The Perils of False Deregulation

The Vermont Senate has passed a massive piece of legislation (S. 62) purporting to allow the people of the state to enjoy the benefits of electricity deregulation.

A more likely description of the bill is that offered by the Cato Institute's Jerry Taylor of a similar "deregulation" law in California: "While the advocates of California's electricity restructuring are wearing the garb and makeup of Adam Smith (the 18th century economist who heralded competitive free enterprise), they are in truth Ira Magaziners in drag - political crossdressers selling higher taxes and more regulation under the guise of 'competition'."

In case anyone has forgotten, Ira Magaziner was the political genius tapped by Hillary Clinton to put the government in charge of the nation's health care industry through "managed competition".

Virtually everyone agrees that the days of the traditional electric industry - monopoly franchises and government controlled rates and practices - are over. Their demise was signalled by a 1973 U.S. Supreme Court case called Ottertail. In that case the Court upheld a rural Minnesota cooperative's argument that the refusal of a competing investor-owned utility to "wheel" power to it constituted an antitrust violation.

Following the Ottertail decision, large power users got the idea that they ought to be able to make contracts with low-cost generators and have that power moved to their plants over the existing grid owned by utilities. Other users began to explore generating their own power from industrial operations, and marketing the excess. (The former Vermont Marble Company in Proctor began doing this in 1886.)

The interest in deregulation was accelerated in the energy-crisis 1970s when state public service boards bought into the idea of making their utilities enter into long term fixed-price contracts to buy high-cost power produced by renewable energy sources. For example, the Winooski One hydro plant, completed in 1993, markets its power under a government-required contract with Vermont utilities at around 13 cents/kwhr. That is about five times what the same power costs today in a free market.

Under a 1978 federal law called PURPA, states were allowed to make estimates and projections of long term power costs, and require their utilities to buy power for 30 years at that price. That would have been fine had oil gone to $100 a barrel. As it turned out, most if not all of these government-forced contracts have become expensive burdens on ratepayers.

Since the changing market is rapidly defeating traditional government regulation, there will be some sort of deregulation. Accepting that fact, all the interest groups involved are taking a hand in designing that deregulation. Unfortunately none of them wants the real thing. They want a "managed deregulation" that keeps the free market from operating, and retains continued, if altered, government control over the electricity industry.

The utilities are concerned about low-cost energy sellers invading their once-impregnable franchise territories, leaving them with potentially enormous "stranded costs". Similarly the PURPA-sheltered renewable energy producers are terrified at the thought of having to compete with cheap power wheeled in from elsewhere. The environmentalists are terrified that utilities will go looking for the cheapest power available, which might be the much-despised coal-fired plants in the Ohio Valley.

The people whose retirement depends on utility bonds are terrified at the thought that their utility might become unprofitable or nonexistent. The HydroQuebec and Vermont Yankee owners are terrified of the prospect of not being able to sell their higher cost power. And as usual, government regulators are terrified at the thought of not having much to do.

The result in Vermont has been a "restructuring" bill which attempts to allow retail wheeling while going as far as possible to buy off all these terrified constituencies. Ordinary homeowners, farms and small businesses who have little market clout are supposed to be represented by the Public Service Department, but in view of that department's historic preferences for making utilities do things other than lower power costs, one may wonder how effective that representation is.

The tipoff to the plan embodied in S.62 is found in its title, which announces "electric price stabilization". In the first section we learn that "regulation alone cannot prevent substantial inefficiency in the electric utility industry", a declaration that would be comical if so many people didn't believe it. From there we are led into a huge Magaziner-style regulatory scheme, complete with "emissions portfolios", "renewables portfolios", "electrical energy affordability programs", and "funding mechanisms for the aggressive acquisition of cost-effective, end-use efficiency resources", including the creation of a new "efficiency utility".

Who is to get the bill for the uneconomic stranded costs (notably HydroQuebec, Yankee, and PURPA contracts, which may total well over a billion dollars) is left to the Public Service Board, the Public Service Department, and the interest groups which revolve around them.

There is an enormous amount of money at stake here: the total of all utility bills paid by Vermonters. The industry views this pot of money as a reward to be captured and protected from aggressive power-selling barbarians. The environmentalists and low-income advocates see it as containing a giant foundation grant to allow them to buy the things they want at somebody else's expense. Deregulation has, not surprisingly, become yet another interest group feeding frenzy.

At the risk of oversimplifying what is admittedly a fiendishly complicated issue, there is one key principle that will eventually bring about the benefits of deregulation. That is actually deregulating. Split the common carrier functions (transmission and distribution) from the deregulated competitive functions (generation). Stop forcing utilities (and thus consumers) to subsidize politically favored schemes like Demand Side Management and high cost renewables. Stop using the utility market as an wealth redistribution scheme. Let the market work, and let all consumers share in the benefits that will flow.

There will be unavoidable transition costs, and a legitimate concern for those who lack the means of sharing in the benefits of aggregated purchases. Government must necessarily make rules for such problems, and those rules will have important economic consequences. But politically designed "managed deregulation" isn't worth doing. Only real deregulation will bring the benefits. When the House takes up S. 62 next year it should keep that proposition in mind, and re-do the whole bill from scratch.

April 1997