regulations delay and contort changes within the industry. Finally, the feds instructed the Army Corps of Engineers and the Bureau of Reclamation to erect the Tennessee Valley Authority and five Power Marketing Administrations, offering tax-subsidized and regulation-exempt power to different parts of the country. That, combined with even more stringent regulations on the state level, is how the industry was regulated until the 1970s, when a new law inadvertently opened the door to change.

In the late 1970s, the new Department of Energy was eager to develop environmentally sound, renewable resources. To that end, in 1978 Congress passed the Public Utility Regulatory Policies Act (PURPA), which required utilities to purchase a portion of their electricity from environmentally friendly producers.

At that time, the industry was dominated by huge, vertically integrated firms. These companies owned electric generation plants, vast networks of electric lines (known in the industry as the transmission grid), and local distribution facilities; they produced, moved, and distributed electricity in one bundle to consumers. PURPA forced those utilities to let small, independent nonutility generators sell energy to other producers over the transmission grid. Suddenly, hundreds of companies could produce and sell their electricity in the wholesale market.

PURPA caused a number of problems: It gave states the power to set prices, for example, and it saddled many utilities with incredibly expensive long-term contracts. But its most notable (and unintended) effect was to show the government that wholesale competition was possible. In 1992, Congress passed the Energy Policy Act (EPAct), which allowed the Federal Energy Regulatory Commission to open wholesale markets to a wider array of companies. In response, the commission adopted Orders 888 and 889, which required utilities owning transmission lines to provide open access to all electricity generators. New firms flooded the market, and a new class of middlemen, known as power marketers and power brokers, arose to sell electricity from generators to local distributors.

Partly because of the new competition and partly because of changes in technology, such as the advent of the natural gas turbine, the underlying structure of the market began to change as well. Economies of scale came full circle: It was now as cost-effective to run small on-site or local generators as to run large regional ones. The notion that the market would always be dominated by huge, consolidated monopolies began to unravel. Businesses and legislators began to wonder if competition could thrive in the retail market, too.

The states have more regulatory authority in this industry than the feds do, and so far they've taken the lead in reform. But while 23 states have begun the process of deregulating or reregulating electricity, only five have actually passed legislation. Congress still has to decide whether the states should keep leading the way in restructuring the industry or whether the feds should step in.

On Capitol Hill, the buzzword of the day is competition, a term that's often used rather nebulously. Almost everyone agrees that competition is possible and that it would be good. But what it means is less certain, and that's the core issue in the debate.

Congress faces roughly three options: deregulate, reregulate, or let the states decide.

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