Federico Peña's speech to the Wharton Energy Conference
Intro
1) Thank you. I am pleased to participate in the Wharton Energy Conference because I believe the topics you address are critical to the economic and national security interests of our country. These conferences are important to you as students of energy policy. You are learning about the complex intersection of finance, regulations and industry dynamics at a crucial time in the history of our country. I hope that my thoughts today will help inform the energy executives, entrepreneurs and policy makers of the future.
2) Acknowledgements
3) I am here today as National Co-Chairman of COMPETE, an organization of electricity providers and large consumers of electricity who believe we need to foster greater competition in the electricity sector of our economy. After all, the business of electricity represents a $365 billion industry or 3% of our GDP.
Let’s begin with a brief history lesson – Consider it the “Ghost of Electricity Past”:
1) For more than a century, the electric industry was a regulated monopoly service, with the same company generating, transmitting and distributing the power to customers – customers who had no choice other than their monopoly service provider.
2) This model developed because it was economically inefficient for there to be competing sets of strung wires to serve customers as the electric industry established itself, grew and matured. Samuel Insull (Thomas Edison’s secretary and a visionary businessman who pioneered the modern electricity industry) helped establish today’s cost-based, regulated model. That model – in which the utility was paid its costs, plus a regulated rate-of-return – served the industry and consumers fairly well for a century.
3) Depression-era legislation broke up the big Edison utility companies that Sam Insull and others established. The New Deal also promoted rural electrification and municipalization. The result is that the U.S. has the most disaggregated electricity industry in the world. In addition to the more than 150 investor-owned utility companies, there are now thousands of municipal utilities and rural electric co-ops.
The “Ghost of Electricity Present” is a complex creature:
1) Toward the end of the 20th Century just as energy was becoming an important part of an increasingly global economy, the regulated-monopoly approach started to fail consumers.
2) Regulators failed to protect consumers from inefficiencies and cost overruns for nuclear-power development. For example, the Pacific Northwest’s Washington Public Power Supply System (WPPSS) debacle became a leading example. Cost overruns for planned nuclear-power development led to the largest municipal-bond default ever ($2.5 billion). The acronym WPPSS was soon transformed to “whoops”. And well-meaning, but flawed regulatory mandates imposed further costs on consumers who were captive to monopoly suppliers. Thus, the Public Utility Regulatory Policy Act of 1978 (PURPA) required utilities to buy electricity from non-utility producers of small-scale, renewable-energy projects and efficient industrial cogeneration, but unfortunately at rates that imposed costs on consumers captive, once again, to their monopoly utility providers.
3) Beginning with the Carter administration, government increasingly looked to end intrusive government regulation and to promote competition in formerly regulated industries. We saw deregulation come to trucking, airlines, natural gas and telecommunications. It was only a matter of time before policy-makers looked to positive results in other deregulated industries and agreed that electricity would benefit from competitive reforms also.
4) Responding to a 1992 congressional mandate, the U.S. Federal Energy Regulatory Commission (FERC, the nation’s independent economic regulator of electric utilities and natural gas pipelines), enacted reforms of the wholesale power market that spurred the development of an entire new “merchant” power industry and the creation of regional markets overseen by Regional Transmission Organizations – RTOs.
5) What were these RTOs? Under the competitive model, the business of “transmission-and-distribution wires” remained a natural monopoly, but the business of “electricity generation” became a market-driven commodity. Today, RTOs are in a way carrying Sam Insull’s 20th Century economies-of-scale into the competition-driven electricity market of the 21st Century. By creating an independent entity to operate transmission systems on a regional basis, power sellers no longer have to pay “pancaked” transmission rates on a utility-by-utility basis, and they enjoy less-costly, one-stop shopping for transmission. It is far more efficient and less costly to purchase transmission service from one regional provider than to negotiate grid access with several different utility companies. By eliminating pancaked transmission rates and by dispatching generation resources across a large regional footprint, enormous inefficiencies are internalized and effectively eliminated.
6) But RTOs aren’t in place everywhere. My home state of Colorado is a case in point. But we are seeing an increasing trend where opposition to the RTO model is starting to wane as consumers begin to recognize that RTOs effectively integrate wind-power resources much more efficiently and cost-effectively than in monopoly markets.
7) This brings us to the time when I had the pleasure of serving as Secretary of Energy. We in the Clinton Administration looked to build on FERC’s successful reforms of the wholesale market – the market where transmission open-access rules and market-based pricing of electricity spawned an entirely new, merchant power industry independent of traditional utilities. We advocated electricity-restructuring legislation that would translate those federally-regulated, competitive reforms from the wholesale markets to the retail markets overseen by the states. While the effort to make electricity competition a national policy unfortunately failed, nonetheless almost half the states have adopted retail competitive reforms absent federal legislation.
8) And then came California – an example of how NOT to restructure – and it unfortunately became the poster child against restructuring. It became accepted that Enron’s market manipulation brought down the market. That was despite a FERC staff investigation that concluded the market manipulation that occurred was made possible due to poorly-designed market rules in combination with a drought that lessened supplies of inexpensive Northwest hydropower. States have been hesitant to adopt retail competition ever since.
We need to usher in the “Vision of Electricity Future”:
1) We now stand at a crossroads where the world must continue to produce copious amounts of energy to support a burgeoning population, and, at the same time, dramatically limit the amount of climate-altering carbon released into the atmosphere.
2) An analysis by the respected Brattle Group estimates that to meet increasing demand in the U.S. over the next two decades, transmission and distribution systems and new generation facilities will require a $2 trillion investment. And that doesn’t even include the cost of controlling carbon emissions.
3) So what is the best regulatory model to meet this enormous challenge? With trillions of dollars in energy and environmental investment looming, do we really want a regulated, monopoly model where investment risk is saddled on the backs of captive rate-paying consumers? Competition on the other hand places the risk with investors (where it belongs), and it disciplines investment decisions to better ensure against flawed investment decisions. In other words, under the traditional cost-plus regulatory model, the state regulator approves an investment proposed by a utility and the costs are placed into electricity rates that consumers pay, regardless of whether the investment ultimately proves worthwhile or cost-effective. In the competitive model, the investor looks to the market to provide the return to justify the investment and to provide a profit. Competition provides a strong incentive for wise decision-making and innovation since the risk of the poor investment is borne by shareholders; not consumers.
4) As today’s history discussion shows, we’ve seen 2 pendulum swings:
(i) Toward regulation with the New Deal reforms after the 1929 stock collapse.
(ii) Away from regulation in response to the economic malaise of the 1970s and 1980s.
And now the pendulum is swinging back to greater government control due to distrust of markets in the wake of the financial crisis brought on by the meltdown of mortgage-backed securities.
5) The good news is that the U.S. competitive electricity industry is a model for how well-structured and well-regulated markets can work in the public interest.
6) These developing electricity markets are not completely “deregulated”, even within an RTO structure. There are multiple levels of oversight and strict rules to prevent the exercise of market power. In the wake of California, FERC now enjoys anti-market-manipulation authority and may impose penalties of $1 million per day per violation.
7) The result? Improved operating efficiencies in RTOs since markets now provide the incentive for plant operators to get more electricity out of facilities that under regulated rates could make money even when they didn’t operate. The generation fleet is inherently cleaner in the organized RTO markets, since markets spurred greater investment in cleaner, natural-gas generation. Wind-power developers find the RTO markets inherently favorable. More than 70% of installed, wind-energy capacity is within the organized RTO markets, despite those regions representing only 44% of U.S. wind-energy potential. Markets are spurring innovation (like demand-response and energy-storage technologies) because price signals and proper alignment of investment risk provide the incentives for least-cost solutions and non-traditional outcomes.
8) Today’s RTO electricity markets are already delivering the results that federal climate-change legislation is intended to produce, such as cleaner generation and greater efficiencies with fewer greenhouse-gas emissions.
9) Congress is poised to enact a market-based, cap-and-trade program for limiting carbon emissions. Under cap-and-trade (which is based on the 1990 Clean Air Act’s successful market-based approach to limiting emissions that produce acid rain), greenhouse-gas emissions limits are set, and affected entities are free to pursue different approaches to limiting their emissions. If someone can reduce emissions more than required, they can sell allowances to another who is unable to meet their emissions limits. In effect, Congress will create a national market for curbing greenhouse-gas emissions even though today a voluntary market and regional emissions markets are already operating. So if the profit-motive incentives of the market are good for the environment (and the Clean Air Act’s acid-rain program is proof of that), then it makes sense to also have a market for the underlying electricity commodity that is creating those carbon emissions. Competitive RTO markets are clearly synchronous with a competitive market-based cap-and-trade program. Most importantly, any objective evaluation of the facts will show that consumers are better off economically with competition. Market forces are driving and will drive innovation and good environmental outcomes. Let’s continue to inform consumers and policymakers across the country to appreciate these positive outcomes -- even in the midst of a general sentiment to move toward greater regulation in the financial-services sector.
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