By Kenneth W. Costello, Robert E. Burns, and Youssef HegazyThe electric power industry is next in line for dramatic change. Competition has edged into individual markets, particularly the bulk-power market. This move toward competition has provoked debate in several states over the merits of retail wheeling. Specifically, should retail customers have the right to purchase their power requirements from sources other than the local utility? Many states have addressed the issue in different forums, at different levels of intensity. No state has yet enacted broad legislation, either requiring or granting authority to a state public utility commission (PUC) to order retail wheeling. But that day will come.
What's at Stake?
Proponents of retail wheeling argue that current inefficiencies in the electric power industry can only be eliminated or significantly diminished by competition at the retail level. This camp includes industrial consumers, nonutility power producers, and market-liberal economists. Of course, industrial customers and nonutility generators see retail wheeling as a means of advancing their economic interests, regardless of the cost to the public interest or aggregated economic welfare.
The opposition naturally includes most electric utilities, who consider retail wheeling a zero- or negative-sum game in which some industrial customers benefit at the expense of utility shareholders. This view is shared by the financial community, which foresees only adverse impacts from retail wheeling on utility creditworthiness. Also opposed are small-consumer groups and conservationists/environmentalists. They fear that the financial pressures will
have negative consequences for consumers and the environment.
Debate at the state level is rooted in this larger public debate, but also reflects the growing movement to correct perceived inequities in the electric industry structure through increased competition. First, retail electric rates vary widely, in part because utilities carry different levels of capital expenditures. Second, current electric prices remain high relative to the cost of new generation, even after deducting transmission and distribution costs. (And the highest prices correlate strongly with the largest differentials between price and marginal cost.) Third, recent attention paid to economic development and new jobs has led state lawmakers, regulators, and industrial groups to speak out on the importance of competitive electricity prices. Fourth, industrial customers argue that utility-funded demand-side management (DSM) programs have led to higher electricity prices while nonindustrial customers have reaped most of the benefits.
The Task of State PUCs
The Energy Policy Act of 1992 (EPAct) encourages states to look at retail wheeling. While EPAct sections 721-726 prohibit the Federal Energy Regulatory Commission (FERC) from ordering retail wheeling, many experts can find no reason why EPAct or federal law in general bar state action. Wheeling proponents argue that the Act's so-called "savings clause" bars the FERC from preempting any state law regulating retail wheeling. They believe the question is left for state legislatures or PUCs to decide.
Nevertheless, some legal analysts argue that EPAct does not extend retail wheeling authority to state legislatures or PUCs, nor remove any existing federal authority over transmission activities in interstate commerce. They interpret the "savings clause" as preserving the states' pre-EPAct wheeling authority. But these analysts concede that the federal courts will likely settle the matter, and in that regard the pundits appear to stand on more solid ground.
The task of state PUCs and legislatures is to take the information, arguments, and positions presented by special interest groups and determine whether retail wheeling would serve the public interest or the long-term economic interest of electricity consumers as a whole.
s Regulatory Roadblocks. Retail wheeling raises several regulatory issues. These include: 1) the unbundling and pricing of generation and transmission services, 2) protection of nonwheeling customers, 3) franchise rights and obligations, 4) allocation of costs from temporary surplus capacity, 5) the efficacy of rate-of-return regulation in a retail wheeling environment, and 6) the effect of retail wheeling on current integrated resource planning (IRP) practices and, in particular, utility-subsidized DSM activities. How will retail wheeling affect the long-standing "regulatory compact" between PUCs and electric utilities? Can PUCs protect core customers (customers that lack power to purchase electricity from alternate suppliers) from higher rates and lower reliability? Will more competition necessarily promote the public interest?
s Technical Obstacles. Some detractors say that retail wheeling could degrade electric reliability. If so, are remedies feasible? How much would they cost? What current inefficiencies in the electric power industry would retail wheeling reduce or eliminate?
s Economic Uncertainties. The debate surrounding retail wheeling pits different interest groups with an intensity rarely seen at the state level. Many argue positions that lie at polar opposites. From the perspective of society at large, which of these arguments are legitimate? How would retail wheeling affect the near- and long-term economic performance and structure of the electric power industry? What general lessons for retail wheeling can we learn from the deregulation of other highly monopolized industries?
Many of these questions lie within a "gray area." From a broad perspective, the greatest challenge facing state PUCs is how to effectively regulate in an environment where a utility would have monopoly power in some retail markets while encountering competitive conditions in others. Past experiences in other industries have demonstrated the inefficiencies and other distortions created by tightly controlled rate-of-return regulation in a hybrid market that is part competitive, part monopolistic.
The task is difficult; the dollars at stake are enormous, especially for utilities that face strong competition from other suppliers. Utilities with large unamortized generation assets (em especially those with recently completed nuclear power plants (em stand to lose significant revenue. To avoid such losses, utilities will fight hard to block any legislation or regulation that would jeopardize their control of the transmission system for retail transactions. Utilities and the financial community alike see the possibility of large capital losses, with electricity prices driven down to market-based levels. For utilities with high long-term production costs, relative to the average cost for the region within which they operate, the future looks especially dim in a retail wheeling world. Some of these utilities will face buyouts or mergers with lower-cost utilities.
Political Realities
For retail wheeling to become politically palatable, legislatures and PUCs must address the question of how to minimize the negative effects on core customers in the short term. Different approaches can be applied to achieve this. For example, the burden of "stranded costs" can be shared between wheeling customers, core customers, and utility shareholders. Similar approaches have successfully been used in other transformed regulated industries, notably the telecommunications and natural gas industries.
State PUCs should realize that the pressure for retail wheeling will not likely fade away. In addition to industrial customers, nonutility as well as utility-affiliated generators will in the future push hard for the right to sell their power directly to retail customers. These generators will not be satisfied with selling their power only to utilities who act as the middleman or broker to retail customers.
In fact, the posture of some interest groups, especially electric utilities, that retail wheeling cannot and will not work will increasingly lose credibility as time passes. Utility opposition to retail wheeling would also seem to diminish if, as a quid pro quo, price caps or other forms of light-handed regulation replace rate-of-return regulation.
Thus, state PUCs should begin a dialogue now. Some electric utilities have increasingly pronounced that retail wheeling will come. They have already begun to prepare for future retail competition by transforming their corporate culture, better understanding their customers' needs, cutting their costs, and restructuring their internal organization. t
Kenneth W. Costello is associate director of the Electric and Gas Research Division and Robert E. Burns is a senior research specialist, both with The National Regulatory Research Institute, Columbus, Ohio. Dr. Youssef Hegazy is a senior consultant with Energy Management Associates, the utility division of EDS, Atlanta, GA. The views and opinions of the authors do not necessarily reflect the views, opinions, or policies of The National Regulatory Research Institute, the National Association of Regulatory Utility Commissioners, or their contributors.
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