Introduction
As state and federal legislators intensify their efforts to restructure the electric utility industry, investor-owned utilities ("IOUs") must vigilantly monitor the changing legislative and regulatory landscapes in order to meet the challenges posed by the evolving industry framework. The transformation is already underway at the state level. Some states, most notably California, Massachusetts, Pennsylvania and Rhode Island, have already enacted legislation to restructure the utility industry and intend to implement their plans in 1998. Other states without restructuring plans currently in place, including Connecticut, intend to tackle legislative proposals in 1998, while still other states patiently sit back and monitor the experiences of their sister states prior to enacting restructuring legislation of their own.
Congress also promises to be heard on the issue of electric utility restructuring in some manner in the near future. The various restructuring proposals floated in 1997 by members of both the House and Senate indicate a strong possibility that Congress will address federal utility restructuring legislation more seriously in 1998. In order to survive the transition into an industry governed by a modified regulatory framework, the prudent utility must remain mindful of the various regulatory considerations certain to emerge in the wake of state and federal legislation designed to engineer a fundamental restructuring of the industry.
The primary issue driving electric utility restructuring is the desire to introduce competition to the industry and retail choice to electricity consumers, thereby enabling deregulation of those industry segments conducive to competitive market pricing, with an anticipated corresponding reduction in electricity prices. As the industry undergoes restructuring, the transmission and delivery of electricity are more likely to remain regulated since that segment of the industry tends to be subject to natural monopoly constraints (although some commentators suggest otherwise). On the other hand, since the assets needed to generate electric power are not as significantly impacted by those natural monopoly forces, generation pricing is more susceptible to control by competitive market forces.
The number of players, each with different agendas, involved in the restructuring process renders predictions concerning the exact areas of concentration for legislators and regulators uncertain at best. The list of parties likely to play a substantial role in the process includes: Congress, the President, the courts, the Federal Energy Regulatory Commission ("FERC"), the Department of Energy ("DOE"), the North American Energy Reliability Council ("NERC"), state legislatures, state public utility commissions ("PUCs"), the utility companies and the consumers of electricity. In light of the complexity and uncertainty involved in accurately predicting the actual nature of the restructured regulatory framework that will eventually evolve, this paper attempts merely to identify and briefly survey the "hot" legislative and regulatory considerations that are most likely to emerge in 1998 and immediately beyond.
Emerging Regulatory Issues in a Restructured Electric Utility Industry
The Tension Between Federal and State Regulators During the Restructuring of the Electric Utility Industry.
By the end of 1997, legislatures or PUCs in virtually every state had at the very least considered whether to restructure its state's electric utility industry. Not surprisingly, those states where electric rates fell below the national average were less ambitious in examining the multitude of issues involved in restructuring the industry. For example, a decision to restructure Indiana's electricity industry died in a state legislative committee due in large part to the fact that Indiana's electric rates were among the ten lowest in the country. Similarly, a bill to introduce competition in Mississippi, another low cost state, also failed (although the Mississippi PUC is addressing this topic again). The states that succeeded in enacting restructuring legislation by the end of 1997 were generally those states with electric rates in excess of the national average, such as California, Massachusetts, New Hampshire, Pennsylvania and Rhode Island.
Action at the federal level has proceeded at a slower pace. While multiple members of both the House and Senate released various draft bills dealing with restructuring of the utility industry in 1997, no Congressional consensus as to the appropriate issues that any final bill should address has developed. The President, with assistance from the DOE, also began to formulate a policy on electric utility restructuring in 1997 (although at a slower pace than members of Congress) and is expected to make a policy announcement in 1998.
In light of the substantial possibility that Congress will proceed with restructuring legislation in 1998, state legislators and regulators have voiced concerns that attempts to enact federal restructuring legislation will serve only to frustrate the ability of the states to develop their own state-specific plans. New Hampshire's governor even requested that Congress make it easier for the states to deregulate and introduce competition to the industry by amending or repealing federal laws that block state action, such as the Federal Power Act. Federal authorities, on the other hand, have noted the coordination problems that could arise under a strict state-by-state approach.
Recognizing the need to avoid conflict, specifically with respect to jurisdiction over retail wheeling, and to foster cooperation between the various state and federal parties involved in restructuring the industry, FERC chairman James Hoecker has urged that federal and state regulators "collaborate" in efforts to complete the complex task of restructuring. Energy Secretary Federico Pena echoed Hoecker's suggestion in assuring a group of state legislators that "state and local issues are paramount as we hammer out the details of our proposal." Congress itself also seems sensitive to the concerns of state legislators and regulators. In fact, the chairman of the House energy and power subcommittee characterized the allocation of jurisdiction between the states and federal government in electric utility restructuring as "one of the more complicated questions that must be answered."
Based on the comments made by leading representatives from FERC, DOE and Congress indicating an appreciation of the need to cooperate with the states in restructuring the electric utility industry, a distracting federal/state clash with respect to the manner in which a particular state accomplishes restructuring in its state seems avoidable. Instead of battling the states for control, Congress may dictate a broad mandate requiring retail competition, allowing each state in turn to determine the manner in which the restructuring is accomplished.
Generation Assets: Functional Disaggregation or Complete Divesture?
One of the first decisions that legislators and regulators must make in evaluating restructuring is whether to require functional disaggregation--retention of control by an IOU of generation assets as well as transmission and distribution assets but in separate business entities--or to require the complete divesture by forcing the IOU to sell off one business or the other. Requiring an IOU to divest its generation assets or its transmission and distribution business completely, as Rhode Island did, will likely result in more immediate and widespread deregulation, as well as enabling competition to spread on a broader scale. However, in part because functional disaggregation is more politically palatable and workable, a trend whereby state legislatures and regulators follow the lead of California (1) in approving plans of functional disaggregation seems more likely to develop.
One of the primary challenges faced by those regulators that select functional disaggregation is the separation of the costs that derive from electricity generation and from transmission and distribution activities. The distinction is important. Since transmission and distribution functions will probably remain regulated, the shifting of generation costs--otherwise subject to competitive pricing--to the transmission and distribution business would enable the utility to achieve a higher return from the PUC setting the rate. It is therefore likely that disputes will arise between functionally disaggregated utilities and regulators attempting to unbundle the rate of return for those utilities over the allocation of costs and expenses between the businesses.
Disaggregation Extended: Transmission and Distribution Unbundled.
Although most discussions of disaggregation focus on the separation of generation assets from transmission and distribution assets, California went one step further by requiring the unbundling of the state's transmission functions into three separate entities: (1) the utilities to own the transmission system; (2) a power exchange to determine prices through an auction process based on supply and demand; and (3) an independent system operator charged primarily with controlling the transmission system and maintaining system reliability.
Since California selected the functional disaggregation model, the decision to unbundle the transmission and distribution segments further was partially intended to alleviate concerns that the IOUs would continue to derive benefits on an anti-competitive basis by owning companies engaged in all segments of the industry. The FERC's similar enactment in December 1997 of standards designed to reduce any unfair competitive advantages that particular wholesale sellers of electric power might gain by virtue of an affiliation with a transmission company, including such measures as directing which employees may work on both the generation and transmission businesses and public disclosure of organization charts reflecting those assignments, signals that both state and federal regulators will continue to focus on ensuring that no one utility retains any unfair competitive advantage based on vertical control of multiple industry functions.
Non-Pricing Issues.
Although the desire to provide electricity consumers with lower electric prices serves as the undeniable driving force behind the push to open the electric industry to competition and deregulation, issues of price and market power are not the only issues likely to attract the attention of regulators as the restructuring process continues. Regulators in 1998 and beyond will also be forced to address issues of service reliability, alternative power sources, universal electric service, social programs and a host of other concerns that will arise in the disaggregation process.
1. The Role of the Regulator in Promoting Reliability.
The party traditionally charged with maintaining responsibility for promulgating national electricity service reliability standards is NERC, a non-governmental entity. As competition begins to proliferate the electric utility industry with the transition from one IOU maintaining vertical control over all phases of the generation, transmission, and delivery of electricity to a disaggregated and unbundled industry framework involving multiple providers, however, the issue of service reliability necessarily becomes a greater concern for regulators.
In response to concerns over service reliability in a restructured industry, FERC may become more active in addressing concerns of service reliability. Indeed, NERC has urged that regulators become more involved in these reliability issues. Though the Commission itself is uncertain as to the current extent of its jurisdiction to ensure reliability, at least one draft proposal from the Senate suggests that Congress may formally define and increase FERC's role in regulating service reliability issues. Finally, DOE supports establishing FERC as the governmental entity responsible not only for ensuring that NERC complies with its mission to establish and maintain reliability standards, but also as the federal enforcer of reliability standards.
2. A Premium for "Green Power."
Under the California plan, suppliers competitively selling electricity must disclose to consumers the energy source used in generating the electricity. This advent of informed freedom of choice has resulted in Californian consumers selecting electricity from suppliers using environmentally friendly "green power" sources, such as wind and solar, often at a premium of approximately ten percent. Consumers in Wisconsin and New England also have expressed an interest in purchasing electricity from green power sources, even though such a preference results in higher electric bills.
The willingness on the part of some electricity consumers to pay increased prices for green power could encourage federal legislators to adopt restructuring legislation calling for the inclusion of "generation performance standards" with respect to emissions, a provision favored by environmental groups. Although such performance standards on emissions would likely increase the cost of generating electricity, consumer support for green power could assist in decreasing Congressional trepidation in enacting utility restructuring legislation that includes environmental protection provisions causing increases in the cost of electricity generation.
3. Universal Service and Social Programs
In enacting or implementing any restructuring legislation, regulators and legislators must also address the issue of the provision of service to all potential customers. Recognizing the need not to leave any consumer without electricity in a deregulated industry, the DOE officials instrumental in formulating the President's policy on electricity restructuring designate universal service as one of six principles that any federal legislation should address.(2) Moreover, both Pennsylvania and California included various social program provisions such as energy conservation and low-income assistance in their restructuring legislation. How legislators and regulators in other states and at the federal level manage this tension between minimizing consumer cost while simultaneously ensuring universal service is yet another issue deserving of close attention in 1998.
4. Other Non-Pricing Issues
As regulators and legislators continue to work through electric utility disaggregation, a host of other concerns have arisen. For example, the introduction of competition and consumer choice of generation providers requires that one or more "default" providers be selected for consumers who do not express a choice and that "standard offer" service for consumers be defined in each jurisdiction. In addition, an increase in competition requires legislators and regulators to create improved consumer protection measures to ensure that their constituents are not victimized by unfair marketing tactics and are properly served by the generation providers they select. Third, competition creates staffing reductions at generation facilities in some states, and in response, some legislatures (such as the Connecticut legislature) have included worker protection measures in restructuring legislation. Finally, in instances in which restructuring is effected through the functional separation of generation and transmission businesses in the same holding company structure, legislators and regulators have imposed codes of conduct and other measures on those companies to ensure that they do not obtain an unfair competitive advantage by virtue of their relationships. As the restructuring process continues, these and other sorts of issues are certain to arise, requiring that the legislators and regulators continue to be vigilant in monitoring the deregulation process.
Stranded Cost Recovery and Securitization.
One of the more controversial issues with which legislators and regulators must grapple is stranded cost recovery. As generation assets are disaggregated from transmission and distribution assets, the method used in determining the price a utility earns on each type of asset differs. The rate of return earned on transmission and distribution assets is still likely to be determined by state regulators. However, in a restructured and deregulated industry, state PUCs will no longer determine the pricing of generation assets, as generation prices will be set by competitive market forces.
Utilities worry that prices on the sale of long term capital generation assets as determined by competitive market forces will be insufficient to recover the remaining undepreciated investment costs expended when such generation capital assets were originally constructed and financed, resulting in a "stranded investment." Since the utilities historically invested in long-term capital assets like power plants under a system where regulators assumed recovery of prudently incurred costs and investments in exchange for a cap on the utility's earnings, and in many cases deferred current costs for recovery in a future period, creating regulatory assets, IOUs argue that state regulators must mandate that electricity consumers should contribute financially to help bear the cost of the utility's stranded investment.
One way to address the problem of stranded cost recovery is to provide utilities with the statutorily-backed ability to securitize stranded investments. (3) Under a typical utility securitization, the utility issues securitization bonds to recover at least a portion of stranded investment up front. Electricity consumers then pay a non-bypassable surcharge constituting a guaranteed cash flow to the purchasers of the bonds. Critics of securitization claim that securitization enables the utility to unfairly shift the risk of non-recovery on the investment to consumers. Because the cash flow streams backing the bonds are based on the stranded costs of a utility that cannot definitively be determined at the time the bonds are issued, consumers might eventually end up overcompensating for the actual stranded cost experienced by the particular utility. In addition, consumer advocates and others argue that stranded cost recovery schemes require consumers specifically to bear the burden of imprudent investment decisions made by IOUs. Finally, in some instances, securitization and stranded cost recoveries can result in a reduction of the price changed by the entrenched utility to a point where competition at that price is impossible.
In response to these criticisms, some states, including Pennsylvania, authorize securitization to recover only a reduced percentage of the utility's overall stranded investment costs. Other states are requiring utilities to take steps to mitigate their stranded costs. Based on assertions by the proponents of securitization that the financing scheme enables a quicker transition to competition and consumer choice, Congress, in addition to the expanded number of states likely to consider authorization of securitization in 1998, may also include provisions on securitization in any restructuring legislation.
Conclusion
It is unlikely that regulators and legislators will become less active, at least in the short term, as the electric utility industry continues to undergo restructuring. Not only is the transmission and distribution portion of the industry almost certain to be regulated, but the chairman of FERC characterizes the role of the regulator in those industry segments likely to be deregulated as that of "guardian or guarantor of competition." Additionally, in attempting to ensure that the costs of generation businesses are truly separate from the costs of the transmission and distribution businesses, legislators and regulators will be active in determining whether to require functional disaggregation or to mandate complete divestiture and in devising the extent to which the functions of transmission and distribution are further unbundled. The role of the legislators and regulators in ensuring service reliability seems likely to increase, and regulators will also work to assure that universal service is not compromised in the transition to a partially competitive industry. The dilemma of the extent to which an utility should be able to recover its stranded cost and whether it can utilize securitization to finance such costs will also be addressed by legislators and regulators. Also, the underlying tension between state and federal legislators and regulators in regards to the appropriate division of jurisdiction responsibilities has yet to be resolved. Finally, regulators must play a key role in monitoring the transition to a restructured electric utility industry. The slew of emerging regulatory issues likely to arise in restructuring the industry will therefore keep state and federal regulators occupied, at least until the industry transition is complete.
1. Although California chose not to require IOUs to completely divest their generation assets, incentives exist for IOUs to voluntarily divest generation assets. In addition, California required functional separation of retained generation assets and constrained existing utilities from gaining a competitive advantage in terms of any retained generation business. The Texas legislature considered a draft bill in 1997 similar to the plan adopted in California. Although the Texas plan required functional unbundling of generation assets from transmission and distribution business lines, it also provided incentives--such as granting greater stranded cost recovery--to those IOUs that completely divested their generation assets.
2. According to the DOE, the other five principles that should be reflected in any federal restructuring legislation are as follows: (1) competitive markets are better equipped than regulation to determine prices and maximize efficiency; (2) reliability should not be sacrificed as competition is introduced; (3) the environment should benefit from electric utility restructuring; (4) the states should be afforded the ability to determine the type of restructuring plan most appropriate for each individual state; and (5) in acknowledging the different concerns of all the players in the restructuring process, the process as a whole should not be derailed on account of the concerns of any one constituency.