Is Deregulation in New York
Worth It?
By Patrick W. O’Hara
January 1999
Deregulation is the greatest issue facing the electric utility industry today. Historically, the federal government has regulated the sale of electricity to businesses, whereas individual states regulated sales to residential consumers. Local utilities generated and transmitted electricity through its own distribution network. Each state had a Public Service Commission that regulated prices that utilities could charge their customers, and carefully scrutinized the basis for large expenditures and frequent rate increases. Under deregulation, electric utility companies split their business into two separate units: generation and transmission. Rate setting is replaced by free market competition, whereby consumers have a choice. Deregulation allows electricity producers to market their power anywhere in the United States. Consumers are billed separately for the electricity and its transmission.
Proponents of deregulations tout the
benefits of increased competition, which they say will force producers of
electricity into lowering prices. Consumers in states that have electric rates
higher than the national average, such as New York, welcome the opportunity for
lower prices. These lower prices are intended to attract and maintain retail
and industrial employers in areas that historically have high-energy costs.
Savings in the residential sector increases disposable income, and stimulates
the economy.
New York State is particularly
vulnerable to outside competitors entering the market as it has higher
electricity rates than the national average. The higher rates are due to
several factors. One of these factors is the cost of labor, which is higher in
New York because of the higher cost of living. The tax structure of federal,
state and local governments also puts a heavy burden on electric utilities --
taxes on both income and property. The need for consistent capacity to meet
energy needs has also caused electric utilities to invest heavily in new
generation plants over the past few years. Additionally, New York and other
Northeastern states are required to abide by several “clean-air” laws from which some midwestern states are exempt.
These and other variables will make it difficult to for New York power
producers to compete in a deregulated market.
There is no dispute that large
consumers will have their rates forced lower as outside “Cherry Pickers”
compete for the large firms willing to contract for the purchase of large
blocks of electricity that do not fluctuate at different times of the day and
night. Having guaranteed daily demand for electricity reduces the potential for
excess capacity, which is one of the greatest expenses to electric power
producers. Taking advantage of the
economies of scale will allow the power producer to become more competitive and
better positioned in the market.
As local producers lose large
customers and begin to have excess capacity, rates among residential customers
will rise significantly as fixed costs are distributed among a smaller customer
base. This will encourage customers to leave the high-priced local company to
seek other power alternatives, thereby increasing the local companies rates
even higher as the customer base continues to shrink. Residential customers may
find that the only opportunity to buy cheaper electricity is to aggregate
through “cooperatives,” which would buy large blocks of electricity and resell
it to members.
Opponents of deregulation say that
the negative effects of competition far outweigh the positive. As outside
companies take over more of the New York state market, local power companies
will be compelled to reposition themselves to remain competitive. In defense,
power companies will be forced to cut costs. The first cost cutting measure
will be to reduce the workforce, increasing unemployment. Programs that have no
short-term benefit to profit, such as energy efficiency and environmental
conservation, will be the first to be eliminated. Companies that have trouble
competing will begin divesting assets in effort to better segment their
business. Other producers may find that stranded costs are too high for
competitive recovery, and may “walk away” from their investments - such as in
the nuclear industry - causing massive governmental bailouts.
Deregulation comes at a cost, and
not just to producers and residential consumers in high price markets. From a
macroeconomic standpoint, there is a fixed amount of electricity available in
the United States market. It has the potential to cause a major market shift
that will cause residential rates to increase for areas that historically have
had low electric rates. As low-cost producers, such as those in the Midwest,
seek to maximize profits by getting the highest price for their electricity
through competition, they are reducing the capacity that would have been
available for their local residential customers. These residential customers
will be forced to seek other alternatives that will most likely carry a higher
cost.
Although proponents of deregulation
acknowledge most of these negatives, they believe the market will stabilize in
five to ten years as active competition subsides. Nevertheless, how will
stabilization occur, or be effective if deregulation causes such a radical
reorganization of the electric utility market? How will plant closures and
divestitures that allow better-positioned larger power producers to grow and
gain market share make the industry more competitive? How does increased
unemployment among the working-class help the economy? Who benefits from new
multi-tier utility distribution networks that include non-producing power
brokers and cooperatives? Who benefits by having to depend on outside
electricity sources?
These and many other serious issues
need to be addressed before full deregulation is implemented in New York.
Fortunately, New York is taking a very conservative approach and has not yet
rushed into restructuring the utility industry. State government and the Public
Service Commission will need to seek ways to encourage equitable competition,
and manage unfair advantages - such as the disparity in the cost of the labor
or clean-air regulations. This may be accomplished through minimum standards
laws or tariffs. Government at all levels will also have to address reductions
in property taxes and corporate income taxes. In the interest of local
preparedness, steps will have to be taken to guarantee a minimum of 15% excess
electric capacity availability from local sources in the event of an emergency
or outage due to long-range transmission failure.
Deregulation will not create big savings
for the average consumer, but rather cause major shifts in the industry. Rate
setting by the PSC will be replaced by state law and local ordinances
regulating interstate trade. Large competitively positioned companies will grow
larger as they buy-out utilities than cannot compete. Consumers will not have
their choice of producers as much as producers will have their choice of
customers. Rates in the industrial setting will decrease, while rates in the
residential setting will increase. Is deregulation worth it? Only the events of
the next few years will tell. However, the last major restructuring involved
the telecommunications industry ten years ago. The significant savings through
competition among long-distance phone companies has not yet been realized by the average consumer.
It is also noteworthy that 60% of the market still belongs to AT&T.