1.0 Introduction

Passage of federal Energy Policy Act in 1992 set the stage for a transformation of the nation's electric industry from a regulated monopoly to a competitive market system.

The core of that transformation would expand competition among generating companies at the wholesale level through greater transmission access and participation of new suppliers. It would also create competition for customers at the retail level through an opening of the distribution systems to power marketers. For many of the nation's electric utilities the shift to competition implies a corporate and operational restructuring into separate distribution, transmission, and generation functions.

Following passage of the Energy Policy Act, the Federal Energy Regulatory Commission established rules to enhance competition at the wholesale level and encouraged states to establish laws and rules that would facilitate competition at the retail level. Twenty-four states have undertaken such action to establish retail competition. Another 24 states are studying the issue to determine possible impacts and options. States with high-cost electricity have taken early and aggressive action in the belief that competition may succeed in reducing costs and rates where regulation has failed to do so. Low-cost states, however, have expressed concern that their costs may rise as a result of establishing competitive retail markets for electric power.

Nebraska has long been recognized to have some of the lowest electric rates in the nation. In 1997 Nebraska was 6 th lowest in the nation for commercial consumers; 7 th lowest for industrial consumers; and 9th lowest for residential consumers. Due to the weighting of various customer mixes, Nebraska was 11 th lowest for an average of all customer classes. (See Map M1-1 following for the 1997 average and Maps M3-1, M3-2, M3-3 in Chapter 3 for each of the customer classes.)

Nebraska is also recognized as the only state in which all consumers are served by consumer-owned municipal systems, public power districts and rural cooperatives whose core principle is delivering electricity as a non-profit service.

Although one may debate whether any change is warranted, the state's electric systems are interconnected with other utilities in the region through regional power grids-the Mid-Continent Area Power Pool and the Western Systems Coordinating Council. Changes in federal requirements, changes in the regional markets, and changes in utilities with whom the Nebraska systems conduct business, as well as the desire of some customer segments, require that the state examine and address the transformation taking place.

While expansion of wholesale markets is underway, Congress has currently left the issue of retail competition up to the states to determine. Proposed federal legislation would allow any state to develop its own plan to prepare for competition in the electric industry. Nebraska has an opportunity to develop a plan to address its unique situation. As Nebraska citizens and policy-makers consider a plan for the future of their electric utilities, it is important to understand the context and key issues concerning deregulation and restructuring of infrastructure industries.

For the purpose of providing a broad context, Chapter One examines the background of restructuring of the electric utility industry; deregulation of other infrastructure industries in the United States, including impacts on Nebraska; electric utility industry restructuring in other nations; and proposed changes at the federal level to restructure the U.S. electric utility industry.

Subsequent chapters provide a comprehensive overview of completed and anticipated developments in wholesale and retail electric competition and possible impacts and alternatives for Nebraska's consumer-owned electric systems. The result is a proposed framework for development of Nebraska's plan to address electric utility competition and restructuring.

1.1 Background on Electric Industry Restructuring

1.1.1 Electric Utility Industry 1935-1995

For the last 60 years, the electric utility industry in the United States has consisted primarily of vertically integrated electric utilities which include generation, transmission and distribution functions. Nationally, it is a mixed system of private investor-owned companies, and federal, state, and local consumer-owned facilities. In 1995 there were 244 investor-owned private electric utilities providing power to 75 percent of the nation's consumers; 931 rural electric cooperatives providing power to 11 percent of the nation's consumers; and 2,020 public power systems providing power to nearly 14 percent of the nation's consumers. Although some public power systems and rural cooperatives own generating plants, most function only as distribution systems. In addition to these utilities directly supplying consumers at the retail level, federal power agencies and independent power producers generate and sell power at the wholesale level.

The nation's power supply and distribution companies are organized into 26 power supply regions operating as part of three major grids of transmission lines, one east of the Rocky Mountains, one to the west, and one in the Texas region. They are also organized into nine regional electric reliability councils. Nebraska's electric systems in the eastern two-thirds of the state are part of the Mid-Continent Area Power Pool (MAPP) which covers a geographic region including South Dakota, North Dakota, Montana, Minnesota, western Wisconsin, Iowa and parts of Saskatchewan and Manitoba. Nebraska electric systems in the western part of the state are members of the Western Systems Coordinating Council (WSCC).

The organization and structure of the nation's electric industry that evolved during the 1935-1995 period resulted from a previous restructuring of the industry prompted by the federal Public Utility Holding Company Act of 1935 (PUHCA). The Holding Company Act broke up 16 major utility holding companies, which had come to control 75 percent of the nation's power output by the late 1920s. It addressed financial and market power abuses of the utility holding companies by creating barriers to limit market power and the potential for future abuse. This had specific significance for Nebraska. Several of these holding companies owned subsidiaries in Nebraska which had bought out more than one-third of the state's municipal electric systems, prevented the formation of rural electric cooperatives, and also hampered development and management of irrigation resources. Statewide initiatives and laws passed in Nebraska in the 1930s, complementary to the federal Holding Company Act, fostered a movement to buy out these holding company subsidiaries and structured the consumer-owned electric industry in the state today.

The state's 121 municipal electric systems, 31 public power districts and 11 rural electric cooperatives were organized as city departments, by petition, or by incorporation, respectively. Local boards of elected or appointed representatives govern these agencies. The municipal systems are regulated by the city council or village board (12 have boards appointed by the city council and mayor). These boards set rates, oversee quality of service, and make financing and budget decisions. The boards often operate in coordination with the city or village council. Major policy questions can be brought to voters as referenda questions in general elections.

Each public power district is governed by an elected board of directors who serve for a term of six years, with no limitation on the number of terms an individual may serve. The boards must have at least five members and no more than 21. Similar to municipal electric boards, the public power district directors oversee decisions on budgets, power supply, rates, and other policies. Board membership is not a full time job. Each board appoints a chief executive officer to manage the district's affairs as directed by the board.

Rural distribution cooperatives are governed by similar boards of directors elected by the member/consumers at annual meetings. Candidates do not appear on the general election ballot like public power district candidates. Because the rural distribution cooperatives are organized under laws for non-profit organizations they are not subject to the same statutory requirements as municipal and public power district systems.

The state's municipal systems, public power districts and rural electric cooperatives are further organized by voluntary coordinating bodies and associations such as the Nebraska Power Association, the Nebraska Rural Electric Association, and the Municipal Energy Agency of Nebraska. They also utilize cooperative and contractual relationships to gain operational efficiencies. At the wholesale level, these systems participate in a power supply market that operates as a voluntary contractual arrangement between interconnected utilities to facilitate reserve-sharing and to market surplus capacity and energy coordination.

Local franchises or leases are the base level of organization for service territories. The Power Review Board has on file some 395 retail service territory agreements in the state. Nebraska Public Power District leases and operates distribution systems in 207 municipalities. Other municipalities franchise their service territory to public power districts, rural cooperatives, or other municipal systems.

Nebraska's locally-directed electric systems face potential changes in organization, principles, operations and governance in order to address expanded wholesale competition and new retail competition. Cooperative arrangements and principles of non-discriminatory, non-profit power delivery and local control utilized by the Nebraska systems are not compatible with the principles of a competitive market which are focused on service to selected high-use customers or selected groups of customers and market-based pricing. Competitive pressures could undermine cooperative arrangements utilized by Nebraska systems, unless they committed to methods to preserve those arrangements. Increased competitive pressure to alter non-profit, cost-of service pricing to market-based pricing could also raise Nebraska's wholesale and retail power costs.

Market pressures and the perception of market pressures are already engendering consideration of certain changes in response to events happening nationally and in the MAPP and WSCC regions.

1.1.2 Changes in the Electric Utility Industry After the Energy Policy Act of 1992

The transition now going on nationally and in the MAPP and WSCC regions was set in motion by passage of federal laws in 1978 and 1992, and subsequent federal regulatory actions.

Deregulation of the electric industry began with the passage of the Public Utility Regulatory Policies Act in 1978. This established the basis for independent, competitive companies to enter the power generation business at the wholesale level. During the 1980s federal regulatory efforts sought to enhance access to transmission lines for these new generators and to help establish competitive wholesale markets. In 1992, passage of the Energy Policy Act (EPAct) mandated broad open access to transmission lines and encouraged greater competition in generation. The EPAct set the stage for the most significant change in the electric utility industry since implementation of the Public Utility Holding Company Act of 1935.

The Energy Policy Act contains a total of thirty sections, including Title VII- Electricity. The primary purposes of the Electricity Title are to open and expand the wholesale transmission market and to encourage the development of new competitive generating companies, in particular to provide wholesale marketing opportunities for Independent Power Producers that were defined as Exempt Wholesale Generators. It did not mandate retail competition and the Federal Energy Regulatory Commission (FERC) was specifically prevented from ordering retail competition. However, FERC efforts to expand wholesale markets has been accompanied by encouragement of states to establish competitive retail markets. The first major step in expanding wholesale markets and setting up retail competition is developing non-discriminatory transmission access.

In April 1996, FERC issued landmark orders 888 and 889 to implement open access to jurisdictional high voltage electric transmission systems. These orders also set in place the process to develop independent system operator (ISO) organizations and independent transmission companies (commonly known as Transcos or Independent Transmission Companies). The central issue is to create non-discriminatory open access for all suppliers and elimination of the ability of transmission owners to use the lines and facilities for their own strategic purposes.

By January 1999, FERC had approved five ISO's: California, Pennsylvania-New Jersey-Maryland (PJM), Midwest (conditional), New York and New England. In addition, the Texas Public Utility Commission had approved an ISO for operation within the Reliability Council of Texas. Numerous discussions concerning ISOs, Regional Transmission Organizations (RTOs) and Transcos for other regions are underway. (See Chapter 5 for further discussion of ISOs, RTOs and Transcos.)

The formation of an ISO for the MAPP region, including Nebraska, has been underway since 1996. MAPP has restructured its organization to include independent power suppliers, state regulators, and power marketers. The organization recently agreed to a regional transmission tariff which it will submit to FERC for approval. Further work is being conducted on formation of a formal ISO, which failed to gain approval of the organization's members in 1998. Discussions are also underway for formation of an alternative private transmission company. Major transmission-owning systems in Nebraska have been active in the MAPP ISO and regional Transco discussions.

In addition, to create greater operational efficiencies, the Nebraska Public Power District has launched a plan, "Retail Realignment" to have existing rural systems take on customers in certain towns for which NPPD provides wholesale power. NPPD has also joined with other large out-of-state public power systems that intend to market wholesale power supplies. The Omaha Public Power District has examined the possibility of forming an alliance with a private company to construct new generating plants, and has considered participation in an Iowa retail competition pilot project. The Lincoln Electric System is selling wholesale power to an organization marketing to retail chain stores in Missouri.

For Nebraska and other states in the region, events to date can be characterized by efforts to form regional ISOs and transmission companies, expansion of the wholesale energy and transmission markets, upward price volatility in new wholesale markets, major utility mergers and reorganizations and the emergence of new competitive energy service companies, retail competition pilots, and limited retail markets opening in several states. In summary, for an industry that has relied upon joint planning of transmission and generation and relatively stable planning horizons, the transition to competition has created general uncertainty concerning the future.

In order to address the broad long term changes ahead, it is important to understand the key forces driving electric industry restructuring, experience with deregulation in other infrastructure industries, and changes proposed at the federal level and in other states.1.1.3 Forces Driving Electric Industry Restructuring

Electric industry restructuring can be attributed to several key factors. It has generally been recognized that once transmission access began to open up and allow more wholesale transactions in the early 1990s, large industrial users and competitive wholesale suppliers in high-cost states pressed for access to develop competitive contracts at the retail level. Supporting these efforts were advances in generating plant and transmission technologies, electricity price disparities between states and regions, and political support for the philosophy of deregulation. Advances in Technology

Beginning in the 1970's, through the Public Utility Regulatory Policies Act (PURPA) of 1978 and other initiatives, the federal government embarked on a long-term effort to reduce dependence upon foreign oil through development of new technologies for meeting electrical demands, including renewable resources, co-generation, conservation, and demand-side management. Generating plants fired by natural gas, in particular, have encouraged hopes to reduce power costs.

The availability of combustion turbines and low-cost natural gas has allowed participation in the competitive wholesale market by more players with much lower capital investment risk compared to building large base-load coal and nuclear generating stations. Combustion turbines can now be acquired with shorter planning intervals and in flexible sizes ranging from 10 megawatt to over 120 megawatt units.

In the future, fuel cells, micro turbines, wind machines and other generation that may be installed by customers, or in small interconnected increments by the utility, may bypass conventional transmission to allow distributed utility or customer-owned generation arrangements.

In addition to changes in generation technology, the expansion of the U.S. high-voltage transmission grid in the 1970s and 1980s, with the assistance of digital electronic protective relays and control systems, set the stage for expansion of the wholesale electricity market. At the retail level, advances in transmission technology also allowed the possibility of multiple buyers and sellers utilizing the transmission grid.

As competition evolves in the electricity industry, market forces could create additional new technologies currently unforeseen as well as marketer packages of combined energy services (i.e. natural gas and electricity), or combined "wires" services including telecommunications, Internet, and cable television, or even more diverse packages including home security and lawn services. Economics Factors Creating Opportunity for Lower Costs

Among the initial market forces prompting competition, are the high cost of electricity production in many states and regions and comparatively lower costs in other states and regions. Notable are the higher levels of electricity prices and costs in California and the New England states. Among the factors creating these high costs are:

dependence upon oil-fired generating plants;
above-cost PURPA-related contract proliferation,
and high-cost nuclear plants.

By contrast, lower electricity prices in Western and Mid-Western states have been created by factors including: availability of low sulfur coal; competitive fuel transportation service; greater prevalence of non-profit cost of service consumer-owned systems; availability of hydro and federal preference power; and relative lack of high cost PURPA-related contracts.

The resulting difference in power prices, while not a major concern for residential and small commercial customers, has become important to large industrial and commercial customers such as General Motors and Wal-Mart who are in a position to observe price differences on a national scale. Large retail electricity end-users have applied pressure for retail electricity competition on an individual basis and collectively as members of trade associations such as Electricity Consumers of America (ELCON). The majority of this pressure has been applied to federal legislation and for retail competition in high-cost states. This pressure has increased as wholesale markets have expanded with the participation of more suppliers and marketers, and has typically moved among neighboring states.

As wholesale markets expand, there is an expectation that the price of wholesale power will decline from previous levels in high-cost states and remain stable or slightly increase in low-cost states as the market prices reflect demand and as market risk is incorporated into price. However, early experience shows a high level of volatility in these markets and an increase, rather than a decrease, in wholesale prices of high-cost states. Recent studies conducted in low-cost states have indicated the potential for substantial increases in power prices. Other national studies, which will be discussed later in this report, indicate conflicting results as to whether Nebraska's consumers would experience price increases or decreases as a result of retail competition.

The opportunity for a low-cost state's generators to sell into the wholesale market can create pressure on low electric rates, depending upon the extent to which proceeds from these sales are returned to maintain or reduce current retail electricity prices. Of special significance and concern will be the extent to which a low-cost state's generating facilities are used to sell to customers outside the state of the detriment to electric rates within the state. Political Support for Philosophy of Deregulation

Expectations concerning lower costs from competitive markets are based on the assumption that market forces can bring about efficiencies and reduce costs better than a regulated market system.

Comparisons are often made between efforts to establish competitive retail markets in the electric industry, and deregulation and competition that is evolving in other infrastructure industries such as airlines, telecommunications, and natural gas. The electric industry is often viewed as the last major infrastructure industry to be deregulated.

The magnitude of the changes involved in creation of competitive markets and restructuring of electric companies dwarfs all other deregulation. No other industry approaches the complexity of issues and the amount of capital in transition. Because of the differences in each industry, great care must be taken in attempts to project parallel results.

1.2 Deregulation of Other Infrastructure Industries in the U.S.

During the last two decades, deregulation of the major transportation and utility industries was brought about in part by the following deregulation initiatives:

  • Natural Gas Policy Act of 1978 and FERC Orders
  • Airline Deregulation Act of 1978
  • Motor Carrier Reform Act of 1980
  • Staggers Rail Act of 1980
  • Telecommunications Act of 1996 and Court Ordered Divestiture

While direct comparisons to the electric industry are limited at best, experience in the deregulation of these industries offers lessons that may prove useful.

1.2.1 Airlines

The airline industry was deregulated with passage of the Airline Deregulation Act of 1978. Prior to deregulation, eight major carriers dominated the airline industry. In 1999, six of those carriers remain in service. With the departure of Pan Am and Eastern, USAir and Southwest entered the top eight. Following deregulation there was an initial surge in competitors with a subsequent shake-out in the industry to concentrate the number of carriers into hub and spoke systems with domination at hub airports by a single airline such as TWA in St. Louis, Northwest in Minneapolis, and American in Dallas.

The deregulation of the airline industry was driven by dissatisfaction with high average fares sustained above competitive levels, the difficulty of entry of new carriers, and subsidies of low volume, short distance routes by long distance, high volume service. Although deregulation has brought about a reduction in average fares and an increase in volume, problems exist in reduction in service to small communities, and anti-competitive practices. Following a two-year investigation, the U.S. Justice Department has charged American Airlines, the world's second-ranking air carrier, with monopolizing air routes and driving out discount competitors. The Justice Department is also investigating United Airlines and Northwest Airlines for similar practices.

For Nebraskans, airline deregulation amply demonstrates the "winners and losers" nature of establishing competitive markets.

Deregulation advocates often point to rising airline traffic statistics and declining airfare trends (measured on an average cents per mile basis) as evidence of the efficiencies gained via deregulation. Often lost in the discussion are questions regarding access to air service in smaller communities, price disparities between certain short haul versus long haul trips and the market dominance of specific air carriers in selected markets.

On a statewide basis, the number of passengers boarding commercial flights (Enplanements) has risen nearly 60 percent over the past twenty years. However this statistic masks the fact that enplanements are currently not possible in places like Columbus or Sidney due to the loss of all commercial air service in these cities. Prior to deregulation, more than 5,000 passengers boarded commercial flights in these communities each year.

CHART 1-1 - Change in Enplanements 1978-1996

Prior to deregulation, more than 130,000 passengers boarded commercial flights annually in Nebraska's small cities. Today that figure is less than 45,000 passengers and falling. Indeed, were it not for Congressional appropriations to a federal subsidy program.

1.2.3 Telecommunications

The deregulation of the telecommunications industry began in the 1970's as MCI struggled with AT&T and the Federal Communications Commission to gain access to long distance telephone service utilizing microwave technology. Deregulation was imposed in part by the courts beginning in 1984 and finalized with the Telecommunications Act of 1996. In the case of telecommunications deregulation and divestiture, the introduction of competition has not led to the downfall of AT&T and has opened opportunities for many new technologies and market participants.

Difficulties remain in the telecommunications industry concerning responsibilities for access charges, universal service and the shifting of cost responsibility from the long distance customer to the local service customer. Additionally, there is considerable concern over shifting funds from the regulated portion of the business to the competitive side and the resultant decline in repair service response. These issues support the position of those advocating the retention of some regulation to oversee access and service issues until there are alternatives to local telephone service, which will provide the market discipline required to improve such service.

The communications industry has prospered under deregulation. AT&T lost nearly 40 percent of its long distance customers to MCI and others following divestiture and FCC orders introducing competition in the long distance service. Court ordered divestiture and FCC regulatory actions started the deregulation process with the breakup of AT&T divesting the Regional Bell Operating Companies (RBOC's). AT&T is now making the full circle with plans to get into the local telephone business. Competition did reduce overall costs and prices, however local exchange telephone rates absorbed the access charges originally charged to the long distance service.

The impact of telecommunications deregulation on Nebraska is similar to experiences in many other states. Benefits include long distance competition and technology growth. The challenge for Nebraska has been the delivery of the benefits to all consumers in the state in a timely manner, recognizing that urban areas usually benefit

from technological innovation more rapidly than rural areas because of customer density and related factors. There is also a problem indicated by a rise in complaints and increasing costs for residential service.

CHART 1-2 Telephone Complaints in Nebraska 1987-1998

As shown in Chart 1-2, the number of complaints filed annually with the Nebraska Public Service Commission has increased substantially over the past decade. Most of these are not service related but rather are associated with unethical practices of the new entrants in the long distance markets. Complaints associated with the practice of "slamming" (the unauthorized switching of one's long distance service) are increasing rapidly.

Local residential telephone rates are now starting to rise. Chart 1-3 shows the pattern of local residential and business telephone and displays that on average, local residential rates are rising faster than business rates. In Lincoln, local residential rates are up by more than 30 percent while business rates have actually declined by about 19 percent since passage of the 1996 Communications Act.

CHART 1-3 Local Telephone Rate Changes 1996-1998


While local phone rates in rural Nebraska are still considerably less expensive than those of the urban areas, there is cause for concern. Under prior telecommunications policy, federal funds collected from telephone companies are distributed as a subsidy to local telephone companies to equalize the cost of local service particularly in rural areas. The Federal Communications Commission (FCC) is now considering revisions to the policy that could have profound effects on large, sparsely populated states like Nebraska. Some local telephone executives in these areas predict a doubling of local telephone rates. The trend of the 1996-1998 period would seem to add credence to this view.

Many Nebraska communities do not yet have comparable communications services with those offered in the larger urban markets. One industry analyst has concluded that although rural Americans are active participants in the "information age" communications technologies, "the liability of geographic isolation which has historically plagued rural areas still exists." This observation is supported by the experience in states such as Pennsylvania, where broadband services were developed for major urban areas, but not for rural areas.

1.2.5  Natural Gas

Competition in the natural gas industry was initiated with the Natural Gas Policy Act of 1978 and subsequent orders issued by the Federal Energy Regulatory Commission. Deregulation of the natural gas industry has progressed for federally-regulated wellhead and transport pipelines. However, retail competition at the local distribution company level is far behind. Service to large commercial and industrial end-users is in place in most states, but competition has yet to reach down to small commercial and residential consumers in most areas.

While there are vast differences between natural gas and electricity (natural gas can be stored, for example) the regulatory orders on gas pipelines and wellheads and the deregulation of natural gas pricing is quite comparable to FERC Orders 888 and 889 on electric utility competition. The general pattern of utilizing regulatory orders to restructure the natural gas industry by FERC are being applied to the electric utility restructuring process.

Other similarities are also apparent. For example transition costs in natural gas may have been overstated initially because much of the cost was already being paid by the end-users. Deregulation accelerated the payment of those costs and unfortunately for residential and small commercial customers, large industrials avoided much of the transition cost through by-pass of local systems. Despite the level of these costs, benefits to consumers have exceeded transition costs, although transition to customer choice for residential and small commercial customers still lags behind opportunities for larger customers. At a structural level, the top five gas marketers dominate 60 percent of the gas market, and new market structures have emerged that include marketing hubs and risk management features, similar to what is now emerging for electric utilities.

Nebraska's experience with natural gas competition is just emerging. Unlike other states, local governmental bodies set Nebraska's retail natural gas rates, not by a state utility commission. Retail customer choice is now being offered in certain Nebraska natural gas markets but it would be premature to assess the results at this stage. Nevertheless, natural gas deregulation at the producer wellhead and open access of the transportation sector are now well established nationally and some preliminary findings of the impact of these efforts on the state of Nebraska are possible.

Gas pricing data for the state of Nebraska as collected and published by the U.S. Department of Energy show that nominal gas prices for all consumers trended downward in the mid 1980s but have edged up again in the 1990s-generally in concert with national pricing trends. However, the gap or percentage markup of retail rates for residential customers over the city gate price has widened substantially over the past ten years while rates to industrial customers seem to more closely track city gate prices.

Similar to the experience in other states, this data suggests that it is the large industrial customers in Nebraska who have reaped the greatest rewards to date from natural gas deregulation while the smaller residential and commercial customers continue to pay higher rates relative to the city gate price. However, this situation may change under the new competitive gas program opened in the state in June 1998.

In December 1997, KN took a broad approach to encourage interest in "choice" in the natural gas arena. According to a federal Government Accounting Office (GAO) report that reviewed an early look at retail gas deregulation in 16 states, the KN Choice program showed 70 percent of eligible Nebraskans (more than 57,000 customers) mailed in ballots (selection forms).

An interlocal organization of more than 60 communities called PACE (Public Alliance for Community Energy) was specifically formed to ensure that Nebraskans had a choice under KN's Choice competitive supply program. PACE was the only significant competition to the KN affiliates. In winning more than 25 percent of all participants and almost 20 percent of all eligible customers, PACE outperformed the 43 competitive gas supply programs examined by the GAO report.

The GAO report also states that overall, about 4 percent of eligible residential and small commercial customers have selected competitive gas suppliers. Percentages vary widely among programs, from lows of zero percent in New Mexico and one-half percent in California to 50 percent in Wyoming (6,000 sign-ups) and 70 percent in Nebraska (57,400 sign-ups).

1.2.6 Summary of Deregulation in Other Infrastructure Industries

The results of deregulation of other infrastructure industries are mixed at best. As seen in telecommunications and natural gas, much of the competitive structure remains to be put in place for small commercial and residential consumers. There have clearly been changes in structure of the industries, and technological advances have been fostered, but this must be weighed against the "winners-and-losers" experience at the local level, and corporate consolidations that may undermine viable competition.

General findings that may be applied to the electric industry from the experience in other infrastructure industries: 1) small commercial and residential consumers and those in rural areas face questionable benefits from deregulated markets; 2) it will take time for a competitive system to evolve to serve all consumers; 3) technological advances and new packages of services may be anticipated; 4) prices may not decline as anticipated; 5) greater and not less regulatory oversight may be required; 6) in particular, market power restrictions and regulatory oversight will be needed to prevent anti-competitive behavior.

In addition to the U.S. experience in deregulating and restructuring key infrastructure industries, such general findings are supported by experience of deregulation and restructuring the electric industry in other nations that began in advance of the U.S.

1.3 Restructuring of the Electric Industry in Other Nations

Electric utility industry restructuring and the introduction of competitive markets in the U.S. have been proceeded by deregulation and restructuring of the electric industries of other nations. Restructuring of the industry has occurred in Australia, New Zealand, Norway, and the United Kingdom (U.K.). Experience in the U.K., in particular, may provide useful perspective because of the many concepts imported to the U.S. restructuring efforts.

1.3.1 Restructuring in the United Kingdom

The electricity industry in the U.K prior to restructuring and privatization consisted of the Central Electricity Generating Board (CEGB) for generation and transmission and 12 regional distribution companies known as area boards. The area boards purchased power from the CEGB under a tariff that was set by the CEGB, which was subject to governmental economic policy. The government influence was a large factor in such economic issues such as continued purchase of high cost coal from the national coal organization and the support of high cost nuclear and R&D programs.

It could be said that during government ownership, electric reliability was more than adequate, however it could also be observed that this reliability came at a price that included over-staffing and overbuilt electrical systems.

Electricity rates prior to restructuring and privatization were high but not out of line with other European countries.

The U.K. began restructuring and privatizing its electric industry during the tenure of Margaret Thatcher. The process started with The Electricity Act of 1989, which set out to privatize the industry, operated primarily by the central government. The Central Electricity Generating Board (CEGB) was divided into four separate organizations. These included two generating companies, one Transmission Company, and the distribution network consisting of the incumbent 12 regional boards, all of which were ultimately privatized. Non-nuclear generating plants were sold to private entities, and nuclear plants were shut down or placed on the market later. Aside from the political agenda for privatization, other major forces in the transition were efforts to obtain proceeds for the national treasury, to lessen dependence on high-cost coal, and to address problems with nuclear plants.

What resulted was profound impact on the British coal industry and reduced coal prices and mining costs. There was also an improvement in nuclear plant generating costs and an unanticipated "Rush-to-Gas" following privatization involving projects with combined cycle combustion turbine technology. Consumer prices went down, but the privatized generation, transmission and distribution companies accumulated windfall profits. This was due in part to the fact that estimated privatized operating costs were initially overstated and prices were maintained according to those estimates while actual costs declined with the introduction of lower cost generating technologies. Oxford economist George Yarrow developed analyses showing prices would have gone done even more on their own due to the decrease in fuel prices.

In addition to high estimates of operating costs, most of the wholesale power transactions were bilateral, with generating companies retaining monopoly power. This reflected a partial failure of the expected competitive generating market mechanism. With only two principal generators, the previous government monopoly became a private duopoly. In February 1999, the UK's new head regulator, Callum McCarthy accused generators of "gaming" the system and overcharging customers nearly $150 million in the month of December alone. Prices dropped 29 percent following his accusation.

At the local level, many large customers received price reductions in the competitive environment. However, the residential consumers began to receive competitive access only in early 1998. This residential access is incomplete and necessary metering is not in place. It remains to be seen when competitive benefits will accrue to this customer class.

1.3.2  Restructuring in Other Nations

While the experiences in the U.K. are particularly instructive for the U.S. because of the import of concepts, significant electric industry restructuring is occurring in many other countries on several continents. In all nations, electric industry restructuring is still a work-in-progress.

The Scandinavian countries, Australia and New Zealand are each involved in making generation more competitive and ensuring equitable and efficient transmission access. As in the U.S., their efforts include developing new power exchange and transmission institutions, wrestling with pricing and ancillary service and secondary market matters, putting in place new regulatory protections, and expanding competition at the retail level. For each country, policy choices must be tailored to their own conditions: geography, capacity needs, political environment, and whether the industry was centrally owned and planned as a cost-of-service operation, or as a diverse public and private enterprise.

One common factor they have all assumed, is that for competition to work, transmission must be independent from other commercial market interests. Because transmission grids in these countries have typically been in centralized public hands, rather than the patchwork of private and public interests in the U.S., the effort to establish transmission independence is a more straightforward task.

In the U.K., privatization and establishment of competitive markets has required substantial regulation and the need for on-going regulatory oversight. Privatization of the electricity industry by the government in the U.K. in fact was accompanied by a major extension of economic regulation.

In general electric industry restructuring in other nations indicates that:

1) expanded wholesale competition does not necessarily equate to lower cost power prices,
2) retail competition does not assure equal access for all customers and broad-based "customer choice",
3) transitions to competitive markets will require on-going legislative and regulatory involvement and are likely to take a decade or more to mature.

1.4 Proposed Changes to Restructure the U.S. Electric Utility Industry

As noted earlier, electric industry competition and restructuring in the U.S. began with passage of the Public Utility Regulatory Policies Act in 1978, and was expanded by the Energy Policy Act of 1992 and subsequent regulatory orders by the Federal Energy Regulatory Commission. Federal actions addressing issues in the wholesale market have prompted activity at the state level on retail competition. These actions are on-going.

Issues addressed by proposed federal legislation that hold impacts for the Nebraska electric systems include:

Repeal of the Public Utility Holding Company Act of 1935: Passage of the Public Utility Holding Company Act in 1935 mandated the breakup of the major holding companies dominating electric generation and supply nationally. The passage of the act restructured the electric utility industry into its current form. It allowed continued holding company operation only under strict terms and conditions. For Nebraska this broke the political influence of these companies and set the stage for purchase of their operations by Consumers Public Power District in the latter 1930's and the Omaha Public Power District in the mid 1940's.

Since the passage of the act in 1935, private electric companies have mounted periodic efforts to amend or repeal PUHCA. Repeal of the act is part of restructuring legislation being proposed. This is especially significant in view of amendments that have been made to the act in recent years and the wave of utility mergers and formation of new electric holding companies currently underway. Critics of the act believe it to be outdated and an obstacle to competition. Those opposing repeal believe that premature removal of restrictions contained in the act could undermine fledgling competitive markets by allowing a few large dominant companies to gain market power. Repeal opponents urge that amendment of PUHCA be viewed as part of comprehensive legislation on industry deregulation and restructuring, and not as independent legislation.

For Nebraska, repeal of the Holding Company Act poses possible pressures from new holding companies with combined service operations and an existing presence in the state through other services. (See Chapter 2)

Merger and Market Power Restrictions: Concerns about concentration of ownership and control of generation and transmission and distribution systems, as well as combined service companies, are paramount issues at the federal level. Such concentration of ownership could undermine fledgling competition. The primary method of addressing increased pressures from new holding companies is through merger and market power restrictions. FERC currently has limited authority to condition mergers. Various federal legislative proposals have suggested that providing the FERC with expanded oversight authority on utility acquisition and mergers would safeguard against undue market power. Public power, rural cooperative, and consumer organizations have urged FERC to declare a two-year moratorium on mergers that would create customer groups greater than one million while assessing the types of restrictions needed.

Sale of the Power Marketing Administrations: Repeated proposals have surfaced to sell off the federal Power Marketing Administrations. Proponents argue that privatization of the Bureau of Reclamation and Army Corps of Engineer facilities of the Southeastern, Southwestern, and Western Area power marketing administrations could provide as much as $6.6 billion to federal coffers. Opponents have expressed concern that if the PMAs were divested, areas served by consumer-owned systems receiving preference power could be significantly harmed by increases in the price of wholesale power. Impacts on water management and irrigation programs are also concerns of opponents.

Nebraska systems purchase approximately 10 percent of their energy from the hydro plants of the Western Area Power Administration.

Level Playing Field Issues: Various bills introduced in Congress have addressed perceived competitive advantages of public power systems or private electric utilities. Private electric utilities have attacked public power access to tax-exempt financing and public power and rural electric cooperative access to federal preference power such as Nebraska's power from the Western Area Power Administration. Private companies have also attacked the authority of public power systems to engage in telecommunications and other "wires" services. Public power systems counter that, private power companies have also utilized $37 billion in tax-exempt financing, enjoy more than $57 billion in deferred tax payments, and should not limit competition and the opportunities for consumer benefits in other wires services. The outcome of legislation in this area is vitally important for decisions pertaining to public power participation in both wholesale and retail electricity competition.

Private Use Restrictions: This is a very important tax-related subset of the "level playing field" issues. Facilities developed with tax-exempt funding such as transmission facilities and generating plants face Internal Revenue Service restrictions that do not allow for, or limit, private use of those facilities. Given FERC's efforts to open up all transmission, public power systems are put in a position of violating their bond covenants and losing tax-exempt financing if the use of those facilities by private power companies exceeds the restrictions. Opponents of public power want to eliminate all tax-exempt financing. However, a number of Congressional bills have proposed to remedy this situation by revising IRS rules so that tax exempt financing may be utilized for transmission and distribution facilities, but not for generating plants that could be viewed as having an unfair advantage in competitive wholesale power supply markets.

Flexible Mandate: Many congressional bills have proposed a date certain for all states to start retail competition. The Clinton Administration bill offers a flexible mandate in which states may opt-out from the date certain of January 1, 2003, if they have gone through a public process to formulate their own plans to address electric utility competition and restructuring.

In addition to the proposals in Congress, regulatory activity at FERC could affect Nebraska systems. The formation of Independent System Operators or regional transmission companies and expanded authority for FERC, could place increased pressures on Nebraska systems to adopt certain practices or policies related to transmission access and wholesale competition. FERC Orders 888 and 889, issued in April 1996 to implement the requirements of the Energy Policy Act of 1992; require all jurisdictional transmission owners to provide non-discriminatory open access to transmission to all current and potential users. It is important to note that FERC orders apply to "public utilities" that are generally defined as private investor-owned companies under FERC's jurisdiction. Public power and rural cooperative systems in Nebraska are not currently subject to FERC jurisdiction. However, because public power and rural cooperative systems own transmission lines that are interconnected with jurisdictional utilities and because they are members of regional power pools (such as MAPP), they are impacted by the FERC orders

FERC's goal is to 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.

Recommendation: It is important that Nebraska state and local policy-makers develop consistent and clear positions on proposed federal legislation and FERC activities, and that they continue to monitor the federal arena for decisions that could have far-reaching impacts for the state's electric consumers and economy.

As noted earlier, Congress has initially left the timing and nature of electric industry restructuring up to the states to decide. States are moving forward on varying schedules and differing proposals for competition. As of October 1, 1999, 21 states have passed legislation to establish retail competition. Three states have established competitive markets by regulatory order, and 24 states and the District of Columbia, are studying the issue. In addition, 24 low-cost states, including Nebraska, have petitioned Congress to allow states to make their own determinations concerning the timing and form that competition and electric industry restructuring will take.

Both direct and indirect pressures resulting from federal actions and evolution in the market can be expected to increase. While consensus has not yet emerged, it is anticipated that after the year 2000 elections, Congress will be much more likely to act on this issue.

In the meantime, Nebraska has an opportunity to develop a plan based on its own conditions concerning the timing and elements of electric competition. Experience in other states and the events taking place in the market described in Chapter Two, can help to inform the key issues Nebraska's plan may address.