Electric Power Industry

     The roots of modern day regulation can be traced all the way back to the late
1800's and found in the form of antitrust. By the beginning of the 20th century,
the U.S. government had formed the interstate Commerce Commission to regulate
the railroad industry, and shortly thereafter, many other regulatory commissions
were founded in the transportation, communication, and securities fields. The
main goal of these regulatory commissions was to create a reasonable rate
structure that would be appealing to both producers and consumers. While this
system has worked for many years, it has recently come under heavy criticism,
with many people pushing for open competition among electric power producers.

Although once believed to be an impossible proposal, competition among electric
power producers is finally a reality in a few areas. Massachusetts is just one
state where legislation implemented to create competition among electric power
producers is not only favored by the people of the state, but has also provided
significant rate reductions as well. The attempt at regulating price in the
electric industry is a troublesome one. The objective is not only to minimize
the cost to consumers, but also to create a rate structure that will entice the
electric company to remain in the industry. The regulatory commission wants the
electric company to have a reason to innovate so that they will be able to
provide cheaper power in the future. However, if the commission captures all
gains from innovation in the form of lower prices, then the electric company has
no incentive to undertake any type of innovation. Therefore, a compromise must
be reached which would provide adequate incentives for firms to undertake
cost-reducing actions while at the same time ensuring that the price for
consumers is not exorbitant. The term regulation refers to government controlled
restrictions on firm decisions over price, quantity, and entry and exit. Each
factor of an industry must be regulated for producers and consumers to truly
benefit. The control of price does not mean setting one fixed price, but rather
entails the creation of a price structure for purchasing electricity during peak
and non-peak times. The control of quantity refers to the government's attempt
to control the amount produced or in this case the amount of electricity
produced. For example, in the electric industry, it does not make sense to have
a lot of small power plants produce electricity. However, at the same time one
company can not be allowed to monopolize the industry and set prices at its own
discretion. Another factor in this problem is the control of entry and exit in
the electric industry. By controlling who can enter the industry, the government
can control who produces the electricity and how much of it they produce.

However, the effectiveness of regulation has begun to be questioned, and created
the evolution of a more competitive market. Ever since the Public Utility Act of

1935, which in turn created the Federal Power Commission, the role of electric
utility regulation and its effectiveness has been questioned. Since that act was
passed into legislation, the question has always remained: has electric
regulation made a difference? Major studies done throughout the 20th century
found conflicting results. A study published in 1962 and conducted by Stigler
and Friedland compared the price of electricity in states with regulation to the
price in states without regulation. However, at the time all states had electric
regulation, so Stigler and Friedland had to go back to the 1920's and 1930's to
find states without regulation. Their finding was as expected. In 1922, the
average price of electricity was 2.44 cents per kilowatt-hour in states with
regulation. However, in states without regulation, the average price increased
to 3.87 cents per kilowatt-hour. While many would say that prices could vary for
reasons other than regulation, Stigler and Friedland controlled the analysis of
other variables and found that no significant difference in price existed. Other
critics felt that this study was done in a time when regulation was just getting
started, and that regulators in the present day are more effective. Two other
studies which found different results were those conducted by Meyer and Leland
and another done by Greene and Smiley. In their study, which used data from 1969
and 1974, Meyer and Leland utilized econometric estimates of demand and costs to
find hypothetical unregulated prices. Their conclusion was that the regulated
prices were significantly lower, but that even lower prices were demanded. In a
similar study conducted by Greene and Smiley, they found that unregulated prices
were 20-50% higher than actual regulated prices. Although these studies seem to
reach conclusions that support regulation, the alternative finding by Leland and

Meyer that even lower prices were demanded seems to be an indication towards
open competition among electric producers. Soon thereafter, the trend toward
competition between electric producers began to emerge. The passage of the

Energy Policy Act in 1992 created the first means of competition among electric
companies by giving the government power to order companies to "wheel"
power from one company, over their own lines, to another company. In 1990, there
were over 3,000 electric systems in the U.S. alone, and most of them were
publicly owned. However, the 267 privately owned utilities accounted for 71% of
the sale of electricity. Also, most of these privately owned utilities have been
vertically integrated, meaning they own the power plants, the substations, the
transmission lines, and the distribution systems. The different utilities are
then linked through a national grid, meaning it is possible for the sale of
power, or wholesale wheeling, from one utility to the other. The Federal Energy

Regulatory Commission is responsible for the regulation of these wholesale
transactions, and has done so through market based transactions. As wholesale
wheeling has become more important, large industrial buyers have begun to demand
participation. Instead of only being able to buy power through their local
utility, they want the choice to purchase it from other companies, thereby
creating some type of open market competition. As this has occurred, the trend
has trickled down to the individual consumer level, thereby creating legislation
such as the Massachusetts Electric Utility Industry Restructuring Act that was
signed into law on November 25, 1997, and upheld with the passage of Issue 4 in
the general election on November 4, 1998. This piece of legislation has allowed
consumers to choose their power supplier, and has led to decreased prices
without regulation. The Massachusetts Electricity Law, passed by legislature and
signed into law on November 25, 1997, was developed over three years with int
and support from consumer advocates, small businesses and large employers,
energy providers and experts, labor and environmental groups. The main objective
of the new law was to allow Massachusetts consumers to choose their electricity
supplier by breaking up the utility monopolies, and creating competition that
will lead to lower rates in the future. Under the new law, local electric
companies still own and maintain the wires that bring the electricity to homes
and businesses, but consumers are now able to choose the company that provides
the electricity they use. The distribution of electricity remains regulated to
ensure reliable service to all consumers and to set distribution rates based on
cost and performance, not at market prices. However, competitive power suppliers
whose prices for electricity are not regulated now provide the generation of
electricity. In addition to breaking up the utility monopolies, the new law also
provides electricity rate cuts to consumers while they choose which company to
buy their electricity from. The rates are guaranteed to drop 15%, with 10%
coming by March 1, 1998 and another 5% occurring by September 1, 1999, as the
law provides a rate cap to lock these lower rates in for years to come. The law
also provides the opportunity to eliminate sales tax on electricity transmission
costs for non-industrial businesses, saving this sector an estimated $30 million
a year. The law also created a 10% rate discount for farmers and others in the
agricultural industry. Therefore, under the new system, your local electric
company still delivers electricity to your home or business. However, you can
purchase the electricity from the local company at the guaranteed minimum rate
reduction, or you can choose to buy your electricity from another competing
supplier if you decide that company offers better rates. In addition to lowering
rates and allowing consumers to choose their power suppliers, the new law also
provides many other provisions designed to protect the consumer. The law
requires all competitive power suppliers to be registered with the state

Department of Telecommunications and Energy, and also requires the suppliers to
continue to provide reliable service. The law also prohibits suppliers from
switching a customer to a different supplier without the customer's consent. The
law also creates rate reductions for low-income consumers, such as senior
citizens on a fixed income. As well as providing for these consumer protections,
the law also entices economic growth within the state by lowering the cost of
doing business through lower electric rates. This lower cost of doing business
due to lower electric rates will encourage new employers, both large and small,
to move into Massachusetts, as well as encouraging existing businesses to stay.

In fact, in the short period of time the law has been in effect, it has spurred
the forecasts of new job growth, and in the years ahead, is expected to create
thousands of new jobs throughout Massachusetts. However, even though the law
seems to have many more benefits than it does negatives, it has come under
recent criticism. Many opponents of the law feel it is not doing its designed
purpose, and consumer backlash was so great that Issue 4 asking whether or not
the law should be repealed. An organization called "The Campaign for Fair

Electric Rates", backed by failed congressional candidate John O'Connor and
consumer advocate Ralph Nader, led the effort to repeal the law, calling it
"the biggest consumer rip-off in Massachusetts history". The big issue
involved in the attempted repeal was lawmaker reneging on their promise to
protect consumers by allowing utilities to recover 100% of their bad
investments. Because deregulation will cause some utilities to lose money on
investments in power plants or on contracts they made when they expected to keep
selling power at a regulated price, the question becomes do they deserve
compensation for these "stranded costs", which may approach $200
billion nationally? For instance, utilities spent more than $5 billion building
the Seabrook nuclear plant in New Hampshire, which produces 1,150 megawatts. In
contrast, private developers have proposed more than 50 new plants, which
combined would produce 30,000 megawatts, and the cost of these projects is
estimated at slightly more than $15 billion. The utilities argue that public
regulators approved those expenses and that the state can not back out on them
now, stating that many plants have already begun to implement the new law,
including selling most of their power plants. Repealing the law now, they argue,
would create utter chaos. Therefore, a provision was written into the law
allowing for utilities to recover all of their stranded costs over a 10-year
transition period. While proponents of the law were hoping for a 30% rate
reduction, of which two-thirds would have come from consumers not having to pay
for most of the utilities stranded investments, they will now have to settle for
a guaranteed 15% rate cut, hopefully with more to come through competition. The
question now on everyone's mind is: has the law served its purpose and reduced
electric rates? In a study done by Standard and Poor's DRI entitled
"Economic and Environmental Analysis of the New Massachusetts Electricity

Law", and released on September 2, 1998, it found that the new has
triggered "substantial economic and environmental benefits". According
to the study, electric rates will decline by almost 28% by the year 2010 as a
direct result of retail competition and industry restructuring. The DRI, a
conservative report when compared to others, predicts that consumers will save
$470 million in 1998 alone, and increases that estimate to at least $550 million
per year in future years as a result of the new law. Also, the study predicts
the Commonwealth to achieve higher economic output and employment growth
triggered by the estimated $10 billion consumers and businesses will save on
electricity costs. By 2010, there will be over 60,000 more jobs, a $19.6 billion
gain in consumers' cumulative real discretionary income, and lower price
inflation. All of this forecasting appears to put the law in a favorable light,
but many want to know how it's working now. According to the Massachusetts

Electric Company, its 970,000 customers have saved a total of $67 million on
their electricity bills in the first six months of the new electricity law. On

September 1, savings for the company's customers increased to more than 15%, or
a total savings of $25 million per month, one full year ahead of the required
rate cut. This was due to the company's affiliates selling their power plants.

Therefore, by examining the early results of the new law, along with projections
such as the ones provided by Standard and Poor, one can determine that the
deregulation of the electric industry has been long overdue.