Electric Utilities: Steering Clear on the Information HighwayJames H. McGrew

Fortnightly Magazine - May 15 1995

One of the most exciting challenges facing electric utilities is the opportunity to participate on the so-called "information highway." Not only is the technology evolving at a dazzling pace, but the opportunities to make or lose money will be staggering. The growth in sales of electricity has been and will be relatively slow compared to the dynamic growth in sales of cable television, information, online, cellular telephone, and other telecommunications services. Most electric utilities have already been traveling on the information highway because they have fiber-optic networks as well as microwave radio and other wireless communications.

Naturally, utilities will want to recover their investment in the communications infrastructure to the extent possible. But cost recovery will depend in part on the scope of communications activity and the manner in which it is undertaken. Any serious entry into telecommunications will probably devolve upon a separate subsidiary for several reasons:

s to establish a wall between the telecommunications business and the utility business

s to avoid allegations of cross-subsidization

s to maximize profits

s to facilitate accounting.

Nevertheless, a utility may wish to invest in telecommunications infrastructure as part of its core utility business. Utilities have for decades used telecommunications technology, including private telephone, microwave radio, land-mobile radio, and other communications equipment for sending and receiving real-time information. Utilities need real-time information to detect malfunctioning equipment, turn generation units on or off, solve transmission problems, and so forth. To the extent that investments in communications equipment are prudent and serve a bona fide utility purpose, there should be no problem in recovering them.

DSM Drivers

Several utilities (em including Pacific Gas & Electric Co. and subsidiaries of Entergy, The Southern Co., and Central and South West Corp. (em are currently experimenting with demand-side management (DSM) programs that use two-way communications with customers. These experimental DSM programs have focused on a limited number of customers, usually in suburban areas. To my knowledge, they have also been underwritten so far by shareholders. However, many are optimistic that the savings these programs create will exceed the cost of the investment, and that utilities will be able to recover their investments in rates. Some refer to utility investment in the information highway as "DSM-driven" or "DSM-financed."

A regulatory issue arises from the incidental revenue that may be derived from leasing excess capacity from an innovative DSM program. Let's say the DSM program requires only 2 to 5 percent of the capacity of a hybrid fiber-optic/coaxial cable. The utility then has the opportunity to lease the remaining capacity to another company, such as a telephone or cable television company, or use it to provide additional services. The same cable can be used to provide television service, telephone service, computer networking, and other services. We do not know how state commissions (PUCs) will view this excess capacity because the DSM experiments are in their early stages. PUCs may permit utilities to retain the additional revenue as nonutility income; they may require sharing the income between customers and shareholders; or they may require that all excess revenues be credited to ratepayers.

For these reasons, utilities may be inclined to take a conservative investment approach, choosing not to stray from their core business. This strategy offers reasonable assurance of recovering their costs. If utilities choose to establish a separate telecommunications subsidiary, additional issues will involve PUCs and possibly the Federal Energy Regulatory Commission (FERC). PUCs may require the subsidiary to reimburse the utility for using its rights-of-way, utility poles, personnel, office and equipment, and the like. Regulators are perpetually on the lookout for cross-subsidization.

Utility Poles

Most electric utility telecommunications systems are classified as private carriers under the Federal Communications Act. But if electric utilities substantially increase the scope and nature of the telecommunications services they offer, they may become common carriers subject to additional regulation at the state and federal level. Common carrier status might require utilities, among other things, to provide access to poles and rights-of-way as well as to telecommunications services.

Section 224 of the Federal Communications Act requires the Federal Communications Commission (FCC) to set rates for pole attachment by cable television systems if a PUC does not. The FCC's pole attachment rates are, however, much lower than utilities believe fair. Nevertheless, the courts have held that section 224 is not an unconstitutional "taking" within the ambit of the Fifth Amendment, and have also upheld the FCC's jurisdiction to set rates even when the cable operator transmits nonvideo matter over its wires.

The legal questions here include whether cable companies have an unfair advantage over other competitors in the telecommunications field because they have a right to FCC-regulated pole attachment rates; whether the FCC will require utilities to offer pole attachment (they are not so required under the present system); whether electric utilities will need to use the poles of other companies, such as telephone companies; and whether the FCC's current formula for setting pole attachment rates should be changed. Most of these issues will have to be resolved by legislation since section 224 ("The Pole Attachment Act") is a creature of Congress.

A PUHCA Detour

Registered holding companies and their subsidiaries are currently prohibited from engaging in telecommunications business by the Public Utility Holding Company Act of 1935 (PUHCA). PUHCA restricts the business activities of associated companies in a registered holding company system to those functionally related to the electric utility business. However, exempt holding companies and free-standing utilities are free to diversify.

In the context of the information highway, PUHCA reform is a hot topic. If Congress does not reform PUHCA to permit registered holding company systems to enter the telecommunications business, the playing field will be tilted in favor of nonregistered companies. If Congress does so reform PUHCA, both the FERC and the PUCs will want Congress to address the Ohio Power problem. In that case (Ohio Power Co. v. FERC, 954 F.2d 779 [D.C.Cir. 1992]), the court held that the Securities and Exchange Commission (SEC) has exclusive authority to set the rate for sales between associates of a registered holding company system. Therefore, the FERC and PUCs are forced to permit passthrough of such SEC-established rates. However, the SEC is not as aggressive or consumer-oriented in setting rates as the FERC and PUCs. PUHCA reform also raises a major issue of potential cross-subsidization. A telecommunications associate could use its utility associate to subsidize its telecommunications business.

The 104th Congress is now considering telecommunications legislation. Both the majority and minority draft bills in the Senate would permit utilities to provide telecommunications services. The Senate majority draft and the House draft also expressly provide for registered holding company affiliates to engage in telecommunications services with appropriate safeguards. Electric utilities must become more involved in this legislative process than they have been in the past. The major "players" in the 103rd Congress were cable companies, telephone service companies, and various public and private interest organizations (em but not electric utilities.

Passenger Comfort

Universal service is a priority under the Federal Communications Act, and electric utilities are well acquainted with this type of requirement. However, the unique technology of the information highway raises a number of questions as to the exact nature of that "service." Does every customer have a right to log onto the Internet? If so, how much basic "lifeline" Internet service does each require? Does every customer have a right to video-on-demand? If so, how much video-on-demand constitutes a minimum entitlement? Should every customer be plugged into local schools and libraries by online services? If so, how much online time should be guaranteed? PUCs will have to make difficult decisions regarding the rationing and cross-subsidizing of these new services if they want to apply the concept of universal service to the new technology.

As telecommunications services expand, providers of those services will have a larger body of data about their customers. They may have access to information about appliance use; when people are home; whether they have dogs; what videos they order; whom they call; how often they call; when they call; what items they buy from home shopping networks; what types of online services they use. The unscrupulous could sell such information to entrepreneurs who wish to solicit or even blackmail individual consumers. The information could also be used by criminals to rob houses or businesses or to make unauthorized charges to a credit card.

The technical issue revolves around whether the technology exists to protect the data, or whether a skilled hacker can penetrate the system and acquire the data at will. The legal issue here concerns rights of privacy and access to the data. The privacy issue is particularly sensitive if medical services are provided by two-way interactive television. Information providers will be forced to insure themselves against possible suits for breach of privacy or confidentiality.

A related issue involves electronic commerce. Since data will be available in real time, people will naturally want to conduct business in real time. For centuries, contracts have been evidenced by a written signature on paper, which can be verified by the signer's own testimony, the testimony of those who know the signer, or handwriting experts. Will there be an equivalent "electronic" signature? If so, who will verify it, and how will it be verified? How will we ensure that the electronic evidence of the contract cannot be altered electronically?

Similarly, material that is reduced to print, compact disc, or video disc can be protected by copyright under Federal law. However, as commerce compresses to real-time electronic transactions, people will be providing information and proposals that they do not have time to copyright. Will a common law of copyright develop?

Road Map

The New Deal legislation that produced the Federal Power Act, the Public Utility Holding Company Act, and the Communications Act evolved from a "top-down" philosophy. Congress in the 1930s assumed that the federal government should shape the development of electric and telecommunications utilities. But technology rather than government is driving the changes in the 1990s. As technology evolves, consumers demand it. Government and service providers, including utilities, will have to adapt. The new technology will revolutionize the way businesses are structured.

For example, a single company can effectively "wire" a household or a business for most services. The broadband coaxial cable, coupled with the traditional copper electric wire, will be able to supply all necessary electric and telecommunications services. The Municipal Light Board of Glasgow, KY, currently provides electric and cable service and is prepared to offer telephone service. This is potentially good news for electric utilities. Consumers have no reason to care which company wires their households as long as the cost is reasonable. In fact, the consumer would prefer to pay one bill a month than to pay separately for cable, electric, and telephone services.

But the fact that one company can provide electric, telephone, and cable service is also bad news for electric utilities. Telephone or cable companies can simply buy out electric utilities and provide all services themselves. Consumers have no interest in who owns the wires coming into their houses or businesses; they are only interested in the package of services transmitted: electric service, home shopping, video-on-demand, interactive video, cable television, online services, information services, educational programs, telephone service. Each of these products may be purchased from separate suppliers, even if only one company owns the wires. There is potentially no limit to the number of suppliers available to consumers if they have nondiscriminatory access to the transmission wires into the consumer's premises.

If the service providers are separate companies (em that is, if supply service is unbundled from distribution service (em consumers can pay one monthly rate for the wire distribution service. This distribution company may be called Bell Atlantic Telecablelectric or Viacom Telectric or some other name. If electric utilities can get into telecommunications, telecommunications companies can get into electric service. In an unbundled world, the suppliers of services would all have access to consumers and would all compete for their business. To the consumer, this new world is eminently exciting. From the electric utility's perspective, it is both a problem and an opportunity. If the electric utility adapts to provide the unbundled services demanded by the consumer, the outcome can be happy. On the other hand, telephone and cable companies have been accustomed to ferocious competition for the past 10 years, and they may simply beat out the electric utilities for the business.

Technological and regulatory change will continue at a rapid pace in the 1990s. Electric utilities should look twice and watch out for flashing yellow lights as they move into the telecommunications fast lane. t

James McGrew is a partner with the Washington, DC, law office of Bruder, Gentile & Marcoux, where he specializes in representing electric utilities and natural gas companies before the FERC. Mr. McGrew is a graduate of Harvard Law School, and served as a supervisory attorney and trial attorney at the FERC from 1980 to 1986.

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