Enron's fall finds FERC toying with cost-based rates. But let's temper the nostalgia.

Enron may not be dead, but its death rattle is certainly being heard loud and clear on Wall Street, Capitol Hill, and in Houston and beyond. If Enron ever was king, will the new king be a scion that also is an aggressive advocate of deregulation? Or, will it be an aged consort, who yearns to return to the "just and reasonable" standard for rate regulation? ¹ The answer may be with the Federal Energy Regulatory Commission (FERC), which in two pre-Thanksgiving companion orders, ² indicated a strong preference for crowning the just and reasonable standard.

Before commenting on whether just and reasonable rates are an appropriate substitute for market-based rates for merchant plants, it should be noted that "Enron ... created an enormous legacy of good ideas that have enduring value." Those ideas included: "de-integration of power contracts," "minimization of transaction costs and frictions," "exploiting the optionality in networks," "rigorous risk assessment" and a "culture of urgency, innovation, and high expectations." ³ On the other hand, even in these early days of Enron's Chapter 11 bankruptcy filing, it is clear that the unique business model of Enron-asset-light, trading operations that included numerous dissimilar commodities, lack of accounting transparency and conflicts of interest-were the Four Horsemen of the Apocalypse which brought its downfall.

Against this backdrop, plus California's energy woes, are FERC's Thanksgiving initiatives that retreat from market-based rates and substitute a "just and reasonable" standard appropriate? Although FERC is not alone in advocating a return to the past form of rate regulation, ⁴ nostalgia should be tempered. When promulgating Order No. 888 five years ago, ⁵ FERC made several observations:

• Inflation. In the late 1960s and throughout the 1970s, a number of significant events occurred in the electric industry. ... This was the beginning of periods of rapid inflation, higher nominal interest rates, and higher electricity rates.
• Overbuilding. During this same time frame, the construction of nuclear and other capital-intensive baseload facilities-actively encouraged by federal and some state governments-contributed to the continuing cost increases and uncertainties in the industry. ... However, due to conservation and economic downturns, the expected demand increases did not materialize. Load growth virtually disappeared in some areas, and many utilities unexpectedly found themselves with excess capacity. In addition, by the 1980s, the oil cartel collapsed, with a resulting glut of low-priced oil. At the same time, inflation substantially increased the costs of these large baseload-generating plants. Surging interest rates further increased the cost of the capital needed to finance and capitalize these projects and completion schedules were significantly extended by, in part, more stringent safety and environmental requirements.
• Rate Shock. As a result, expensive large baseload plants-for which there was little or no demand-came onto the market or were in the process of being constructed. Accordingly, between 1970 and 1985, average residential electricity prices more than tripled in nominal terms, and increased by 25 percent after adjusting for general inflation. Moreover, average electricity prices for industrial customers more than quadrupled in nominal terms over