Issues: Oil & Energy

A few months ago, I came upon an implausible photograph that I would never have expected to find outside a history text. It showed a nondescript California street with a line of electric distribution poles marching off into the middle distance. Nothing remarkable there, but a few feet to the left of the line of poles was a parallel line of poles bearing a duplicate distribution wire. The second line was brand new, and it had been built by the Merced Irrigation District to serve long-time customers of the Pacific Gas & Electric Company. The targets of the raid were almost exclusively large commercial and industrial facilities.

Hundreds of miles to the north, a city in the state of Washington faced the prospect of more duplicate lines. The sponsor, Public Utility District No. 1 of Whatcom County, had for five decades maintained electric service for precisely one customer other than itself: a giant oil refinery. It proposed now to extend additional distribution facilities to two nearby industrial customers already served by Puget Sound Energy's grid, and to 2000-2500 other customers within economic distance of the new lines.

In both instances, proponents justified the extension of duplicate facilities in the name of competition, cost savings and customer choice. The rhetoric was that of the competitive values that have driven electric-industry restructuring over most of the past decade. Proponents argued that duplicate facilities would open the way for better and cheaper service. Moreover, according to the Whatcom Public Utility District, "the availability of competitive utilities is critical to attracting and retaining environmentally clean quality industries that provide jobs and economic growth."¹ I do not doubt the sincerity of those views or the good intentions of the proponents.

But others saw it differently. They saw publicly-owned utilities in the act of cherry-picking choice (and very willing) prospects from a neighboring power grid, reducing the neighbor's capacity and motivation to maintain a robust distribution system for all its constituents and adding unnecessarily to America's exploding population of 170 million utility poles.² This behavior invites comparisons to rapacious enterprises dominated by short-term shareholder interests. Yet those responsible are nonprofit institutions drawing on a history of local control and community service.

The duplicate grid advocates are a small and unrepresentative sample of the public power community. There is little risk that the anomalies will become the rule, but careful scrutiny of this false path is important in illuminating the continuing rationale for public power in the face of industry restructuring. Duplicative distribution systems are hostile to public power's core traditions and values, and invocations of competitive models and virtues are helpful primarily to power power's adversaries. A much more compelling mission statement starts with the image of America's hometown electricity company, committed to serving poor and rich alike, helping all customers use electricity more efficiently, and promoting cleaner power sources. The roll of honorable examples is already long and reaches every part of the nation. But even public power's finest have yet to execute urgently needed reforms in the structure of their electricity rates and revenues, which will ensure that promoting the public interest in efficient electricity use doesn't injure the credit rating of the hometown utility.

The Restructuring Challenge

Do we still need public power in a fully electrified nation, with privately owned companies seemingly able and eager to provide service for all? What is government doing providing a commodity service in a competitive marketplace, anyway?

For more than two decades, I have listened as some public power leaders answered these questions with the rhetoric of competition and competitor, drawing on one basic formula: "we're cheaper." This argument grounds public power's fundamental rationale on its capacity to deliver kilowatt-hours that cost less than those supplied by privately owned companies. Few would deny the importance of this performance measure, and public power has a generally strong record in holding down commodity prices for its constituents. Yet this justification by itself leaves public agencies achingly vulnerable to the juggernaut of electric-industry restructuring. Americans are used to relying on markets and for-profit competitors to minimize the cost of their commodities. We have limited tolerance for governmental entities as participants in competitive markets, and even less for the proposition that public ownership is an essential ingredient of cost-minimizing efficiencies in product delivery.

Public power's leadership takes understandable pride in a longstanding institutional commitment to low-cost electricity, but survival in the next century will demand a broader rationale. Fortunately, it's not hard to find.

The Resilient Rationale for Public Power

Electric-industry restructuring does not assume that all elements of this essential service are inherently competitive. Distinctions routinely are made between the generation and grid sectors. Most of the world still views the grid as a "natural monopoly," in that costs are minimized and other public interests best served by having geographically defined grid franchises that operate under price regulation.³ This means that public power need not and should not base its case on the rhetoric of competition; the most important of its functions are performed outside unregulated markets. A few still find this offensive; the Cato Institute, for example, wants to release distribution service to competitive providers without price constraints.⁴ Yet actual experience with alternatives to grid monopoly systems hardly invites imitations.

Consider Georgia: not the Peachtree State, but the former Soviet republic. The electricity grid for the capital, Tbilisi, is in chronic disrepair. The affluent cope by paying for the installation of a second electric line, which provides enough power for one lamp and a television. Those not so fortunate are learning to cope with what the New York Times calls "a 19th century existence of kerosene-fueled space heaters and wood stoves as sources of warmth, hot water and light." According to a recent Times investigation, duplicate distribution lines for the well-to-do are now "[a] common part of the landscape here and in other suffering parts of the former Communist world."⁵

This singularly unappealing model is unlikely to trump America's natural-monopoly rationale for distribution franchises any time soon. As a result, public power's advocates need not feel defensive about any alleged incompatibility of public ownership with competitive values and markets. Public power can continue to focus instead on the public interests with which the monopoly elements of electric service are so palpably entwined.

In at least two significant respects, those public interests offer an obvious role for public agencies. These involve minimizing the environmental consequences of electricity generation, and ensuring that access to this essential service is not allocated solely by ability to pay. Taking the U.S. economy as a whole, electricity produces more than one-third by weight of four major air pollutants, and reliable access during times of extreme heat or cold is quite literally a matter of life and death. Electricity is the largest single contributor to urban ozone, increases in greenhouse-gas concentrations, acid rain, and the obstruction of free-flowing rivers. And absent an enforceable duty to serve all customers, electricity grid operators often could strengthen their balance sheets by systematically avoiding low-income neighborhoods.

Electric distribution companies can make significant public interest contributions by mobilizing systemwide investment in energy efficiency, renewable energy and low-income energy services. Strong efforts of all these types have emerged in jurisdictions like Austin, Eugene, Los Angeles, Osage, Palo Alto, Sacramento, Salem, San Antonio, Santa Clara, Seattle, and Snohomish County. In California, public power collectively proposed and secured enactment of a statutory commitment to match investor-owned distribution systems' public-interest investments, measured as a percentage of total revenues.⁶

For detailed illustrations of the best that public power has to offer in stewardship commitments, consider the Eugene Water & Electric Board (EWEB). In 1998, a national survey concluded that EWEB, on behalf of its 73,000 customers, invested more in energy efficiency than the Southern Company, Entergy, Commonwealth Edison, and American Electric Power combined, which serve more than 12 million accounts.⁷ Today, EWEB sustains dual commitments to invest five percent of its gross revenues in energy efficiency improvements and to add renewable generation equal to 1% of total load in new resource acquisitions each year.⁸ This relatively small distribution company would be on any short list of the global leaders in sustainable energy development.

And new opportunities are emerging for public power, some of which hearken back intriguingly to its origins. Advocacy for public ownership initially reflected concerns that many residential and rural customers would not generate large enough profit margins to interest investor-owned electricity providers. That same issue is resurfacing as retail electricity markets initially deliver disappointingly few options for small electricity users. Public agencies or cooperatives offer one way to aggregate the demand of those who cannot or will not choose a supplier, creating purchasing power comparable to that of the large users who have been the focus of most marketers to date. Given the high transaction costs of enrolling individual subscribers, however, the aggregation function looks promising only with the equivalent of a franchise, in which all who do not choose an alternative supplier in a specified geographic area are assigned by default to a specified aggregator. Montana acknowledged as much in 1999, establishing a statutory basis for default aggregation covering much of the state's residential and small business sector. A nonprofit electricity buying cooperative has been seeking that designation from the state's Public Service Commission.⁹

In a world of regulated monopoly functions with strong environmental and equity dimensions, there is no clear empirical basis for preferring private over public ownership; the two have coexisted productively in the North American electric industry for much of the last century. Neither system appears to have an inherent advantage, and neither can afford the luxury of complacency. Grid franchises are not eternal, and the possibility of new management should serve as a continuing caution to incumbents.

But if the strongest rationale for public power's survival lies in the equity and environmental dimensions of monopoly distribution service, public power is a major loser when its own members act to subvert that justification. If distribution grids are redefined as competitive enterprises, inescapable and corrosive questions will follow regarding the appropriateness of including public agencies among the competitors.

A False Trail: Duplicative Distribution Systems

I doubt if we will find that any method of distribution will be invented that will supplant that which we are using; and if such be the case, we should rather welcome than fear new inventions, feeling that [electric distribution companies] are the most desirable purchasers of any inventions which may lessen the cost of electrical energy to our customers.

Samuel Insull, Address before the Edison Association, September 14, 1897¹⁰

Many still view Samuel Insull as the caricature of a predatory profiteer. But his century-old prophecy about the grid's resilience has been vindicated in two fundamental respects: distribution wires have proved a durable basis for monopoly franchises, both public and private, and technological advances consistently have proved to be grid enhancements rather than grid replacements. Why, then, the sudden emergence of public-power initiatives to bypass functioning distribution grids? The answers turn out to have nothing whatever to do with changes in grid technology.

Whatcom County: Public Utility District #1 of Whatcom County was formed by citizen vote in 1937, with the aim of replacing the county's investor-owned electric company. The project never came to fruition, however, and throughout the rest of the 20th century, the PUD's electricity business never expanded beyond a single oil refinery, which took advantage of its status as a PUD customer to secure an allocation of inexpensive federal hydropower. This did not escape the notice of nearby industrial customers, and over the past decade a few began threatening to install a wire to the PUD and sever their connection with Puget Sound Energy, the local distribution company. To avoid these revenue losses, Puget was forced repeatedly to provide special contracts on favorable terms for these large customers. In the latest iteration of this script, the PUD proposed early in 2000 to build new high voltage power lines and substations to serve two industrial plants, owned by Georgia-Pacific and Bellingham Cold Storage. Whatcom certainly cannot claim any special expertise in grid construction or maintenance; it has no staff to perform these functions, and has always relied on other distribution companies to do so.

One of two unhappy outcomes is wholly predictable here. Either Puget will once again make a deal with the prospective defectors, potentially eroding the revenues available to support its grid, or a few duplicate wires will inflict the same damage without offering the vast majority of Puget's customers any competitive alternative. If the wires go in, Whatcom's purchases of inexpensive federal hydropower for its enlarged industrial clientele will leave less for allocation to the Northwest's residential and small farm constituencies. In either case, a few large industrial plants will benefit at the expense of almost everyone else involved, and the undeserving winners' leverage will come courtesy of public power. For a movement born principally from a desire to serve small customers whom no one else wanted, either alternative is a breathtaking departure from the founders' vision.

California Irrigation Districts: The Whatcom story is being retold on a larger scale in California's Central Valley. There the principals are irrigation districts, led by Modesto, which already have used duplicative but highly selective distribution extensions to wrest some $20 million in revenues from the Pacific Gas & Electric Company. Only about one-tenth of one percent of those revenues represent service to residential customers.¹¹

Modesto's plans for the future are ambitious. The District proposes to extend a largely duplicative grid over 5,500 square miles, covering one-eighth of PG&E's huge Northern California service territory. Modesto foresees no significant environmental impacts, "with the exception of aesthetic effects."¹² PG&E has responded in part by seeking regulatory permission to discount distribution services to customers in the line of fire. At the same time, interests concerned about reliability are pressing for significant new capital investments in the company's distribution system.¹³ Such investments are challenging enough in the face of continuing uncertainties about the future of industry restructuring; an insecure distribution franchise exacerbates the problem, to the manifest disadvantage of the millions of PG&E customers who could never attract the wandering eye of an irrigation district. They have to live with a deteriorating hometown grid, without realistic hope of any alternative. Ironically, Modesto's case for further encroachments on the PG&E system is based in part upon contentions that PG&E's recent reliability performance is poor and getting worse.¹⁴

A backlash is both imminent and predictable. For example, advocates for low-income households are sponsoring legislation in California to restrain the irrigation districts' duplicate grid extensions.¹⁵ And the Modesto Irrigation District has signaled a willingness to open settlement talks with PG&E, which could revive an earlier long-term agreement simply to readjust the boundaries of their respective service territories.

But what some may see as transitory and isolated examples are important in underscoring a much broader point: public power should not continue to ground its existence, let alone its expansion, in the rhetoric of marketplace competition and comparative price advantage. The justifications offered for duplicative distribution are just the latest in a series of efforts to invoke these competitive values in support of public power initiatives; all play directly into the hands of the private interests that yearn for access to public power's customer base, and the ideologues who oppose public-agency involvement in any aspect of the electricity business. There is a much better and less hazardous way forward, and it requires a return to public power's first principles.

Toward a Secure Future for Public Power

If public power overcomes its challenges, as I hope and expect, its historians are likely to view the debate over duplicate distribution as a momentary distraction. Lacking a base in technological or product innovation, this squabble could fizzle without much damage to either the perpetrators or the movement collectively. States can establish secure distribution franchises and adjudicate boundary disputes while continuing to encourage robust competition in generation and related services. And distribution companies can concentrate on what they ought to be doing best: providing reliable, universal service at the lowest possible environmental and economic cost.

To succeed, however, distribution companies will need to get much better at helping their customers get more work out of less electricity. Our collective electricity bill is less than 3% of the gross national product, but for major air pollutants the relative contribution is more than tenfold greater.¹⁶ The environmental challenges that implicate electrical generation include urban and regional smog, fine particles, acid deposition, excessive nutrient loads to important water bodies, toxic mercury emissions, nitrogen saturation of sensitive forest ecosystems, regional haze and greenhouse gas emissions.¹⁷ Even that daunting list is incomplete, given -- for example -- electricity's dominance in debates over disposal of radioactive waste, survival of endangered salmon fisheries, and the preservation of undammed rivers. And its importance on all these counts has grown with a surging market share. The United States saw electricity generation almost double between 1973 and 1998, while petroleum use barely increased and natural gas consumption actually declined.¹⁸

Electricity's carbon dioxide emissions rose more than 15% from 1990-1998, outstripping growth rates in the rest of the economy and putting at severe risk the nation's treaty commitment to help stabilize greenhouse gas concentrations in the atmosphere. Coal-fired plants accounted for almost 90% of the electricity sector's total.¹⁹ Regulatory pressures also are growing to further limit emissions of nitrogen oxides, mercury and sulfur dioxide, even as coal-based generation continues to surge in competitive wholesale markets. Almost all agree that the fastest and cheapest remedial strategy lies in reducing electricity needs by promoting energy efficiency in all sectors. This creates a basic dilemma for public and private power alike as long as distribution revenue recovery continues to hinge, at least in part, on the volume of electricity that travels over distribution wires.

There are two straightforward solutions. One, favored by many in the utility industry, is simply to convert all distribution costs into fixed charges on each meter. But as David Moskovitz has observed, this would mean a radical shift in most current rate structures, creating a large class of net losers whose anticipated unhappiness would deter most publicly accountable decisionmakers from adopting the proposal.²⁰ The better route for public (and private) power is to continue to recover distribution costs as a portion of usage-based charges, but to introduce modest annual adjustments that automatically correct for unexpected fluctuations in electricity use. In other words, if traffic over the wires exceeds or falls short of estimates made at the time rates are set, rates for the next year should be adjusted modestly to compensate. The recovery of distribution costs would then be independent of the total volume of electricity passing over the wires, although customers would continue to be charged on the basis of kilowatt-hour consumption. This is the model that the Oregon Public Utility Commission embraced in 1998, in response to a joint request from utility, governmental, consumer and environmental parties.²¹

Some economists object to this form of distribution cost recovery, on the ground that it sends the wrong economic signal. In their view, since distribution costs are independent of consumption in the short run, the charges that recover these costs should not vary with consumption either. When fixed distribution costs are recovered by raising the cost of kilowatt-hours, customers are being overcharged for those kilowatt-hours and socially beneficial electricity use is being suppressed, the critics say; their preference is to recover the distribution costs instead as fixed monthly charges that do not vary with consumption. A response at the same lofty theoretical level is that distribution costs are extremely sensitive to consumption over longer periods, with sustained growth periodically requiring costly equipment replacements in order to handle the higher volumes safely. That argues for making customers pay higher distribution costs as their electricity consumption grows.²²

However one resolves the theoretical debate, it is difficult to contend seriously that society today is suppressing socially beneficial growth in electricity consumption by imposing excessive charges on its use. The opposite seems far more likely, given the environmental strains already catalogued, and the abundant evidence that pervasive market barriers continue to block energy savings that are much cheaper than additional energy production.²³ We should not make a bad situation worse by reducing customers' rewards for using less electricity, which is precisely what would happen if we raised their fixed charges and cut their usage-based distribution charges by a corresponding amount.

With a combination of usage-based charges and regular true-ups of distribution rates, public power can help ensure that its energy efficiency successes do not undermine its financial health. Aggressive energy efficiency improvements can stabilize and then reduce electricity use with strong and continuing encouragement from the local distribution company. Electricity rates will go up slightly to restore the lost distribution revenue, but the community's electricity bill will drop as cost-effective efficiency eliminates the need to purchase kilowatt-hours that would have cost more. Utilities will distribute less commodity with no corresponding loss of distribution revenue, while customers will benefit from avoiding the economic and environmental costs of unnecessary electricity generation. And public power need not temper enthusiasm for tougher building and appliance efficiency standards with anxiety about cutbacks in the budgets that sustain reliable grids.

Unleashing public power in this way could pay huge dividends for energy efficiency progress. This conclusion rests not on any inherent distribution-company expertise in redesigning buildings and equipment or in delivering efficiency services to their owners. Rather, the potentially decisive contribution of the hometown utility lies in creating much greater local enthusiasm and understanding about efficiency opportunities, which will help the efficiency providers slice into otherwise daunting transaction costs. Utilities are widely trusted sources of information and quality control for customers otherwise disinclined to open their homes and facilities to previously unknown efficiency initiatives. And modest uniform charges on distribution service remain the best way to have all customers contribute to investments that reduce the entire system's environmental and economic costs. While investor-owned systems can do all of this too, public power has the opportunity to demonstrate a comparative advantage in mobilizing public interest and support. Such an advantage is at least potentially to be found in the "local control" values that figure so strongly in the movement's history and ideology.

At the same time, public power can do more to help customers minimize the environmental damage associated with any given level of electricity use. Part of the answer lies in giving distribution customers access to commodity products that include substantial contributions from new sources of renewable energy generation, such as those offered by the Los Angeles Department of Water & Power and the Palo Alto Electric Utility.²⁴ An attractive additional option emerged recently in the Pacific Northwest, where the Bonneville Power Administration initiated a system of rigorous certification for environmentally preferred renewable generation, and dedicated part of the resulting power-sales revenues to a new and wholly independent Bonneville Environmental Foundation (BEF). The enthusiastic involvement of independent environmental groups and several of BPA's public-power customers ensured a successful launch of this venture in 1998; former Senator Mark Hatfield chairs the BEF, which uses donations from sales of the environmentally preferred power to underwrite new fish restoration and renewable energy ventures. In addition to BPA, particular credit here goes to Snohomish PUD, Emerald PUD, Flathead Electric Cooperative, and Orcas Power and Light Company.²⁵

Armed with a strong public-interest record and rationale, public power could open the way for a healthy and altogether legitimate new form of competition for the distribution franchise itself. Distribution's natural monopoly character does not require a permanent incumbency. System managers should be exposed periodically to a formal challenge on the merits of their environmental, equity and efficiency records. But the challenge should embrace the entire geographical franchise, not just those lucky enough to live near a distribution system boundary and electricity-intensive enough to make duplicate connections practical.

Every winner should take on the same duty to serve that the incumbent owes to all within the contested territory, regardless of commercial clout. State legislatures are the proper place to establish the rules for such contests. At regular intervals, let's give elements of both public and private power a chance to offer better distribution service for entire communities or regions, with the final decision driven by those same public-interest values that continue to underpin the franchise itself. This will help ensure that the hometown utility's enduring responsibilities remain in good hands, regardless of external changes in the increasingly competitive commodity markets for electric generation.

Notes

1. Public Utility District No. 1 of Whatcom County, The Power of Choice, p. 17 (2000).

2. See James Salzman, Beyond the Smokestack: Environmental Protection in the Service Industry 47 UCLA Law Review 411, 450 (December 1999).

3. A rather notorious exception is Washington State, which has no tradition of geographical franchises but does allow for regulatory approval of service territory agreements negotiated by distribution providers.

4. Peter Van Doren, The Deregulation of the Electricity Industry: A Primer (Cato Institute: October 6, 1998) (arguing for elimination of all state-granted franchise monopolies).

5. Steve LaVine, In Former Soviet Republic, Bribes Light the Night, New York Times, February 7, 1999.

6. See California Public Utilities Code section 385.

7. J. Coifman, Utility Deregulation a Bust for Energy Efficiency Programs (Environmental Media Services Press Release, October 1, 1998). On the other hand, Commonwealth Edison's subsequent appointment of CEO John Rowe virtually ensured an energy-efficiency renaissance there at least.

8. Interview with Randy Berggren, EWEB General Manager, April 3, 2000 (the energy efficiency commitment is at least five years old, while the renewable energy target was adopted by the EWEB board in 1999); the quotation is from the March 31, 2000 draft of EWEB's "Energy Resource Strategy 2000."

9. The statute, S. 406, was signed into law by Governor Racicot in April 1999; the Montana Electricity Buying Cooperative was incorporated soon after. The ultimate decision on default supplier status rests with the Montana Public Service Commission.

10. Reprinted in Samuel Insull, Central Station Electric Service (1915), at p. 7.

11. Pacific Gas & Electric Co., "PG&E Customers Departed or About to Depart to Modesto ID and Merced ID (as of 3/10/00)".

12. Modesto Irrigation District, Draft Program Environmental Impact Report: M.I.D. Electrical Expansion Program (December 17, 1999), at p. 2-1.

13. See, for example, letter from Senator Byron Sher to Richard Bilas, President, California Public Utilities Commission (December 9, 1999) (identifying proposed reductions in major utility's distribution capital budget, and noting that "energy reliability is a vital issue for the high-technology companies and other constituents in my district" and that "I support a robust distribution infrastructure which incorporates innovative, environmentally sound activities such as energy efficiency improvements and other 'distributed' energy resources to reduce ratepayer costs and improve performance of distribution systems").

14. Memorandum from Chris Mayer, Modesto Irrigation District, to Ralph Cavanagh (April 14, 2000).

15. S.B. 1939 (Alarcon) would restrict the capacity of irrigation districts to offer duplicative service and introduce more searching regulatory scrutiny of such efforts.

16. For a useful review of the downward trend in U.S. electricity costs since the early 1980s, see K. Smith, Electricity Pricing Trends Challenge Conventional Wisdom on Retail Wheeling, Electricity Journal (April 1996), p. 84.

17. Letter to Congressman Edward J. Markey from Mary D. Nichols, Assistant Administrator for Air and Radiation, March 28, 1997, p. 1.

18. U.S. Energy Information Administration, Monthly Energy Review (March 1999). Petroleum consumption increased by 5% over that period, while natural gas was down by 3%. Electricity generation totals are approximate, since EIA data for nonutility generation do not extend back to 1973.

19. U.S. Environmental Protection Agency, Inventory of U.S. Greenhouse Gas Emissions and Sinks: 1990-1998 (Draft: February 2000); Testimony of Daniel Lashof, Senior Scientist, Natural Resources Defense Council, before the Committee on Energy and Natural Resources, United States Senate (March 30, 2000).

20. See David Moskovitz, Profits and Progress Through Distributed Resources (National Association of Regulatory Utility Commissioners: February 2000), p. 22.

21. Public Utility Commission of Oregon, Order No. 98-191 (May 5, 1998) (approving "alternative form of regulation" based on proposal by PacifiCorp, the Oregon Department of Energy, the Citizens Utility Board, the Natural Resources Defense Council, and the Northwest Energy Coalition).

22. For discussion of these issues in a study commissioned recently by the National Association of Regulatory Utility Commissioners, see David Moskovitz, note 21 above.

23. For discussion of these barriers, which obstruct even overwhelmingly cost-effective savings, see, e.g., Mark D. Levine et al., Energy Efficiency Policy and Market Failures and Ralph Cavanagh, What Electricity Prices Can't Deliver, in Annual Review of Energy and the Environment (1995), pp. 519-525 & 535-555. For a very recent empirical demonstration of the economic opportunities associated with intervention to overcome these barriers to cost-effective energy efficiency improvements, see RAND, The Public Benefit of California's Investments in Energy Efficiency (March 2000).

24. As explained in www.greenla.com, LADWP's product includes 100% renewable energy with 20% coming from new sources. Palo Alto launched its Green Pricing Program in April 2000, with 25-100 percent of the product from new renewable resources. Memorandum from Tom Kabat to Ralph Cavanagh, March 9, 2000.

25. The BEF maintains a website at www.BonEnvFdn.org.