SJR 259

Joint Subcommittee Studying Electric Utility Restructuring

July 15 and 16, 1997, Richmond

The joint subcommittee convened a two-day workshop to examine key questions emerging during its second year of studying retail competition in the sale of electricity. Retail competition would permit the competitive sale of electric power, releasing electricity customers from their local public service companies to purchase power in a nationwide electricity market. Proponents contend it would lower the price of electricity for everyone, while critics suggest that the benefits of retail competition would be enjoyed by only a narrow class of large industrial customers, leaving a disrupted market for the remainder. To date, eight states have passed retail competition legislation, while the majority of states—like Virginia—have convened legislative or regulatory studies of this issue.

Virginia's residential, business and industrial electricity rates are relatively low-to-moderately-priced when compared to prices in New Hampshire, Pennsylvania, Rhode Island and California—high-cost states that have enacted retail competition legislation. To date, the joint subcommittee has not received information suggesting that Virginia's electric customers are paying excessive rates. However, as a New Hampshire Public Service Commission attorney told the joint subcommittee, retail competition offers benefits in addition to potential reductions in the cost of electricity. Thus, the joint subcommittee is determining whether there exist other compelling practical and policy reasons for redesigning the Commonwealth's electricity delivery system—a system currently comprising the service territories of investor-owned utilities (such as Virginia Power and AEP Virginia), electric cooperatives, and municipal power systems.

The joint subcommittee convened this two-day workshop to answer the following questions: (i) How many states have enacted restructuring legislation, and what are the features of their bills? (ii) What do the federal restructuring bills look like, and how likely is their passage? and (iii) Is the current electricity transmission system in Virginia and across the country technologically ready to support nationwide retail competition? Finally, the subcommittee requested information from the public utilities staff of the Virginia State Corporation Commission (SCC) concerning the status of its working groups as the SCC prepares its recommendations concerning a Virginia restructuring plan and a report on that plan slated for November. The subcommittee also reviewed historical and regulatory developments in the electric utility industry triggering this intensive, complex debate.

State Legislative Activity

The joint subcommittee learned that while nearly every state is looking at this issue, only eight states have enacted retail competition legislation thus far. In 1996, legislatures in New Hampshire, Rhode Island, California and Pennsylvania passed bills authorizing retail competition. In 1997, legislatures in Oklahoma, Montana, Maine and Nevada have enacted retail competition laws. Thus, four high cost states moved on this issue in 1996, and three lower-cost states (Maine is considered high cost) have acted in 1997. At the same time, however, retail competition bills failed in 18 states (including Texas, Connecticut, New York, Vermont, and Illinois) during the 1997 legislative season, while legislative study proposals were not approved in Colorado, Georgia, Florida, South Carolina and Vermont.

A utilities market analyst pointed out to the joint subcommittee that the scope and details of the eight restructuring bills enacted vary widely. Some states, like New Hampshire and Pennsylvania, have initial pilot programs in their legislation (in which a percentage of electricity customers may shop for their electric suppliers), followed by phase-in periods to a date in which retail competition is available to all customers statewide. In contrast, Oklahoma's 1997 bill directs its public service commission to develop a retail competition plan. Furthermore, the Oklahoma bill conditions any such plan on the development of an acceptable strategy for dealing with restructuring's potential impact on state and local tax revenues from electric utility taxation.

Federal Legislative Activity

The momentum for legislative study on the state level may be driven, in large part, by the potential for federal legislation preempting state authority over electric competition. Significant federal intervention in the interstate electricity market began in 1978, when Congress passed the Public Utilities Regulatory Policies Act (PURPA), requiring public utilities to purchase power from independent power producers if the latter could produce it as cheaply as the former. And, as underscored by a Virginia Tech professor currently analyzing the utility market's transformation, a federal electric utility policy favoring open markets was declared in earnest with the passage in 1992 of the National Energy Policy Act (EPACT). EPACT and a resultant Federal Energy Regulatory Commission Order (FERC Order 888), opened the transmission system to independent power producers for wholesale power sales. EPACT, however, did not permit FERC to implement retail competition, leaving that issue to the states.

However, a number of federal legislators are eager to open up the retail market, and soon. For example, legislation introduced in 1996 by Congressman Dan Schaefer of Colorado (HR 655) mandates full retail competition in all states by the year 2000. Whether Congress possesses sufficient constitutional authority to mandate state implementation of retail restructuring is open to interpretation, however, following the U.S. Supreme Court's 1997 decision in Prinz v. U.S. The Prinz decision questions federal authority to direct state implementation of federal legislation unless the federal government has clear preemptive authority granted by the U.S. Constitution over the legislation's subject area. However, a former FERC commissioner told the joint subcommittee that in his opinion, a key U.S. Supreme Court case upholding the constitutionality of PURPA (in which state public utility commissions were effectively directed by federal law to assist in that law's implementation), is probably not in jeopardy despite the Prinz decision. Thus, the extent of federal authority in opening the nation to retail competition remains an open question.

A consensus in Congress has not emerged on this issue either. Bills such as Congressman Schaefer's, Congressman DeLay's HR 1230 (mandating full nationwide retail competition by 1999) and others before the House Commerce Committee are, according to a representative of the Edison Electric Institute, in conflict with another view of restructuring in Congress, represented by Senator Thomas's S 21 pending before the Senate Energy Committee. That bill presents a pro-state view emerging in the Senate empowering retail competition in the states, but without federal mandates. Consequently, while both Senate and House committees continue their work on this issue with frequent committee hearings and workshops, no agreement between the two chambers appears imminent.

Restructuring and Transmission System Technology

As part of its two-day activities, the joint subcommittee focused on restructuring and the current electric power transmission system. Subcommittee members toured the Virginia Power System Operations Center to observe that utility's computerized generation, dispatching and transmission management system and also received a presentation from an Electric Power Research Institute (EPRI) representative concerning ongoing research and development work in the field of electric transmission technology. The EPRI representative emphasized that power generation and transmissions related to wholesale power sales ("contract flows") result in power flows in all directions across the interconnected electrical transmission network.

Wholesale power transactions, frequently uncoordinated through any centralized operations system, can potentially overload transmission lines, resulting in their shutdown and—in a severe case—cascading shutdowns of adjacent lines to which power is shifted. According to EPRI's representative, at least one significant recent power outage in the West may have been caused by line overloading relating to wholesale wheeling. EPRI's representative's conceded that these line problems were not caused by retail competition, but stated that retail competition may exacerbate them.

To address these and related load-flow issues, EPRI is participating in establishing an integrated, computerized regional communications network designated as the Open Access Same-time Information System, or OASIS. OASIS, currently in testing stages, will be used by system control centers to determine accurate system status, safe networking operating limits, network overload capabilities, and the impact of power transactions in near real-time. A related system under development (the Flexible Alternating Current Transmission System, or FACTS) is likely to replace generation control as a means of controlling flow over transmission lines. Computerized electronic "valves" will boost power flows on specified transmission lines as a means of ensuring transmission system integrity.

EPRI's representative also warned that regional power generation is essential to steady state voltage security. Large regions importing virtually all of their power will have, he said, extreme difficulty maintaining steady state voltage, which is essential to the safe and efficient operation of electrical equipment. Unstable voltage outside certain tolerances can result in damage to electrical systems and equipment.

SCC Staff Activities

Four members of the SCC public utilities staff appeared before the joint subcommittee to report on the work of staff-coordinated work groups examining five specific topics: (i) a model for a restructured industry, (ii) reliability issues from both a generation and transmission perspective, (iii) stranded costs and stranded margins associated with potential transition to a more competitive generation market, (iv) the costs and benefits associated with the introduction of more competition into the generation sector, and (v) the potential impacts of a restructured industry on the environment.

The work groups, comprised of representatives of investor-owned utilities, electric cooperatives, independent power producers, major industrial electricity customers, environmental groups, and others with a stake in this issue met extensively in 1997. The groups recently concluded their meetings, and the staff will incorporate the groups' work into the SCC's report on a retail model for Virginia, scheduled for presentation to the joint subcommittee in November.

Models

The models work group examined and critiqued legislation or models proposed or implemented in other states (including Texas, Indiana, Pennsylvania, New Hampshire and California), and members were furnished opportunities to propose and explain models of their own design. Significant models-related issues included concern about price leveling in an open retail market, resulting in rate increases in regions currently served by low-cost utilities. Additionally, group members debated whether regulated local distribution companies (in contrast to generation companies) should be required to be a generation service supplier of last resort and whether any restructuring should be accomplished through pilot programs and transition periods.

Reliability

The reliability group focused on the challenging issues of reconciling customer choice with the physical realities of electrical flows—an issue highlighted in EPRI's presentation to the joint subcommittee. Power flows are dynamic and difficult to control. This group also identified critical ancillary services such as frequency control and voltage regulation—all essential to the provision of reliable electric service in any market, but particularly so in a competitive one. Mandatory generation reserves, a feature of the current, regulated generation system, proved to be a potentially contentious area. Transmission grid users can theoretically rely on the reserves of other generators to assure reliability and may have little incentive to individually provide for sufficient reserves. Reserve cost-sharing in a competitive market may be necessary to ensure generation reliability.

Environment

The environmental group was unable to reach consensus about the effects of retail competition on air pollution. Some members predicted that competition will cause older, more polluting coal plants to be run more often, while others asserted that the mandates of the federal Clean Air Act will minimize emissions. A related issue is the potential competitive disparity between new plants that must be built with expensive pollution control technologies and those plants built prior to 1978 that are subject to less stringent emissions standards. The group also addressed concerns about the impact of restructuring on the future of utilities' current conservation and load-management programs. Minimizing the construction of new generation and transmission facilities through such programs is thought by some to be at odds with the concept of retail competition, while others suggested that competition may promote energy efficiency.

Costs

Finally, the work of the stranded costs and costs/benefits groups was discussed. The latter group's work encompasses much of the activity of the other groups and will not be discussed in this article. The stranded costs group confronted one of the most difficult issues presented by retail competition. Stranded costs or margins are characterized as the differences between the market value of utilities' generation-related assets in a competitive environment and their book value. In a restructured market, older, high-cost nuclear plants, for example, may not be competitive with new, more efficient natural gas-fired generation units, and the nuclear units' value may be substantially reduced as a result.

The potential for substantial write-downs in generation asset values has resulted in some characterizing the difference between such plants' book values and their potential market value as a stranded cost. For some, like Virginia Power, numerous long-term purchased power contracts with non-utility generators (a byproduct of federal PURPA legislation) at prices currently above-market represent their stranded cost exposure. Such contracts have the same cost effect on a utility as undepreciated generation units. On the other hand, low-cost investor-owned utilities, such as AEP Virginia and Potomac Edison, have existing plants that are fully depreciated. These utilities may have net stranded margins or minimal stranded costs at most, the SCC staff reported.

Utility recovery of stranded costs from rate-payers was the key issue before this work group. The justification offered for this recovery is founded in the notion of a regulatory compact said to exist between franchised public utilities and their regulators. It suggests that stranded costs are essentially sunk investments, which the utilities made to fulfill their legal obligation to provide adequate service to all consumers within their service territories.

Some work group participants advocated full recovery from rate-payers, while others suggested that such costs should be shared fifty-fifty between rate-payers and utilities' shareholders. Those in the latter camp contended that shareholders have explicitly assumed the risk of potential regulatory and statutory reform within the industry. One important consensus: the difficulty of projecting stranded costs, a fact underscored by national estimates of utilities' potential stranded costs ranging from $50 billion to over $500 billion.

The work group apparently favored a time-specific, non-bypassable "wires charge" as a mechanism for recovering stranded costs, if they are to be recovered at all. Moreover, the group agreed that utilities should be obligated to mitigate the extent of their stranded costs. In that vein, the California and Pennsylvania restructuring legislation offers up stranded cost "securitization" as a means of mitigation. Securitization enables low-cost debt refinancing of potentially stranded utility assets, securing that debt with legislation establishing a rate-payer-produced stranded cost recovery income stream.

Future Joint Subcommittee Activities

The joint subcommittee will convene its next meeting on August 12, and is slated to receive a report from its task force examining the likely impact of restructuring on state and local tax revenues generated by electric utility taxation. An agreement was reached among the joint subcommittee members during the two-day meeting to request the SCC's assistance in modifying electric utilities' billing statements to itemize state and local taxes currently embedded in customers' monthly electric charges. Currently, state and local taxes paid by electric utilities are recovered, dollar for dollar, from their customers, since taxes are included in utilities' rates. The taxation task force had recommended this action, suggesting that such information will be useful to electricity customers in the event a transition to retail competition results in direct customer payment of utility taxes in lieu of the indirect method described above.

Additionally, the subcommittee will use its next meeting to receive updates and briefings from the wide variety of groups interested in the subcommittee's work, including power producers, power customers, and others such as environmental groups. These groups will respond to some of the issues raised at the two-day workshop, and will update the joint subcommittee concerning their positions on the issues generated by potential transition to retail competition. The joint subcommittee has also made tentative plans for a meeting in September.