Promoting competition in the US electric industry

   MI 2 1997 US 

The American electric industry is characterised by the predominance of approximately 250 investor-owned utilities (IOUs). Even though most of the industry is privately owned, however, it remains subject to regulation `in the public interest'.In countries with large state-owned utility monopolies, the restructuring of the industry often involves some form of privatisation, as well as some form of regulation that encourages new market entrants. The latter development has started in the US and the FERC (or the Commission) and its state counterparts are trying to improve the efficiency of this diverse industry by actively promoting competition.

IOUs produce about 76% of all energy sales to retail customers in the US. Other participants in the industry include publicly-owned utilities (POUs), federally-owned utilities (FOUs) and co-operatively-owned utilities (COUs). They operate under much less regulatory scrutiny than do IOUs.

While making up about 14% of the retail market, POUs are widespread throughout the country. Most POUs are municipal utilities, owned and operated by cities. FOUs are power agencies which were created by Congress to develop regional power resources, particularly low-cost hydro-electric facilities. Power from the federally-owned hydro-electric facilities is frequently made available on a preferential basis to POUs and COUs.

COUs are co-operatively owned by members and receive low-cost financing from the federal government. COUs were first organised as distribution co-operatives to serve rural areas of the country during the 1930s. Retail customers of COUs are actually member/owners of the co-operatives.

The FERC is an `independent regulatory' agency, meaning that commissioners (once nominated by the President and confirmed by the Senate for office) cannot be removed from office during their terms because of policy disagreements with the President or Congress. The value of independent regulation is the application of technical expertise to public policy questions independent of political interference.

Congress nevertheless exercises oversight over the Commission and its budget and occasionally holds hearings to review its progress in a particular area. The federal courts ultimately review legal challenges to the agency's actions. FERC decisions must be based on substantial record evidence and `reasoned decision making'. Despite its independence, the FERC is accountable to the public as represented by various institutions. This model generally prevails in state level regulation as well.

Retail end-user rates of IOUs are regulated by public utility commissions located within the states. The state commissioners are either elected or appointed officials of the state government. Wholesale or sale for resale rates are regulated by FERC. The FERC regulates the industry pursuant to the Federal Power Act (FPA) adopted by Congress in 1935 as part of President Roosevelt's New Deal, and amended periodically since then. In addition to regulation over wholesale sales of electricity, the FPA grants the FERC authority to determine rates, terms, and conditions for interstate transmission service. The statute also gives the FERC limited authority to order utilities (including publicly-owned utilities) to provide transmission service.

The FERC can issue rules and regulations which have the force and effect of law. This procedure, known as rulemaking, codifies regulations in Title 18, Code of Federal Regulations, which is widely available to the public. Hearings are conducted by one of its Administrative Law Judges (ALJ) when it is necessary to make findings of fact as well as conclusions of law about a rate or service. If an ALJ's decision is upheld by the FERC, it has the force and effect of law and thereby creates part of the `common law' of the Commission. This is the method most often used to set rates or review complaints against the conduct of a regulated company, and constitutes the Commission's quasi-judicial function.

The emergence of competition

Competitive pressures are steadily building in the electric industry. Much of the competition in long-term generation came from non-utility entrants who sell electric energy from small scale units at lower prices than many utilities selling from existing generation facilities. Many of these new entrants, however, had difficulty reaching buyers, because they are dependent upon transmission service owned or controlled by the IOUs with whom they are competing. Similarly many power marketers who purchase electricity from any number of sources and repackage it to suit the specific service needs of customers experienced trouble obtaining non-discriminatory transmission service.

Recognising the importance of non-discriminatory transmission access to a competitive wholesale power market, the FERC issued Order No 888 in 1996. This order requires all transmission-owning public utilities to have tariffs on file to provide transmission service under non-discriminatory terms. The Commission explained that:

In this rule, the Commission seeks to remedy both existing and future undue discrimination in the industry and realise the significant customer benefits that will come with open access. Indeed, it is our statutory obligation under sections 205 and 206 of the Federal Power Act (FPA) to remedy undue discrimination. To do so, we must eliminate the remaining patchwork of closed and open jurisdictional transmission systems and ensure that all these systems, including those that already provide some form of open access, cannot use monopoly power over transmission to unduly discriminate against others.²

The Commission concluded that the benchmark for measuring non-discrimination is the services that the transmission-owning utility provides. This has proved critical. The wholesale power market is increasingly characterised by multiple sources of generation, where a transmitting utility is itself competing in the wholesale power sales market. Simply put, new power suppliers now need transmission access under fair terms and conditions of service in order to be competitive with vertically integrated IOUs.

Consequently, Order No 888 requires that transmission-owning public utilities must offer transmission service to all eligible customers on a non-discriminatory basis. However, utilities are able to propose their own rates for service. Pursuant to Order No 888, all IOUs have filed open access transmission tariffs that contain minimum terms and conditions of service.

The Commission also encourages non-jurisdictional utilities, including POUs and COUs that own interstate transmission, to offer open access service. In addition, the non-jurisdictional utility must provide open access service to the IOU from which it is receiving open access service. This `reciprocity' principle is also applied to foreign utilities wanting to sell power in the US markets using domestic transmission facilities.

Order No 888 also requires utilities to `unbundle' their new wholesale transactions. In other words, a utility must price generation and transmission service separately, including ancillary services for sales to its wholesale customers. Since the utility must take transmission service under the same transmission tariff that it provides service to others, the transmission price must be the same for itself as it is for the IOU's customers. The goal is to deprive transmission owners of any inherent competitive advantage.

Transition from a regulated to a competitive environment inevitably raises issues of fairness. Many utilities contend, for example, that to be fair the transition should provide a means for them to collect `stranded costs'. These are costs or obligations which the utility incurred on behalf of a customer because it expected the customer to remain on its system and expected to have to stand ready to serve that customer. If the customer leaves the system earlier than the utility could reasonably have expected, the utility or its remaining customers will be left to bear responsibility for paying the costs incurred on behalf of the departed customer.

To address these concerns, Order No 888 acknowledges there will be a cost associated with the transition to wholesale competition. The FERC will therefore allow utilities to seek recovery of all legitimate, prudent and verifiable costs that may be stranded when their customers use open access transmission service to obtain power elsewhere. However, it decided not to hear stranded cost claims arising because of state retail access plans unless the relevant state regulatory authority does not have authority to provide for stranded cost recovery at the time retail access was put into place.

ITEM TYPE OF ELECTRIC UTILITY
IOUs POUs COUs FOUs Total
Number of utilities 250 2005 939 10 3204
Utilities(percent) 7.8 62.6 29.3 0.3 100
Kwh Retail - Sales to End - Resale(percent) 76.3 14.4 7.8 1.6 100
Kwh Wholesale - Sales for Resale(percent) 43.6 17.9 21.7 16.8 100
Kwh Retail Price (c/ Kwh) 7.1 6.1 7.0 2.8 6.9
Kwh Wholesale Price (c/ Kwh) 3.5 3.9 4.0 3.5 3.7

This article will be concluded in the next issue of Smart Energy International.

References

  1. Energy Information Administration, US Department of Energy, Financial Statistics of Major U.S. Publicly Owned Electric Utilities, US Government Printing Office, Washington DC, December 1995, p 3.
  2. Promoting Wholesale Competition Through Open Access Non-discriminatory Transmission Services by Public Utilities, and Recovery of Stranded Costs by Public Utilities and Transmitting Utilities, 61 Fed. Reg. 21,540 (May 10 1996); FERC Stats. & Regs., Regulations Preambles 31,036 (1996). (Referred to as Order No 888)