A Monopolist Takeover

Deck: 

Dominion and AEP want to put the toothpaste back in the tube, but re-regulation could get messy.

Fortnightly Magazine - March 2007

Is it possible to go back to the way things were? Nostalgia for the old regulated model seems to be waxing of late, particularly in Virginia. The 70-percent rate increases in Maryland last year at the expiration of price caps—part of the transition to electric competition—has become the calamity that some state regulators fear most. Several utilities are pushing for re-regulation:

• At press time, Dominion was pushing a far ranging re-regulation bill that, most observers believe, Virginia’s governor will sign into law.

• AEP CEO Michael Morris voiced similar ideas at the Exnet Annual Utility M&A symposium in late January.

Dominion CEO Tom Farrell and AEP’s Morris believe re-regulation is the only answer to attract the billions needed to build large-scale coal and nuclear plants. “We cannot put down $2 billion to $3 billion or $4 billion to $5 billion, and say, ‘I hope I get a return on this investment down the road.’ So, the re-regulation model makes a tremendous amount of sense for us,” Morris said.

Morris added that full regulation this time around means utilities will look for “upfront assurances, rather than the more historical electric utility model where they build and hope the regulator likes it.”

But according to some bankers who asked to remain anonymous, capital markets currently are lending to utilities at favorable rates for the big buildout, regulation or no.

In an interview with Public Utilities Fortnightly, Morris acknowledged that he could finance the plants without re-regulation, but said he would not get the most favorable terms in such a case. That may explain why Duke Energy has been pushing South Carolina lawmakers to allow it and other utilities to add construction costs for major plants into the ratebase as those facilities are built. The legislation is important to Duke’s plans for its proposed $3 billion Cliffside coal-plant project and the $4 billion to $6 billion nuclear plant it may build in Cherokee County, S.C.

Such policies have not met without resistance. Last year, North Carolina’s attorney general challenged Duke Energy’s bid to raise customer rates there to pay for nuclear plants yet to be built.

It stands to reason that what regulators fear more than skyrocketing unregulated prices is skyrocketing regulated rates. And worry they should. The world has changed dramatically since the days of monopoly. Every cost input, whether it be raw materials or the price of labor, has increased dramatically. Neither regulation nor competition can hold back rising inflation.

But history does show that support for either regulation or competition seems to be moved by the basic economics of whether the industry is in a build mode, with capacity shortages, or in a no-build mode, with excess capacity. In the early 1990s, when deregulation came into fashion, the electric utility industry was coming off of a 15-year period of excess capacity, which had reached its zenith in the early 1980s, when many nuclear plants under construction were canceled. That occurred in part because capacity growth in the 1970s and 1980s turned out to be much less than expected, mainly because of conservation efforts in the wake of the various Arab oil embargoes.

Now, as the industry heads into a big build with capacity shortages in some parts of the country—and as high prices loom—the industry’s policy reverses again.

It may be that in choosing the preferred model of regulation—whatever form it may be, whether ratebase regulation or RTO-styled competitive markets—the need to raise capital (or not) for a plant building cycle is, as it always has been, the prime factor dictating policy.

Genies and Toothpaste

As convincing as the arguments from AEP and Dominion may be, it might just be too late for others to climb on the bandwagon. The move to competition took a lot of utility assets and placed them in private hands. Unless the government is going to begin confiscating that private property, the power plants and infrastructure that has been sold are now operated by private unregulated entities to run as they please. AEP and Dominion can only re-regulate because they still are vertically integrated. So, are there any other forces at work?

“FERC and certain industry players have a renewed sense of re-regulation, and I fear even a rollback of many years of competitive evolution,” one insider at the Exnet conference told me, on the condition of anonymity.

“And after hearing Morris, it only reinforced some of these trends. I fear these issues also are being caught by the politicians, who find it a ripe breeding ground for posturing,” said the industry consultant.

His take is that “there is too much hard evidence to turn the tides of competition, and when markets get a taste of competition, they usually don’t go back.”

“However, I do think the regulatory compact will remain as a parallel path, particularly in certain areas of power generation, new build and environmental issues,” he added. “So, this hybrid industry is apparently here to stay.”

C&I: The Power Behind the Policy

There is yet another force pushing utilities to consider re-regulation: commercial and industrial customers—the very customers that pushed for restructuring in the first place. John Anderson, president of the Electricity Consumers Resource Council (ELCON), has been very vocal about his dissatisfaction with “organized markets.” Today’s organized markets (PJM, NYISO, ISO-NE, and MISO), he has said, neither are competitive nor advancing the cause of competition. The benefits are so questionable that all alternatives—even a return to traditional cost of regulation—should be explored, he has said.

That’s a strong statement, coming as it does from a strong supporter of competitive markets. In a presentation last year, Anderson said that the regulated environment produced mixed results. “Some utilities were relatively efficient, but many others were not. Very few were customer friendly. [Furthermore], utilities viewed regulators as their ‘customers’ and had no incentive to lower rates or seek lower-cost power.”

Anderson listed seven conditions needed for a competitive market that are not being satisfied in current “organized markets”: 1) price as an interaction of supply and demand; 2) new capacity encouraged through market forces; 3) market entry and exit determined by market forces; 4) consumer ability to hedge future prices with long-term bilateral contracts; 5) adequate transmission infrastructure; 6) mitigated market power; and 7) relaxed wholesale price caps and bid-mitigation measures.

The ELCON president asserted that what we have today is not true competition but rather a new form of regulation—indeed, something worse than traditional regulation. Perhaps it is ELCON’s view that has set in motion hearings on electric competition at the Federal Energy Regulatory Commission (FERC).

Last December, FERC Chairman Joseph T. Kelliher announced a series of conferences (the first hearing was two weeks ago). These meetings are exploring a range of issues, including federal-state cooperation, the need for new infrastructure, demand response and renewable energy, the availability of long-term contracts, and market-design issues affecting wholesale markets. The commission also is addressing the challenges faced by all wholesale markets, including organized markets and bilateral contract markets.

In short, FERC plans to address nearly everything that C&I customers want to see improved.

Should they be satisfied with the changes, AEP and Dominion may again have to squeeze the toothpaste.