POWER PLAY

For electric-utility deregulation is the biggest-bucks issue to hit the Congress in years. The dollars at stake dwarf the sums involved in most of the disputed items in the president’s new budget. America’s residential consumers pay their electric companies $ 90 billion per year to keep the lights on, heat their homes and water, and power their electric appliances. The nation’s factories run up annual electric bills of $ 47 billion. And those nice, well-lit, and delightfully year-round temperate malls and shops pay utilities $ 68 billion to keep, their commercial establishments attractive to shoppers.

Providing all this service are some 3,200 electric utilities, 700 of which operate generating stations, with the balance distributing electricity purchased from others. Some of these are huge companies, operating in many states; others are tiny companies serving a single town or city. More than three-quarters of the industry’s output comes from the 244 of these companies that are investor-owned. The remainder are owned by the federal government (the Tennessee Valley Authority is perhaps the best known) or by smaller government entities (the New York Power Authority is among the largest of these). The investor-owned segment of the industry spends at least $ 20 billion a year on construction and currently has almost $ 400 billion invested in generating plants, transmission lines (those huge wires you see strung from towers as you drive through the countryside), and distribution lines (smaller wires running from poles or underground directly into your house).

All in all, well over $ 200 billion passes from customers to electric utilities each year, about the same flow of dollars that consumers hand over to the various providers of long-distance and local telephone service. If the restructuring of the industry proceeds along the lines of any one of the dozen bills already in the congressional hopper, savings to consumers from increased competition might amount to anywhere from $ 20 billion to $ 60 billion annually, the latter figure three times the cost of all the new social programs the president is proposing in his budget. Little wonder that the legislative battle is shaping up to be a bonanza for the denizens of Gucci Gulch, and a mouth-watering source of campaign contributions for the relevant committee chairmen.

Until very recently, electric utilities were regarded as natural monopolies. After all, no one wanted two or more companies stringing parallel wires around the neighborhood, or competing to dig up the streets. And generating plants were thought to operate on the bigger-is-better principle, or, as economists put it, to possess economies of scale that made it cheaper to produce electricity in plants so large that each market had room for only one seller.

In order to obtain the benefits of these economies of scale, governments granted electric companies franchises to operate as monopolies in designated geographic areas, often a city. Thus, Consolidated Edison became the exclusive supplier of electricity in New York City, and Pepco the sole supplier in the District of Columbia. Since monopolists with legal protection from challenges by other companies that might want to offer better service or lower prices have a license to exploit consumers, the franchise grant was accompanied by regulation of the rates the companies would be allowed to charge and the profits they would be permitted to earn.

There is wide disagreement about just how well this system of regulated monopoly worked. Critics contend that the utilities soon captured the regulators and, using their superior access to cost and other information, persuaded them to tolerate inefficiency and high rates. Defenders of the regulatory regime concede that it was far from perfect — as a competitive regime also often is — but that it did provide a reliable supply of electrical energy to a growing nation at prices that generally rose less rapidly than the consumer price index.

There is no longer any need to adjudicate that debate: All parties agree that the old regulatory system is no longer viable, the victim of intellectual and technological revolutions. The first of these revolutions was the realization that many industries long thought to be natural monopolies, requiring government control of entry and regulation of prices, would perform better if Adam Smith’s invisible hand were substituted for the heavy hand of the regulator. The battle over airline deregulation in the late ’70s brought leading academics into congressional hearing rooms in an educational campaign so effective that even Ted Kennedy came to understand — at least temporarily — that competitive markets serve consumers better than the best-intentioned regulators.

Airlines were only the first to be freed from regulation, with a resultant decrease in fares to non-business travelers that led to an explosion in air travel. People who never even contemplated boarding a plane found that they could afford to visit Grandma in Florida or take a vacation trip to the beaches of Hawaii in planes operated with safety records that steadily improved.

Then came the deregulation of natural-gas production and long-distance telecommunications. Both industries reacted to the bracing winds of competition by lowering prices and increasing the range of services available to customers. The intellectual case for deregulation was thus reinforced by experience: Markets worked, just as the academic economists had said they would.

The second revolution that paved the way for current efforts to deregulate the electric industry — or, more precisely, the generating segment, the wires still being regarded as natural monopolies — was a dramatic change in technology and in the price of one of the fuels used to generate electricity, natural gas. Technological advances resulted in small generating stations that in many places are every bit as efficient as, if not more efficient than, the big coal and nuclear stations that long provided most of the nation’s electrical energy. These smaller plants are run on natural gas, which has become progressively cheaper, in part because of the additional supplies that came to market when natural-gas prices were freed from regulation — a case of deregulation of one product (natural gas) facilitating the deregulation of another (electricity).

No longer is the generation of electricity a natural monopoly, with each plant so large that only a single seller can operate successfully in the market. Now, small entrepreneurs can and do build plants and offer the electricity they produce to customers once captive of their local utility. Indeed, in recent years non-utilities have been adding about as much to the nation’s capacity to produce power as have traditional electric utilities. Worst of all, from the point of view of the old-line companies, these newcomers can sell electricity, profitably, at prices as low as one-half to one-third of the prices existing companies must charge in order to recover the capital they have sunk in their nuclear plants.

Needless to say, companies that own these nuclear plants are not happy at the prospect of having to meet this competition, a move that would involve writing off billions of dollars of investment. Nor are those of the industry’s six million shareholders who hold stock in companies with large sunk investment in non-competitive plants — a group of owners that includes enough widows and orphans to warrant the attention of legislators, and the sympathy of policymakers.

And they have a reasonable argument for protection against such financial devastation. In return for their monopoly franchises, electric utilities accepted an obligation to serve all customers: Throw the light switch, and you get light, even in areas where new houses are going up by the score. Unlike the telephone companies, which always accepted that during peak demand — Mother’s Day, for example — a certain percentage of consumers would get busy-circuit signals, electric companies planned to have enough capacity for that 100-degree, humid day when everyone runs his air conditioner at full tilt.

Having prudently invested billions to serve customers under a set of rules that utilities contend assured them a return on that investment, utilities now argue that it is unreasonable to ask them to bear the losses associated with a radical change in those rules. Indeed, some reputable scholars contend that wiping out the utilities’ sunk investment by changing the game from regulated monopoly to market competition is an unconstitutional taking of the utilities’ property.

The industry’s critics disagree, contending that no such social compact ever existed and that consumers should not have to bear the cost of the errors utility managements made when they built plants that are now proving too costly to operate in a competitive market. If power from nuclear plants costs three times as much as power from new, gas-fired plants, say these critics, it is both unfair and inefficient to require consumers to pay some surcharge to the utilities that built the now-inefficient plants.

That surcharge could be levied by the utilities in a variety of ways. They might charge industrial customers who switch to another supplier an “exit fee, ” on the theory that the customer is abandoning long-lived facilities that were constructed to meet his needs. Or they might charge competitors an extra fee for access to the transmission and distribution wires that they must use to get power from their plants to their customers’ premises.

The treatment of the costs of these white-elephant plants — so-called ” stranded investment” — is no small matter. Estimates of the sums at stake vary widely, with some cited by the Department of Energy running as high as $ 500 billion. That’s why the industry cares intensely about what the bills now before Congress say about their stranded investment. An analysis of nine of these bills by Linda Stuntz, formerly deputy secretary of energy and now an attorney representing several utilities, shows that seven are silent on the subject, while one, sponsored by Sen. Dale Bumpers, would require regulators to permit utilities to recover their stranded investment, and another bars such recovery. That latter bill, innocuously titled “The Consumers Electric Power Act,” comes courtesy of Texas congressman Tom DeLay. It not only requires utilities to absorb any losses resulting from their inability to meet new competition, but mandates that such competition be introduced promptly at the retail and wholesale levels.

Some of the forces arrayed on both sides of the issue are obvious: Utilities oppose any measure that fails to guarantee them cost recovery; large industrial users of electricity favor measures that put the burden on the power companies rather than on their customers. But there are other important players. The environmentalists are reluctant to sign on to the deregulation team, for two reasons. First, they have in the past cut deals with utilities and regulators to conceal the cost of their favorite but cost- ineffective conservation and other programs in utility rates. If those utilities now have to compete with the lower rates of new entrants not burdened with these social costs, they are likely to stop funding the greens’ programs.

Second, open competition would result in lower-cost, coal-based power from the Midwest replacing more expensive, less polluting nuclear power in the Northeast. Environmentalists, not hitherto known for their fondness for nuclear power, appear to be even less enamored of coal-fired generation, which they now associate with global climate change. But the greens can be had: They will support bills that in essence reserve a given share of the electricity market to sun, wind, and other renewable sources of energy that are too costly to survive in a competitive market.

Besides the widowed and orphaned stockholders, the environmentalists, and the utilities, there is another powerful group that is unenthusiastic about federal legislation to restructure the power industry — defenders of states’ rights. Organized as Citizens for States Power and chaired by former New Hampshire governor Steve Merrill, this group wants the feds to keep hands off what has until now been a matter left largely in the hands of state legislatures and state regulators. “Most of the major proposals introduced in the Congress trample on the rights of states to pursue their own visions of reform,” says Merrill. And the states are doing just that. Karen Palmer, a fellow at Resources for the Future, a non-partisan think tank, is completing a study that shows that 13 states have already enacted some form of pro- competition regulatory reform, while 36 more proposals to move in that direction are now before either the legislature or the regulatory agency (only South Dakota appears content with the status quo).

Indeed, because of state action, many utilities are already restructuring themselves to meet competition. Some have struck bargains by which they sell off their generating stations to competitors and open their transmission and distribution lines to anyone who wants to use them. In return, they get the right to set charges for the use of the lines high enough to recover any stranded investments. In essence, customers in these states are inducing utilities to drop their opposition to future competition by picking up the cost of their past mistakes.

Unfortunately for states’ rights advocates, only federal regulators have jurisdiction over the terms of access to and use of long-distance transmission lines. And access to those lines is crucial for companies that want to compete for business across state lines, as many of the new entrants do. Enron, for example, is probably the most vigorous and feared of the newcomers. It wants to sell electricity to everyone, everywhere, at competitive prices — if not now, soon. Its television ads herald a day when even the smallest homeowner will have as many choices of electric supplier as he now does of long-distance telephone carrier. And a day when diners will be interrupted by still another call from some telemarketer, this one offering electricity at bargain prices. A small price to pay for billions in savings on the nation’s electric bills.

Irwin M. Stelzer is director of regulatory policy studies at the American Enterprise Institute.