Power Politics

If last year's activity is any indication, 1983 could be the year Ronald Reagan leads his presidency through the political briarpatch of electric utility regulation. Beginning last February, the White House turned its attention to the troubled utility industry when Vice-President Bush called a meeting of electric company representatives and nuclear vendors to discuss the causes and potential effects of recent power plant delays and cancellations.

In May an intergovernmental task force was formed—the Cabinet Council Working Group on Regulation, Competition, and Efficiency in the Electric Utility Industry—to study the industry's problems and recommend solutions. This twenty-one-member group since has been focusing on the relationship between the financial condition of the industry and investments in new capacity. Preliminary findings indicate that financial constraints are causing underinvestment in electricity supply capability, and that the source of the problem is politically motivated price controls by utility regulators. Thus, the recommendations discussed so far center on reforms in rate regulation—changes that might be made in rate-making procedure as well as altering the basic jurisdictional framework of electric utility regulation itself.

The group, known informally as the Electricity Policy Project (EPP), has not sent its report to the White House yet; and no one now knows which, if any, of its recommendations ultimately will find their way into proposed legislation. One thing, however, is certain: whatever proposals are made surely will attract a great deal of political attention. Electricity is an area in which political interests are as widespread and interconnected as the grid itself. Any change in the current structure of regulation is bound to affect many of those interests, and the EPP already has caught the eye of some of the strongest lobbies on Capitol Hill.

Part of the EPP's work has been to synthesize the results of thirty-three analytical reports, some done at the Department of Energy's Office of Policy Planning and Analysis (OPPA), but most performed under contract by outside consultants. Aside from these paper studies, the project is aggressively fact-finding by speaking with industry representatives' regulators, trade associations, and Washington-based policy groups, a process EPP members feel is important to building a consensus for its proposals.

Regulation and long-term supply

According to Hunter Chiles, EPP chairman and director of OPPA, the central issue under investigation is the effect of rate regulation (or government price controls, as he puts it) on the long-run supply of electricity. In a November speech before the National Association of Regulatory Utility Commissioners, Chiles outlined the "danger signs" that indicate to him that traditional utility rate regulation is ineffective—and perhaps even counter-productive—in sending utility managers the investment signals conducive to assuring an efficient supply mix over the long run.

The first of these danger signs, says Chiles, is that while utility regulation traditionally has taken place in an era of declining costs for electricity, that period ended in 1969 and commissions have shown no sign of adapting to new conditions. Contrary to the conventional wisdom, he says, electricity demand—stronger than total energy demand since 1973—may well continue to be strong in the future, especially if the economy experiences a vigorous recovery. While the market for electricity appears strong, however, price controls of the type imposed under conditions of falling costs now have increased the risk of new investments in capacity. The result, Chiles says, is that utility managers now are canceling projects in response to short-term financial indicators at the expense of long-run efficiency or a "need-for-power" criteria. A real danger, according to Chiles, is that regulators may be institutionally incapable of authorizing the revenue increases necessary to build new power plants. Commissioners who are elected rather than appointed, he says, tend to reflect the views of the rate-paying public and—because the public fails to draw a connection between current rates and future electricity supply—this disassociation will continue to characterize utility regulation.

One of the central building blocks of the EPP's analysis is a February 1982 OPPA report titled The Nation's Electric Future: Perspectives on the Issue of Electricity Supply Sufficiency. This study makes the point that declining profitability in the utility industry, caused by a drop in companies' allowed rate of return from 6.2 percent to 2.2 percent between 1970-80 (adjusted for inflation), has placed financial constraints on new capital expenditures. The report concludes that if this trend continues through the early 1980s, "continued utility financial problems against a background of modest electricity demand growth may cause a long-term shortfall in electricity supply."

Upbeat views

While project spokesmen view their study's findings as a cause for real concern, there are those who think the situation is not nearly as bad as the EPP makes it out to be. An example is the Electric Consumers Resource Council (ELCON), a trade association that represents the nation's largest industrial electricity consumers. According to Executive Director Jay Kennedy, ELCON's members have perhaps a bigger stake in an adequate supply of power than anyone, and they simply do not share the EPP's gloomy view of the future. For one thing, Kennedy disagrees with the project's basic assumption that utilities are in financial trouble. Citing lower fuel prices, interest rates, and inflation, and $8 billion in recent rate increases, Kennedy thinks electric companies are in better shape than they were two years ago. Moreover, he says, the evidence on future supply capability is mixed; he cites an August 1982 report by the Congressional Research Service—Do We Really Need All Those Electric Plants?—that uses essentially the same numbers as the OPPA study but concludes that "most areas of the country are expected to be in rather good condition in regard to electric generating capacity in the future, assuming moderate economic growth and the middle capacity case."

Another group that finds fault with the EPP's articulation of the utility problem is the American Public Power Association (APPA), which represents 1,750 publicly owned power systems throughout the country. APPA Deputy Executive Director Larry Hobart took issue with Hunter Chile's belief that private power companies are not earning enough money to make investments that are in the national interest. In support of his point, Hobart quoted Austin Koenen from the investment firm of Lehman Brothers Kuhn Loeb, Inc: "The investor-owned electric industry is currently experiencing a major secular improvement in its underlying operational and financial characteristics due to slower load growth, responsive regulation, improved cost recovery mechanisms, lower inflation, and a moderate energy crisis."

"The overriding reason for power plant cancellations," Hobart said, "is not financial constraints, but a falloff in expected load growth." He cited recent plant cancellations by two large investor-owned utilities, which company spokesmen attributed to declining demand projections.

Members of the EPP do not dispute that projections for future electricity demand have been scaled down considerably from the historic rate of 7 percent per year. But, they say, two factors may serve to boost load growth over the next ten years: a slow rise in the real price of electricity compared to prices for substitute forms of energy, and an increase in economic growth. The EPP's primary concern is that if such conditions did spur electricity demand, we might well get caught with our plants down, and regulators would be institutionally incapable of providing the revenue relief required to undertake new construction.

To guard against such a possibility, the EPP would recommend reforms in the way rates are established for utilities as well as a redistribution of authority over electricity planning and regulation from the federal and state levels—where it currently is lodged—to newly created regional bodies.

The specific proposals discussed so far within the EPP center on three basic objectives: deregulation of certain types of electric power transactions; the development of a "model policy" for utility regulation that draws a legal link between rates and a preapproved supply plan; and the establishment of regional planning and regulatory bodies.

Partial deregulation

As an example of its thinking, the EPP believes that sufficient competitiveness exists in the market for bulk power sales to justify at least partial deregulation of wholesale transactions between willing buyers and sellers and for sales from new generating facilities dedicated to the wholesale market. If this assumption is true, competition also may serve better than regulation as a means of removing inefficiencies (high costs and low supply) from the bulk power market.

The APPA, however, is not so enthusiastic about the idea of deregulating wholesale rates. APPA members—mostly small and predominantly unregulated publicly owned power systems in forty-nine states—are both competitors and customers of their large, privately owned neighbor utilities. The mistrust between public and private power systems is long-standing and has many sources. On a philosophical level, investor-owned utilities feel that public systems are unfairly subsidized through their access to tax-exempt financing and that this is not only inequitable, but also economically inefficient. On a more practical level, private companies find more often than not that the rates charged for public power are less than those they can afford to charge, a circumstance that sparks competition between public and private companies for choice industrial customers.

While a little healthy competition is usually a good thing, the situation in this case is complicated by the fact that some 900 of the APPA's members also are customers of private utilities and from them purchase most or all of the power they need to serve their systems' requirements. In light of the fact that bulk power purchases account for three-quarters of the total cost of the power supply for these public systems, it is easy to see why they feel federal regulation over wholesale rates continues to be important to them.

Linking rates and supply plans

The idea of establishing legal and regulatory links between rates and electric supply planning also has a good deal of merit, but here again the political reception for any such proposal depends heavily on the specifics. It is no secret that traditional utility planning has been rather one-dimensional: facing a steadily increasing growth rate for demand, a company has had only to decide whether to build a new large power plant. Meanwhile, increasing sales, coupled with falling unit costs, always ensured that sufficient revenue would be generated to pay for the plant when it came on-line.

But traditional utility planning has gone the way of the nickel phone call. Today's utility planners are far less sure how fast demand will grow or where they will get the capacity to meet it. About the only thing they are sure of is that whatever they do need will be very costly.

Recent developments have added a whole new dimension to utility planning. Least-cost strategies for meeting electrical demand have come to include customer investments in conservation and energy efficiency measures as well as alternative sources and configurations for electric generation. The institutionalization of new approaches to low-cost supply planning would be an important step toward reducing the risk of utility planning error. At the same time, linking the rates a utility may earn and its implementation of a supply plan that has received prior public approval seems to be an equitable way of allocating any remaining risk among all who benefit from the system, rather than laying it solely upon the company itself.

Among those who have responded to this concept, the Natural Resources Defense Council (NRDC) has expressed initial support and cited its past interest in model legislation that assures consideration of least-cost means of delivering energy services. But what NRDC means by "least-cost energy planning" may well differ from what those in the Electricity Policy Project have in mind. The environmentalist group points to the Northwest Power Planning Act as its idea of good prototype legislation. This act gives priority to conservation and renewable energy resources in developing a least-cost plan.

By contrast, the Department of Energy's vision of long-run cost minimization reflects a decidedly supply-side perspective. The EPP articulation of the problem as the need to build central station power plants already has raised the suspicions of environmentalists and renewable energy advocates that its effort is more teleological than objective. Before these groups endorse the EPP's idea that planning should guide rate regulation, they would certainly want to know more specifically how plans are to be established and approved, and by whom.

Regional bodies

There is a lot to be said for the idea of bringing electric system planning and regulation to the regional level. The current regulatory structure follows political lines, with wholesale rates set by the Federal Energy Regulatory Commission and retail rates—and a variety of other aspects of utility operations—regulated in fifty slightly different ways in the states. Unfortunately, this political framework for regulation does not accurately reflect the economic and engineering realities of the electric power business. Some utilities do business in more than one state and different regulatory treatment from the commissions involved can make the development of a uniform company plan quite difficult. Even utilities that operate wholly within one state are interconnected with other systems and their planning is designed to capture whatever economies and opportunities for risk reduction may exist by virtue of intersystem coordination. Substituting regional bodies for the arbitrary political boundaries that now define regulatory policies could be an excellent way of changing regulation to fit reality.

But is the concept of regional bodies politically acceptable? On its face it is a neutral proposition. In practice, such bodies might be charged with anything from developing nonbinding supply plans for their region to regulating wholesale and retail rates. The National Governor's Association and the National Conference State Legislatures have expressed initial reluctance to support any proposal for regional cooperation that is not voluntary. The latter, in particular, is concerned that regional bodies might usurp state authority over plant siting and rates, issues that have critical importance for local economies. Until the details of any proposal for regionalization are made known, it is likely that these and other representatives of state interests will assume a wait-and-see attitude.

Overcoming inertia

Apart from the specific concerns that these interest groups may have with EPP proposals, perhaps the greatest obstacle to their implementation will be indifference. As one informed Capitol Hill energy staffer pointed out before the National Governor's Association Electric Utility Task Force, the congressional agenda in 1983 already is overcrowded with more urgent issues, and if the Reagan administration wants anything done in the electricity area it will bear the burden of proving that the wolf is at the door.

It may be difficult to demonstrate the existence of a crisis urgent enough to get congressional attention. Conditions in the utility industry have improved, financial indicators are up, demand forecasts are down and—with everyone complaining about rates—there seems to be little political inclination to make changes that might boost rates still higher. The important issue, however, is not what things are like today, but what they will be like in the future: the real lesson of recent experience with electrical planning is that it has become more complex and that the costs of an error will continue to rise.

The investment climate for electric supply indeed has changed dramatically in recent years, and with the cost and supply pressures temporarily low, this would appear to be an appropriate time to develop a national policy for the industry that accounts for those changes. In the abstract, the Electricity Policy Project proposals represent at least an initial approach to such a policy, and on that score they deserve consideration. But these or any other proposals are unlikely to enjoy any real political consensus until interest groups are satisfied with the details, and until Congress is convinced that a problem truly exists.