A Welcome Truce in the Electricity Wars

Deck: 

Let's enjoy this brief period of diminished acrimony before implementation of this landmark law.

Fortnightly Magazine - October 2005

In a time of record high gasoline prices, war, and increasingly shared global climate concerns, it is lamentable that the Energy Policy Act of 2005 does so little to address these critical issues. Within the narrower context of policies primarily affecting the electric power industry, however, this is a much more significant piece of legislation, and it includes a few accomplishments bordering on the extraordinary.

For more than a decade, Congress has expressed little more than ambivalence on the subject of electricity regulation. Of course, nearly all policymakers professed alliance to the goal of wholesale markets, and to local decisionmaking in matters of retail industry structure. Absolutely everyone favored strengthening electric reliability, and yet Congress stubbornly refused to pass reliability legislation. As the industry weathered its worst crises since the 1930s, from California blackouts to the collapse of Enron, Congress stood on the sidelines.

Congress' inaction cannot be blamed entirely on lethargy or a lack of courage. Underneath the pro-market, pro-reliability talking points shared by all members there lurked deep disagreements over retail deregulation and FERC's authority to force vertical de-integration (or membership in a regional transmission organization [RTO]), impose open access and reliability rules for all bulk power entities, and to oversee and remedy market wrongdoing.

Constructive Compromise

In these vitally important areas, the act strikes a constructive and much-needed compromise. To the proponents of deregulation and divestiture, the legislation articulates preferences for RTOs and markets. More importantly, it clearly establishes that operating a transmission grid that enables competition and protects reliability is federal business, and that every entity that uses this system must operate under a common set of rules. Reliability standards are mandatory, regional transmission planning is essential, and transmission incentive rates are desirable.

But if the legislation leans toward making the grid safe for markets, it also leans toward making the markets safer for customers. The act sets an earlier refund effective date and expands the authority of the Federal Energy Regulatory Commission (FERC) to oversee power markets in important and appropriate ways. Under Section 1281, FERC may obtain any information it needs, from any market participant, to make wholesale markets work-authority roughly comparable to that of the U.S. Department of Justice or the Commodity Futures Trading Commission. Market participants now explicitly are barred from false reporting to federal agencies and from using "any manipulative device or contrivance (as those terms are used in the section 10(b) of the Securities Exchange Act of 1934), in contravention of such rules and regulations as the commission may prescribe as necessary or appropriate in the public interest." FERC's penalty limits also were raised dramatically, from $10,000 to $1 million, for each violation of each rule for one day. All in all, this is the most significant expansion of federal electric policy authority in most of our lifetimes-a bargain between pro-consumer and pro-market forces that is long overdue.

With all this talk of markets, it is easy to forget that well over 90 percent of today's ratepayers still take service from a traditional bundled provider. Three-fifths of the country (by area) has no RTO, and more than 30 states do not have electric retail choice.

In the Energy Policy Act, Congress did not forget all this. At the same time it leveled the playing field for markets and consumers Congress seemingly codified the rights of vertically integrated electric companies-whether owned by customers or investors-to exist within a market framework. Although these utilities must grant comparable access and observe reliability rules, they are entitled to long-term transmission rights and other more amorphous native-load protections. These provisions are the sound of Congress bowing to post-"California crisis" state and local desires to insulate against energy supply and market risks, even if this means more traditional or more local control. It is a belt-and-suspenders strategy for troubled energy times: Enable markets, but enable self-supply as well where voters perceive this as a more secure option in highly uncertain times.

The Prospects for Expanding Markets

For 50 years, the complexity and balkanization of electric power regulatory authority has been a defining feature of this industry in the United States. Many point to this aspect of the industry as the primary culprit for the relatively weak results of electric deregulation in America, as compared with, for example, Great Britain. The obvious question to ask in the wake of the Energy Policy Act is whether this law fixes our transmission capacity and authority problems enough to make electric deregulation universal.

Unfortunately, on this central question there is no fast answer. There is an unquestionable improvement in grid governance and the policing of electric markets. New transmission economic policies-such as accelerated depreciation and incentive rates will help, assuming they are implemented thoughtfully. These are essential and positive steps toward ensuring that the markets we do have work reasonably well. When they improve their track record, it is possible we will see an expansion of markets into retail and other areas, though probably not until then.

But the more important objective is to convince all stakeholders that we can expand our grid in a reasonably fair and efficient manner and thereby make our present system work reasonably well.

In short, there still is the overarching question as to whether a hybrid industry vertical structure can succeed much beyond the level of performance we observe today. The new act seems to say that major portions of the industry can remain vertically integrated and receive treatments that enable them to continue to serve their customers, while deintegrated load serving entities buy entirely through the market. The legislation may help, but we may be searching for a coexistence that is simply impractical in the long run, because a mixture of integrated and deintegrated firms in this highly scale- and capital-intensive industry is inherently unstable. Regardless of whether this is true, creating an industry structure that allows continued vertical integration-physical or effective- alongside a robust market remains an extraordinary challenge.

The Prospects for Expanding Transcos

Several provisions of the legislation are aimed directly at the alarming decline in the rate of U.S. transmission additions since the advent of competition. The law requires FERC to adopt transmission incentive regulations, streamlines the environmental review of power lines sited on federal lands, and contains a controversial provision allowing for eminent domain over transmission siting, though only after a rather lengthy series of findings and procedures. It also enables interstate transmission siting compacts, allows federal agencies to join RTOs under certain conditions (including an ability to leave them), allows participant funding, and urges regional planning.

There is not a bad apple in this lot, and these provisions should "rev up" transmission investment to a degree. Transcos will receive a new lease on life, while regional transmission planning and siting will make significant progress with little, if any, actual use of the new federal condemnation authority. Just the possibility of invoking this authority may reduce debate. Intermittent generators will get a little more access, too, as net metering becomes universally required.

The reality check here is that, even without these measures, most of the owners of the grid had awakened to the fact that they were going to have to invest in grid expansion. The most recent Edison Electric Institute survey, taken well before the energy bill took form, showed a 50 percent increase in planned grid investment from the IOUs between 2003 and 2005.1

In this context the bill could have gone much further in the direction of encouraging new technology and a new design of the power grid to become more intelligent and reliable.2 The grid's underlying design technology is 50 years old, and better designs are on drawing boards (and, in some cases operating) around the world. Yet the act provision on innovative transmission technologies is little more than a list of desirable new technologies and a blessing to go forth and multiply. When contrasted with the billions of dollars of tax credits and investments directed toward coal, nuclear, and (to a much lesser extent) renewable technologies, we recognize an all-too-familiar tilt toward large-scale generation R&D rather than transmission and decentralized resources.3

The Prospects for Mergers and Acquisitions

Much has been made of the repeal of the Public Utility Holding Company Act (PUHCA).4 Almost everyone expects the repeal of PUHCA to unleash a large wave of industry consolidations, but many industry participants are not so sure. There undoubtedly will be another wave of consolidation, but it may not be as large as many fear.

First, FERC is now required to prevent cross-subsidization between affiliates much more formally than under PUHCA. Yet many complex issues may arise, especially for the first several mergers between non-utilities and utilities, or between utilities with very disparate geographic features or operating systems. Is it cross-subsidization when a utility centrally funds a common spare-parts pool that is disproportionately used by a subsidiary in a particularly adverse operating climate? And how should an insurance company that owns an electric utility allocate its corporate overhead? In addition, some insist that the repeal of PUHCA allows states to enact their own laws controlling holding companies.

Section 1289 of the law requires FERC to accelerate the time period for merger reviews, including affiliate issues, according to criteria it must develop. This certainly will pressure FERC to approve smaller and less controversial mergers more quickly, but as markets consolidate further and mergers threaten the already besieged market designs in transmission-short RTOs, it is hard to tell whether this will make mergers easier. The idea is to require FERC to articulate some bright-line standards that ensure rapid merger approval, and to approve mergers quickly if they meet these criteria. But my own view, as a fairly busy practitioner in this area, is that these criteria will be somewhat conservative and inherently unsuited to very large mergers, which tend to raise unique economic and policy questions.

In my opinion, economies of scope and scale (including related financial drivers) are as large as they've ever been in the electric industry, and consolidation was likely to have ratcheted up anyway with or without PUCHA. The results of PUHCA's demise will invite some experimentation between new types of mergers, such as bank acquisitions of utilities, with much higher political and operational risks than the usual utility-utility combinations.

There is, without doubt, an enormous amount of work left to do in electric policy. The industry is farther from a sustainable fuel and emissions trajectory than ever before. The grid is expanding, but it is nowhere near its potential to harness the power of better demand-side technology. Natural gas is awfully expensive, and each region of the country seems to cycle from capacity glut to nerve-wracking near-shortage.

Nevertheless, there has not been a time in recent memory when so many segments of the industry looked at a piece of legislation and unanimously claimed that some progress had been made, a few problems had been fixed, and little major damage had been done. Let's hope Congress can build on this success with new policies that address energy efficiency, environmental issues, and the redesign of our national grid. Until then, we all can enjoy a brief period of diminished acrimony over deregulation and get ready to focus on the many rules FERC must issue to implement this landmark law. When we do, the truce no doubt will end-but at least we'll have enjoyed a moment of respite.

Endnotes:

  1. See EEI Survey of Transmission Investment, Historical and Planned Capital Expenditures (1999-2008), May 2005.

  2. See Peter Fox-Penner, “Rethinking the Grid: Avoiding More Blackouts and Modernizing the Power Grid Will Be Harder Than You Think,” The Electricity Journal, March 2005, pp. 28-42; Jesse Berst. Smart Grid Newsletter at www.smartgridnews.com.

  3. In fairness, I should note that the bill gives accelerated depreciation for new transmission investment as well as incentive rates, which I have noted. While these provisions can be helpful, they do not necessarily stimulate new technologies or new industry-wide design approaches, but rather greater investments in present-generation technologies and designs. The bill also provides many pockets of support for distributed and renewable energy outside the electricity title, which is my primary focus in this article.

  4. For example, see “When China Owns Our Utilities,” www.truthout.org/docs_2005/063005y.shtml, 30 June 2005.