A Little History: Regulation and Deregulation

If you do not own them, they will in time own you. They will destroy your politics [and] corrupt your institutions.

– Tom Johnson, Mayor of Cleveland (1901-1909) on private electric companies

In many states since the 1990s, the electric power industry has succeeded in dramatically reducing the scope of state public utility commissions.  Power companies and their financial backers have pursued what they call “deregulation” to free large parts of their business from control by government regulators.  At the present time, the Federal Energy Regulatory Commission has joined this attack so that FERC can more directly privatize the electricity business.

There is a history to the controversy about regulation/deregulation of electric power companies, and it extends far back beyond the 1990s.  Originally, privately owned power companies pushed for regulation of private monopolies as an alternative to city and public ownership of electric utilities.

So the relatively recent debate about regulation is not really a debate at all, it is the final stage of a long fight by power companies and big banks to squeeze as much profit as possible from the US electrical system and electric rate payers.

Regulation

In the early days of the electrical industry, private electric companies emerged, primarily in cities, and competed with each other to attract customers.  Private electrical companies also battled with publicly owned, municipal systems to increase their market share.  In 1912, a third of power companies were publicly owned and private companies were deeply concerned about the threat of public power.

The stated rationale for state regulatory commissions was that the states would grant monopolies to private utility companies but regulate them to ensure they did not take advantage of their captive ratepayers.  Granting monopoly status made sense as a way to avoid unnecessary duplication of wires and infrastructure (i.e. so that multiple companies weren’t building electric grids to serve the same people).  But, contrary to modern expectations, the idea of state regulatory commissions was championed by Samuel Insull, president of Commonwealth Edison, one of the largest privately owned companies at the time.

In the 1910s and 1920s, Insull created an electricity empire that owned nearly 10% of the nation’s electricity supply, until he was bankrupted by JP Morgan and fled the country under charges of embezzlement. Insull was such a strong proponent of state regulatory commissions because he was afraid of the widespread movement for public ownership of electric utilities.  He thought, correctly, that (a) establishing state regulatory commissions would undermine the movement for public power and (b) that the commissions would be massively under-resourced and easily captured. The reason that state regulatory commissions look strikingly similar from state to state is that the National Civic Federation (an organization of big business leaders) created model legislation that it promoted to state politicians.

The National Electric Light Association (which later changed its name to the Edison Electric Institute) wrote a report in 1926 called “State Regulation Through Commissions Urged as a Method of Combating Public Ownership and Operation.”  The number of publicly owned power systems fell more than a quarter from 1923 to 1927.

As the regulated private power companies grew, they became increasingly consolidated as they bought out their competitors. By 1929, J.P. Morgan controlled more than a third of the country’s electricity generation and Insull controlled nearly 10%.  Holding company structures allowed investors to own controlling interests in hundreds of utilities with relatively small investments. Moreover, the parent holding companies were out of the range of regulation of individual states.  In 1935, the Federal Trade Commission found that “the milking of operating companies” to benefit the parent holding companies was a common practice.  One way this was done was to inflate the value of assets on the books of operating companies to earn a greater return from ratepayers – which should sound familiar to readers of The Power Line.

Congress passed the Public Utilities Holding Company Act (PUHCA) in 1935 to limit the scope of holding companies.  PUHCA and subsequent Federal Energy Regulatory Commission regulations (like applying uniform standards of accounting to the utility industry) helped eliminate some of the early excesses of holding companies.  PUHCA was weakened in the 1980s and 1990s and ultimately repealed in 2005.

Deregulation

Deregulation of the electrical industry refers to the break up of utility companies into separate generation, transmission, and distribution companies.  The distribution companies, which deliver power directly to customers, would continue to be regulated. But the generation companies would compete to see who could sell power the cheapest.

Deregulation was sold to the public in the 1990s as a way to increase competition and thereby lower rates.  (Although given that we all learned in Econ 101 that perfect competition drives profits to zero, one should question the underlying motives of any private corporation advocating for more competition).  The companies that were really pushing deregulation were industrial customers who thought they could get better deals purchasing power on wholesale markets, independent power generators, and companies who saw potential for huge profits from unregulated power markets.  The largest of these was Enron.

Deregulation first took off in California.  The regulated utilities themselves were initially skeptical but they agreed to accept deregulation in exchange for being allowed to recover from ratepayers $28.5 billion in stranded costs  from the construction of expensive nuclear plants in the 1980s.

When California deregulated, Enron’s dreams were realized.  The power market that was set up to sell power to California’s electric utilities could be easily manipulated.  Generators colluded to withhold generation and bid up prices.  Generators and power marketers sold power back and forth among affiliates to bid up prices.  Enron sold power back and forth across state lines to evade state-imposed price caps.  Enron also realized that it could get paid to relieve transmission congestion that it created itself.  At the end of the day, after rolling blackouts, purchases of over-priced electricity, and ratepayer-funded bailouts of the state’s major distribution utilities, deregulation cost California electricity customers an estimated $71 billion.

Needless to say, the industrial customers who had sought lower rates through deregulation did not fare so well.  But ratepayers of publicly owned utilities that had opted out of deregulation, like the Los Angeles Department of Water and Power, were spared many of the impacts of the California electricity crisis.

Some states have adopted deregulation and others have not.  Several regional electricity markets have emerged – in the mid-Atlantic, New England, New York, Midwest, and Texas, in addition to California.

Although no state has experienced a repeat of the California electricity crisis, there are still plenty of opportunities for market manipulation (here, here, and here).

West Virginia also moved towards deregulation, driven largely by Allegheny Energy.  Allegheny saw big opportunities in deregulation and was remarkably candid about the potential to profit from power marketing in its 1998 Annual Report, stating “[w]e have direct or easy access to a number of trading hubs and can take advantage of price differences among them”.  But the disaster in California prompted West Virginia regulators to abandon deregulation.

Today

Deregulation created a complicated patchwork of regulated and non-regulated companies and regional markets.  Holding companies are able to own both regulated and deregulated subsidiaries – that is, despite the fact that vertically integrated companies were required to split up into separate distribution, transmission and generation companies, parent holding companies can still own all of them.  Since the generation and transmission subsidiaries are out of reach of state regulatory commissions, it is impossible for even the most effective state regulators to have access to information to determine exactly how regulated companies are being manipulated to the benefit of deregulated affiliates.  Although, in some cases, it is fairly obvious.

In West Virginia, our regulated power companies are subsidiaries of American Electric Power and FirstEnergy, two of the largest holding companies.  Although the WV subsidiaries are still regulated, they are interconnected into the regional electrical grid operated by PJM and participate in buying and selling electricity in PJM markets.

More than ten years after the California electricity crisis, deregulation does not appear to have produced any of its promised benefits.  Electric rates have not gone down.  No efficiencies have materialized from streamlining supposedly bloated bureaucratic regulations – instead, setting up markets for energy and capacity has led to an incredibly complicated set of market rules and stakeholder groups (since electricity is not a commodity that lends itself well to markets) as well as new agencies designed to limit abuses of market power.

In fact, deregulation doesn’t appear to have worked out all that well even for some of the power companies.  Credit ratings for electric utilities have declined markedly since the 1970s, largely due to the inherent riskiness of deregulation.  Heavily coal-dependent generation companies are facing increased costs of regulation and competition with cheap natural gas – and no way to recover those costs from ratepayers as they would under a regulated system.  Furthermore, with weak load growth across PJM, there is limited opportunity for sales growth.

In this unfriendly business environment for private utilities, what can we expect?  (1) investment in transmission, which has a higher rate of return than investments in regulated generation; (2) cutting service, leading to reduced reliability of local distribution systems; (3) efforts to snuff out competition (see here, here, and here); and (4) continued schemes to manipulate regulated states to the benefit of out-of-state parent holding companies.

— by Cathy Kunkel

Much of the source material for this page from:

S. Beder, “Power Play,” The New Press, New York, 2003.

4 thoughts on “A Little History: Regulation and Deregulation

  1. Great article but a bit one sided. I love the history lesson and it’s something we should never forget. The problem I have is here in Ohio deregulation has lowered gas and electric prices. I have seen a many a business save thousands on their bills. Residential markets are slower but they save never the less. Gotta put the good with bad and vice versa.

    • Yes, there are pluses and minuses of deregulation. The pluses are somewhat less than hyped by the power companies, while the minuses are generally hidden within the greatly expanded bureaucracies that have grown up in RTOs.

  2. Friends, I’m gathering data to present against Eastern Clean Line Transmission line. I need your help. Could you please send me any data to present at a hearing at the Capitol in Little Rock the first week of Nov.? I would appreciate letters, documentation, testitmonials, concerns, and past experiences with this group. Thank you in advance. If you are interested in standing up to big energy cartels, please make plans to attend November 10, 1:00 in Little Rock at the Capitol. This will be a peaceful and respectful event.
    Against Eminent Domain and against Clean Line raping the state of Arkansas & it’s citizens.
    LAC

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