SPECIAL REPORT--POWER DEREGULATION
That Crazy Patchwork Called Electricity Deregulation
The results so far are mixed -- at best. Doing better will mean more big, painful changes in energy markets and policies nationwide
That Crazy Patchwork Called Electricity Deregulation
Have you benefited from deregulation of the electricity industry three years ago? Still depends on what state you live in, and the season of the year. For example, last summer saw extensive brownouts and blackouts across Southern California, spot outages in New England, and a few power shortages in New York. In these areas, customers complained of higher electric bills. But across the Midwest and in New Jersey, Pennsylvania, and Maryland, there seemed to be plenty of electricity to go around. Some customers actually saw their bills go down.
Welcome to the checkered, new world of Reddi Kilowatt. In 1997, Congress lifted long-standing controls on the utility industry, granting states the power to create competitive markets for electricity generation. The idea was to give consumers a choice of power suppliers -- all competing to deliver reliable service at low prices. No longer would both businesses and consumers have to rely on the staid, old regional utility to do right by them under the watchful eye of government.
UNSETTLING RESULTS. So far 25 states and the District of Columbia have embraced deregulation. But the results have been decidedly mixed: Restructuring has created a patchwork of approaches, with power flowing to some regions in abundance and leaving others in scarcity. Some areas have seen drops in energy costs. Others have seen unsettling spikes.
A national energy policy? Not in this environment. Today, federal officials say they can measure adequate supply only regionally, not nationally. Deregulation leaves the Federal Energy Regulatory Commission (FERC) with only one course of action: smoothing the transition from a heavily regulated utility environment to one that relies more on market dynamics of supply and demand. Not that market forces won't eventually result in benefits to consumers over the long run.
That's the whole idea behind deregulating the industry. But getting over the hump will take big investments in new power-generation plants, not just by old-line utilities but by new competitors eager to make a buck in the market. Large industrial customers will have to seek out independent power supplies. Burgeoning wholesale power markets will have to realize new efficiencies of scale. And development of alternative energy sources that rely on renewable resources instead of fossil fuels will once again have to become a national priority.
HOTEL CALIFORNIA. The biggest problem right now is explosive growth in the demand for power. For those unfortunate enough to live in California, the dimming of the lights was mainly attributed to a spike in air-conditioning usage in the second-hottest season in the West in 100 years. But other factors contributed, too: a proliferation of so-called Internet hotels -- buildings that house massive server operations enabling Web access -- for example.
Then there's the overall surge in the high-tech gadgetry that has become indispensable to the New Economy: fast computers, company servers, cell phones, DSL lines, etc. The shortages and outages certainly caught the attention of Californians, who protested loudly. In the land where people usually worry about an earthquake someday heaving Los Angeles into the Pacific Ocean, dire predictions arose that the U.S. was running out of power. On the East Coast, where states have taken a different path to restructuring the utilities sector, reserve capacity helped to avert disaster, but consumers were none too happy, either. Prices soared.
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"You can't store electricity the way you can stockpile home-heating oil"
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Yes, electricity usage is increasing, in part due to the demands of new technology. Some say computer-related electrical use already accounts for 13% of total electrical usage and will grow to 50% in the next 20 years. As for the weather, to paraphrase Abraham Lincoln, everybody complains about the weather, but nobody can really do anything about it.
Alas, weather forecasters predict slightly-colder-than-average temperatures this winter in the U.S. And peak demand for this winter in North America is expected to be about 3% higher than it was last year, according to the North American Electric Reliability Council. "Early indications are that next summer will be the same or, more likely, worse than summer 2000," says a 2000/2001 Winter Assessment report from NERC.
MIDWEST SURPLUS. The main issue is that demand is growing faster than capacity in highly populated areas. "There is cause for concern," says Charles Gray, executive director of the National Association of Regulatory Utility Commissioners (NARUC). "You can't store electricity the way you can stockpile home-heating oil." Over the next five years, demand will probably grow at an average of 1.9% a year for the whole country, NERC predicts in its 10-year "reliability assessment" published in October.
In California, however, peak demand for 2000 is so far 13% higher than it was in 1999. And getting the environmental approval to build a power plant in California is a bear. It can take five to seven years to get all the approvals to raise a plant there.
But consider the Midwest. In 1998, it was plagued by power shortages as bad as California's. This year, after speeding up new power-generation capacity, the region was able to sell excess electricity to other parts of the country for most of the year. And the surplus seemed to drive prices down for Midwest consumers. The average price of a kilowatt hour in the region dropped to 6.6 cents from 6.8 cents from July, 1999, to July, 2000, while the U.S. average went up from 7.04 cents to 7.09 cents in the same period.
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East Coast dereg included stipulations about reserves utilities must keep on hand. Not so in California
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The lesson here: Consumers must be willing to give deregulation a chance to work. Fact is, the U.S. should have adequate generation and distribution through 2009, NERC insists. But that prediction is based on the assumption that all the new power plants being planned for construction across the country actually get built. The appetite for power surely will rise. In the next four years, the report says, demand will grow by 60,500 megawatts nationally, but new capacity would offset that, providing anywhere between 109,000 and 193,000 additional megawatts during the same period, NERC estimates.
That may sound comforting, but whether your pocketbook benefits will depend on whether you're in the right state at the right time. On the East Coast, where utilities have pooled power reserves since the 1920s, deregulation included stipulations about reserves utilities had to have on hand. Adequate capacity includes pooled reserves that cover spikes in electricity demand. The reverse is true in California, where deregulation omitted reserve requirements. That encourages utilities to keep as little extra capacity available as possible to handle usage spikes and has made its capacity shortage even more critical.
SPOT MARKETS. One aspect of deregulation that has significantly helped states manage their power supply better is the development of a wholesale power market. That is, utilities can buy power from each other or from any power-generation facility that's selling. Companies such as Enron (ENE), AES (AES), and Dynegy (DYN) have rushed into the market to take advantage of the trading arbitrages in electricity prices, spreading power around at the same time. As much as possible, the feds at FERC are encouraging the use of forward contracts among utilities to ensure adequate power supplies (such contracts are agreements to buy a commodity, in this case, electricity, at a set price on a set date in the future).
The wholesale-power market has spawned an entire industry of power-generation companies that aren't utilities at all, just suppliers to utilities. From 1998 to 1999, the capacity of utilities to produce power actually declined by 6.9%, to 639,143 megawatts, according to the 1999 Electrical Power Annual Report by the EIA. The growth in capacity came from nonutilities, whose total output increased by 64%, to 146,846 megawatts. In 1999, nonutilities generated 18.7% of the U.S. electricity supply, vs. 11.5% the year before.
These nonutility power sources also sell power directly to end users. And big manufacturers and multinationals are once again looking at skirting the middlemen. At the beginning of the 20th century, corporations routinely generated their own power to conduct their businesses. But starting in the 1930s and continuing through the 1960s, large manufacturers ceased doing that because utilities were able to do it better and cheaper.
SOLO POWER PLAYS. Interest in homegrown power rose again during the oil shocks of the 1970s and 1980s, but cheap energy in the 1990s doused the flame one more time. Now it's coming alive again. With the cost of power outages now measured in "network downtime," losing computers to an electric outage can be a catastrophe. So corporations are once again striking out on their own, either building their own small generation facilities or buying forward energy contracts from the cheapest provider. Companies such as Intel (INTC) and Oracle (ORCL) want to be certain their PC screens won't flicker for a nanosecond.
Aside from independent power production, environmentally friendly alternative sources of energy are also increasing in importance. It's the 1970s all over again, with wind, solar, and geothermal power once more thrown into the fray. But the economics of alternative energy have changed markedly this time around.
Already, wind and hydroelectric power are within reach of offering competitive rates. And technologies such as fuel cells hold great promise. Still, widespread adoption of these new generation methods will depend on whether suppliers can provide power on a large scale at a cost at or below that of burning coal, natural gas, and other fossil fuels.
NOT TOO PRETTY. If alternative-fuel technology becomes competitive, watch out. "Fuel cells are the cell phones of the electricity industry," says NARUC's Gray. "Once they are adopted, they will change the economics and structure of the industry forever." But for now, renewable fuels still account for only 4% to 5% of the nation's electricity supply. Coal accounts for 51%, natural gas 14.8%, and nuclear power 19.3%. As the electricity industry becomes more and more market-driven, consumers will ultimately decide whether cleaner or cheaper fuels are better.
Put it all together, and the picture is a patchy mosaic -- still hard on the eyes. Achieving a truly deregulated market for electricity in a country the size of the U.S. appears to be a monumental task -- one that sometimes looks as if it will never be completed.
But not to worry. "Clearly the electricity industry is still in a transition phase," Gray says. "It took 15 to 20 years to restructure telecoms, 10 years to restructure natural-gas markets, and electricity only began its restructuring in earnest in 1997." In the meantime, consumers and businesses are in for a few more years of brownouts, shortages, and volatile prices before supply keeps pace with demand evenly across the country.
By Margaret Popper in New York
Edited by Douglas Harbrecht
businessweek.com |
