Sunday, October 15, 2006

Climbing Rates Shock Private Elec Customers

Competitive Era Fails to Shrink Electric Bills

New York Times


Published: October 15, 2006

A decade after competition was introduced in their industries,
long-distance phone rates had fallen by half, air fares by more than a
fourth and trucking rates by a fourth. But a decade after the federal
government opened the business of generating electricity to competition,
the market has produced no such decline.

Instead, more rate increase requests are pending now than ever before,
said Jim Owen, a spokesman for the Edison Electric Institute, the
association for the investor-owned utilities that provide about 60
percent of the nation’s power. The investor-owned electric utility
industry published a June report entitled “Why Are Electricity Prices

About 40 percent of all electricity customers — those in 23 states and
the District of Columbia where new competition was approved — mostly
paid modestly lower prices over the past decade. But those savings were
primarily because states, which continue to have some rate-setting
power, imposed cuts, freezes and caps at the behest of consumer groups
that wanted to insulate customers from any initial price swings.

The last of those rate protections expire next year, and the Federal
Energy Regulatory Commission and other federal agencies warn in a draft
report to Congress that “customers may experience rate shock” as
utilities seek to make up for revenue they did not collect during the
period of artificially reduced prices and to cover higher costs of fuel.
They warned that “this rate shock can create public pressure” to turn
back from electricity prices set by the market to prices set by
government regulators.

The disappointing results stem in good part from the fact that a
genuinely competitive market for electricity production has not developed.

Concerned about rising prices, California and five other states have
suspended or delayed transition to the competitive system.

And voters around two California cities, Sacramento and Davis, will
decide next month whether to replace investor-owned utilities with
municipal power in hopes of lowering rates. Drives are under way to
expand public power in Massachusetts. In Portland, Ore., the city
council tried and failed to buy the local utility company.

Electric customers in other states are facing rude surprises.

In Baltimore, an expected 72 percent rate increase in electricity prices
has aroused so much protest that the state legislature met in special
session, where it arranged to phase in the higher costs over several
years. In Illinois, rates are about to rise as much as 55 percent.

The three New York area states opened their electricity markets to
competition, with different results.

In Connecticut, residential electric rates rose up to 27 percent last
year to an average of $128 a month, and are expected to go up as much as
50 percent more in January.

In New Jersey, rates rose up to 13 percent this year, and are poised to
go much higher.

New York residential customers, by contrast, paid an inflation-adjusted
average of 16 percent less in 2004 than in 1996, a state report said. It
is not known how much of that is attributable to government-ordered rate
cuts, but the state benefited from huge increases in power generated by
its nuclear plants and by buying power from New England plants that,
starting next year, may have less electricity to sell to New York.

The Federal Energy Regulatory Commission and five other agencies, in the
draft of the report to Congress, are unable to specify any overall
savings. “It has been difficult,” the report states, “to determine
whether retail prices” in the states that opened to competition “are
higher or lower than they otherwise would have been” under the old system.

Joseph T. Kelliher, the commission chairman, said Friday that eventually
“market discipline will deliver the best prices” and noted that every
administration and Congress since 1978 had pushed the industry toward
competition. He added that the commission recognized a need for
“constant reform of the rules.”

Under the old system, regulated utilities generated electricity and
distributed it to customers. Under the new system, many regulated
utilities only deliver power, which they buy from competing producers
whose prices are not regulated. For example, Consolidated Edison, which
serves the New York City area, once produced almost all the power it
delivered; now it must buy virtually all its electricity from companies
that bought its power plants and from other independent generators.

The goal is for producers to compete to offer electricity at the lowest
price, savings customers money.

Independent power producers, free-market economists and the Clinton
Administration cheered in 1996 when the federal government allowed
states to adopt the new system. The new rules “will benefit the industry
and consumers to the tune of billions of dollars every year,” Elizabeth
A. Moler, then chairwoman of FERC, said at the time. She said the new
rules would “accelerate competition and bring lower prices and more
choices to energy customers.”

But that has not happened. A truly competitive market has never
developed, and, in most areas, the number of power producers is small.
In New Jersey, for example, only six companies produce power, and not
all of them sell to every utility.

Some utilities have decided to buy electricity not from the cheapest
supplier but from one owned by a sister to the utility company, even if
that electricity is more expensive. That has been the case in Ohio.

And if electricity is needed from more than one producer, utilities pay
each one the highest price accepted in the bidding, not the lowest. This
one-price system, adopted by the industry and approved by the federal
government, is intended to encourage investment in new power plants,
which are costlier than older ones.

But critics say that, as in California five years ago in a scandal that
enveloped Enron, the auction system can be manipulated to drive up
prices, with the increases passed on to customers. What is more,
companies that produce electricity can withhold it or limit production
even when demand is at its highest, lifting prices. This happened in
California, and the federal commission has found that it occurred in a
few more instances since then. Critics say that more subtle techniques
to reduce the supply of power are common and that the commission shows
little interest in investigating.

Bryan Lee, a FERC spokesman, said complaints of manipulation are
investigated, but only last year did Congress give the commission the
legal tools to punish manipulators.

Under the new system there have been some big winners — including
Goldman Sachs and the Carlyle Group, the private equity firm — that
figured out that there were huge profits to be made in one area of the
new system.

Such investors have in some cases resold power plants they just bought,
making a large profit. In other cases, investors have bought power
plants from the utilities at what proved to be bargain prices, then sold
the electricity back at much higher prices than it would have cost the
utility to generate the electricity.

Richard Blumenthal, the Connecticut attorney general, said the
supposedly competitive market has been “a complete failure and colossal
waste of time and money.”

He asked the federal commission to revoke competitive pricing in his
state, but the commission dismissed the complaint last Wednesday, saying
the state had not proved its case.

Advocates of moving to the new system say that, in time, the discipline
of the competitive market will mean the best possible prices for
customers. Alfred E. Kahn, the Cornell University economist who led the
fight to deregulate airlines and who, as New York’s chief utility
regulator in the 1970’s, nudged electric utilities toward the new
system, said that he was not troubled by the uneven results so far.

“Change,” Professor Kahn said, “is always messy.”

But some advocates of introducing competition to the electric industry
have soured on the idea. They include the Cato Institute, a leading
promoter of libertarian thought that favors the least possible
regulation and that concluded earlier this year that government and
electric utilities have made such hash of the new system that the whole
effort should be scrapped.

“We recommend total abandonment of restructuring,” Cato said. If the
public rejects a greater embrace of markets, Cato wrote, the next best
choice would be a “return to an updated version of the old” system.

The conflicting results among the many studies of electric prices stand
in contrast to the sharp, unambiguous drops in the prices of telephone
calls, air travel and trucking.

One study by the utility economist Mark L. Fagan, a senior fellow at the
Kennedy School of Government at Harvard and a consultant to various
businesses who favors a competitive system, found that the new system
often produces better results. He found that in 12 of 18 states that
restructured, prices were lower for industrial customers than they would
have been under the old system. But he also found that prices were
somewhat lower than his model predicted in seven of 27 states that did
not open to competition.

In Virginia, a state that did not move to the new system, a report last
month by the agency that regulates utilities found “no discernible
benefit” to customers in the 16 states that had gone the farthest and
warned that electricity prices in those states “may actually be
increasing faster than for customers in states that did not restructure.”

And Professor Jay Apt, a former astronaut who runs the electricity study
center at Carnegie-Mellon University, found that savings from
introducing competition to sales of electricity to large industrial
customers “are so small that they are not meaningful.”

Regardless of the debate over the effectiveness of the new system,
electricity prices are expected to rise in the next few years for
several reasons apart from any rise in the price of coal, natural gas,
oil, uranium and other fuels.

A study issued in June by the Edison Foundation, which represents
investor-owned utilities concluded that utilities would have to raise
rates to upgrade local distribution systems and to finance long-distance
transmission lines, as well as for new power plants. The study found
that utility profit margins had thinned and financial strength had
weakened. It called for relief in the form of higher rates.

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