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UNPLUGGING
THE ELECTRIC POWER
MONOPOLIES

UTILITY DEREGULATION:
THE POLITICAL BILL
IS COMING DUE
ON CUSTOMER CHOICE
by Toby Eckert

The debate over deregulation of the nation's $210 billion electric industry is as complex and unsexy as they come.

No one, with the possible exception of utility executives and their government regulators, thinks about retail wheeling, stranded costs or customer aggregation when they flip on the lights at night. But the jargon can be easily boiled down to two simple words that fuel the entire debate: customer choice.

The wave of deregulation that washed over the airline, trucking and telephone industries is now engulfing power generators. In Illinois and other states, legislators are poised to dismantle the regulatory environment that for decades has assured Common wealth Edison, Illinois Power and other utilities a monopoly in their service territories — and comfortable profit margins to boot.

The movement, known as "retail wheeling" by the utility industry, is being nudged along by powerful corporate interests, who see the possibility of extracting huge cost savings from utilities competing for their business. Consumer groups are more wary, fearing that residential customers will be a mere afterthought in the rush to deregulate for the sake of commerce.

Utility executives, meanwhile, are far from united on the best way to enter the new era, as evidenced by the competing legislative proposals floated by Illinois' power giants with their differing approaches to piloting customer choice programs. But most, if not all, view the trend as inevitable.

Deregulation has made its deepest inroads on the East and West coasts, where electricity bills are relatively high. Six states — California, Pennsylvania, New York, New Hampshire, Massachusetts and Rhode Island — already have approved plans to phase in competition.

States that don't act soon may be nudged along by Congress. U.S. Rep. Dan Schaefer, a Colorado Republican, would require states to open utility markets to competition by 2000.

"A year ago, the industry's motto was, 'Just say no,'" says Schaefer. "Today, few utility executives will deny, at least in public, that retail choice for their customers is coming."

The stakes are enormous. Estimates of potential savings nationwide for electricity users in a competitive environment range from $60 billion to $200 billion annually.

Researchers from Clemson University in Clemson, S.C., concluded that the average monthly bill for Illinois industries in 1994 would have been $28,503 if they could have shopped

12 /January 1997 Illinois Issues

around for lower rates, 35 percent less than the $38,588 they paid that year. The bill for smaller businesses would have been $367 compared to $497, while homeowners would have paid $49 instead of $66.

Such price breaks would be an enormous boost to the profit margins of steel mills and other heavy industries, where electricity can account for 50 percent or more of production costs. They're also important to retail businesses, particularly those with a national presence.

Take Simon Property Group, which operates malls in Illinois and across the country. The company now buys power from 118 different utilities. Prices range from 3 cents to 15 cents per kilowatt hour. Linda Hagadone, the company's energy manager, estimated that in a competitive environment Simon could deal with as few as six utilities, negotiate price reductions of 25 percent and pass some of the savings on to retailers in the form of lower rents,

"I think you will still have some regional differences" in electricity prices, she says. "But I don't think they'll be as drastic as they are now."

Indeed, a recent survey by the Illinois Manufacturers' Association found that some of its member industries were served by up to four utilities and that the rates they paid varied by as much as 50 percent.

"There are significant savings that can be achieved here," says IMA President Gregory W. Baise.

The IMA and several other powerful business lobbying groups recently negotiated a customer choice plan with Commonwealth Edison, Illinois Power and several smaller utilities. The plan calls for an eight-year transition to a competitive environment, beginning in 1997 with limited pilot programs like those currently being conducted by Illinois Power and Central Illinois Light Co. (CILCO).

Starting in 2000, large industries would be able to buy electricity from any utility willing to sell. Smaller commercial users would be phased in between 2000 and 2005. Residential customers could start shopping for power starting in 2005.

"Our bill will bring the benefits of competition to all Illinois electricity users as rapidly as possible without putting the reliability, accessibility and safety of the current system at risk," Illinois Power CEO Larry Haab said when the plan was unveiled in November.

But consumer groups found the proposal anything but electrifying. They don't see why residential customers should have to wait until 2005 to take advantage of deregulation.

"They call this a competition plan. It's an abuse of the English language," says Martin Cohen, executive director of the Citizens Utility Board. "It's a monopoly protection plan that will insulate the utilities from an open market and hold most of their customers captive until at least 2005. There's no reason for the big dogs to eat first."

Not all utilities agree with the plan, either. Peoria-based Central Illinois Light Co. has floated a competing proposal that would bring competition to all customer classes starting in 1998.

THE PLAYERS: WHO'S WHO IN THE STRUGGLE OVER POWER There are nine INVESTOR-OWNED electric utilities in Illinois. These for profit power companies are regulated by the Illinois Commerce Commission, which is responsible for setting the rates charged customers. Chicago- based Commonwealth Edison and Decatur-based Illinois Power are the largest of these companies. ComEd and IP are part of a coalition of power companies and business groups, including the Illinois Manufacturers' Association, that proposes phasing in competition in the utility industry. Their plan calls for an eight- year transition, beginning in 1997 with limited pilot programs like those currently being conducted by IP and Peoria-based Central Illinois Light Co. (CILCO). Starting in 2000, large industries would be able to buy electricity from any utility willing to sell. Smaller commercial users would be phased in between 2000 and 2005. Residential customers could start shopping for power starting in 200 5. However, the utility industry is not unified behind that plan. CILCO has floated a competing proposal that would bring competition to all customer classes starting in 1998. Illinois also has 26 MEMBER-OWNED power co-ops, serving half a million rural customers, as well as 41 MUNICIPALLY OWNED utilities. For a concise, balanced and readable primer on utility deregulation, look up A Shock to the System: Restructuring America's Electricity Industry, published in 1996 by Resources for the Future, Washington, D.C. The book was written by economists Timothy J. Brennan, Karen L. Palmer, Raymond J. Kopp, Alan J. Krupnick, Vito Stagliano and Dallas Burtraw.

Illinois Issues January 1997 /13

"We believe in consumer choice now, rather than in the year 2000, and for all customer classes, residential as well as industrial and commercial," says CILCO spokesman Neal Johnson. "That seems to be the difference between us and the big guys."

The differing timelines for full competition are a product of the rates charged by the utilities. Because CILCO has comparatively low rates, a quick start-up date for competition would give it an edge in the marketplace. ComEd and other relatively high-cost utilities need a longer transition period to cut production costs and bring down rates.

Another competitive factor vitally important to utilities is so-called "stranded costs." Simply put, these are costly, sometimes imprudent, investments that the utilities made under the current regulatory environment, when they were reasonably certain they would be allowed to recover the costs through their rates. In a competitive environment, they would lose that assurance. The investments would be a drag on their ability to offer competitive rates and still make a profit. Expensive, underutilized nuclear power plants are a prime example of stranded costs.

Chicago-based ComEd and Decatur-based Illinois Power are nuclear producers. CILCO is not. Moody's Investors Service has estimated that ComEd has a whopping $4.4 billion in stranded costs, while Illinois Power has $682 million. CILCO has none.

Still, both of the rival competition plans would allow the utilities a period to recover such costs. The Illinois Power/ComEd plan contains a "transition charge" that bolting customers would have to pay their former suppliers for five years after taking their business to another utility. The charge would be based on the difference between the revenue the utilities would have received under the current regulatory structure and what they receive in a competitive environment. Cost savings achieved by the utilities would be deducted. The IMA's Baise doesn't believe the charge would be high enough to effectively discourage a customer from leaving one utility for another. The discount in rates that a business would be able to negotiate with a rival utility would outweigh the charge, he says.

"If they were not low enough, our representatives of our larger companies would not be signing on" to the plan, he says.

Under CILCO's proposal, utilities could ask the Illinois Commerce Commission for permission to impose a "lost margin charge" on all customers during a four-year window, from 1998 to 2002. The ICC would base the amount of the charge on a utility's financial condition, cost-cutting efforts and potential market power.

Cohen says CUB believes that most of the stranded costs should be eaten by the utilities, since they decided to make the investments in the first place. But he did not rule out "reasonable sharing" of the expenses by customers.

California's legislation, which is seen by some as a national model, allows Golden State utilities to reduce stranded costs by adding a surcharge to all ratepayers' bills. The federal legislation offered by Rep. Schaefer would allow states to decide how to handle the issue.

The debate is crucial to utility shareholders, who were previously assured of stable returns on their investments because profit margins were set by state regulators. Indeed, the very survival of a local utility as a distinct entity could depend on the way the issue of stranded costs is handled.

In any event, competition is expected to intensify consolidation of the industry. Ten large mergers have occurred throughout the country since

14 / January 1997 Illinois Issues

early 1994. Resource Data International, a Colorado-based utility consulting firm, expects the number of investor-owned utilities nationwide to dwindle from the current 101 to 80 or fewer by the turn of the century. Those left are expected to be efficient, low- cost producers.

At the same time, a new industry is emerging: power marketing. These companies, many of which have no power plants, will tailor their customers' energy needs to their power- purchasing strategies. They also are expected to act as "aggregators" for residential customers, bringing enough of them together to have some leverage to negotiate lower rates.

While the clash of the utility titans is occurring nationwide, there are some areas of cooperation, most notably in joint efforts to create the infrastructure necessary for competition. Twenty-two Midwestern power generators from 10 states — including Illinois — are laying the groundwork for a 71,000-mile electricity superhighway. They are creating a unified transmission grid that will be operated by an independent entity.

The "independent system operator" (ISO) will be responsible for moving power throughout the grid as utilities respond to orders from customers. The idea is to create a single transmission charge, avoiding multiple tariffs that would otherwise be collected by each utility as the power passes over its lines.

It is also hoped that the independent system will mitigate problems that accompany the transmission of large amounts of power between service territories, including overloads that could cause massive blackouts.

"We believe the ISO can facilitate the transmission of power in the open power market and maintain reliability," says John Procario, an executive at Cincinnati-based utility Cinergy Corp. who heads the committee that is steering the industry discussions.

Many daunting issues must be worked out, notably the amount of the transmission charge and procedures for regulating how much power the grid carries on any day. But the member utilities are confident they can start implementing the system by 1998 and have it fully operational by 2000.

The utilities are trying to set up the system in response to a federal ruling last year that required them to open their transmission lines to competitors for sales to wholesale power buyers, such as cities and other utilities, known as wholesale wheeling. But the system obviously would serve as a model for retail sales, as well.

The complexities of shaping a deregulated power industry will fall to Illinois lawmakers when they return to the Capitol next spring.

Although there was some speculation that the legislation favored by ComEd, Illinois Power and the industry groups would be pushed through during the fall veto session, legislative leaders were wary of dealing with such a complex issue in a tight time frame. Senate President James "Pate" Philip, a Wood Dale Republican, told Grain's Chicago Business in September that he would not support a lobbyist-crafted deregulation bill because there had been little public debate on the issue.

A Joint Committee on Electric Utility Reform held hearings for the past year, but it has backed off from endorsing a specific plan.

"I think a lot of people are ready to introduce bills," says Sen. Steven Rauschenberger, an Elgin Republican, a key member of the committee and a strong proponent of utility competition. "The next step may be to dissolve the joint committee and just move ahead with the traditional legislative process." 

Toby Eckert is a reporter at the Indianapolis Business Journal. He was Springfield correspondent for the Peoria Journal Star from 1990 to 1996.

Illinois Issues January 1997 / 15