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Virginia's
decade-long experiment with electric deregulation is coming to a close.
Legislation under consideration by the General
Assembly would submit Dominion, Appalachian Power
and the smaller electric utilities to a form of
"hybrid" regulation -- regulation lite, if
you will.
A
recent night-time hearing of the Commission on
Electric Utility Restructuring was standing room
only, packed with representatives of power companies
-- big ones, small ones, independent ones -- as well
as big industrial and residential consumers,
academics and journalists. Not bad for a topic the
details of which are so numbingly dull they could
serve as novacaine.
There
appeared to be a consensus in the room that the new
law should balance twin goals: holding electric
rates as low as possible while keeping power
companies profitable enough to embark upon a major
round of power plant expansion. Everyone gave a
ritual nod to the need for
"conservation" and "renewable fuels." But no one in the room made money by
shrinking sales through conservation, and
"renewable fuels" providers aren't big
enough to hire a bug swarm of lobbyists and lawyers to
push their interests.
Environmentalists,
concerned about acid rain, nitrogen deposition,
low-level ozone, mercury emissions and the release
of greenhouse gases, were not invited to join the
"stakeholders" who thrashed out a
compromise. Defenders of property
rights, opposed to forced takings of land for
high-voltage transmission lines, had no seat at the
table. Proponents of a "distributed grid"
electric system, which would expand the role for micro
power producers, were notably absent. Manufacturers
of energy-saving technologies weren't even in the
picture.
In
other words, the vested interests -- the power
companies, industrial customers and citizen
consumers -- get a seat at the bargaining table and
a hand in writing the legislation. Inevitably, the
resulting regulatory regime will balance the
competing interests of those groups. Equally
inevitably, there will be no bold departure from the
past.
In
their book, "Revolutionary Wealth," Alvin
and Heidi Toffler characterized the United States
energy infrastructure as a product of the
industrial-wave wealth-creating system. Built around
heavy fixed assets, that system is inflexible and
difficult to adapt in response to rapid change. But
the legacy system endures, they wrote, because it is
"politically defended by some of the world's
biggest and most influential corporations."
The
Tofflers could have been writing about Virginia.
Electric "re-regulation" will serve the
interests of the established players who were
invited to participate in the process of drafting
the legislation. The perspectives of other interests
-- either too powerless or too nascent -- will be
largely missing.
Still,
it is instructive to know how we reached this point
and what we have learned about electric regulation
and deregulation. Perhaps we can gain some insight
into what it takes for Virginia's electric
infrastructure to one day encompass the conservation,
renewable fuels and micro producers that will better serve us in the
volatile energy economy of the 21st century.
To
bone up on electric re-regulation, I sat down last
week with David G. Shuford, vice president-state
regulation for Dominion Resources Services, Inc. My
first questions for him: Why was Dominion pushing
for re-regulation? In what way had deregulation
failed?
The
simple answer: Virginia never truly deregulated. The
restructuring of Virginia's electric
utility sector did not work as anticipated, and no meaningful competition ever
emerged. Shuford listed
three reasons why.
First,
the State Corporation Commission never permitted
Dominion to divest its power plants. It is an axiom
of electric deregulation that the people who
generate electricity cannot live under the same
corporate roof as the people who transmit and
distribute it. For competition to work, power
generators need a level playing field -- cross
subsidies not allowed.
But
Virginia's regulators had big reservations about
breaking up the power companies. Should deregulation
fail, they feared, it would be extremely difficult, as the
analogy goes, to "unscramble the egg" and
go back to the old regime of regulating vertically
integrated power companies. Of
course, such fears became a
self-fulfilling prophesy. Without divestiture of the
power plants, deregulation never had a chance to
work in the first place.
"In
Virginia, the folks at the Commission were
not ever going to allow for that legal separation
between generation and distribution," says
Shuford. "That
was cited routinely by competitive suppliers as a
flaw in our process."
Second,
the SCC imposed rate caps on Virginia's power
companies. Except for modest cost-of-fuel
adjustments, Dominion has not increased rates since
1996, when rates were capped at 1993 levels, despite a 28.5 increase in the Consumer
Price Index over the past decade. Capping rates adds another hurdle for competing suppliers, Shuford
says: "They have to compete against an
artificially capped price."
Virginia
is not the only state to cap electric rates, Shuford
says. While politicians like the theoretical notion
that free markets yield lower rates on average than
regulated rates, they are uncomfortable with the
messy reality that free-market prices are more
volatile, which means that they sometimes spike
higher than regulated rates. After observing what
happened in other states, Dominion concluded
that Virginia policy makers would never lift the cap.
"That made us wonder if retail competition
really would develop to the point where it would be
an effective regulator of prices in Virginia."
Third,
there was a flaw to the restructuring plan that
Dominion hadn't anticipated, Shuford says. Back in
the 1990s, there was a sense of inevitability about
deregulation. Railroads had deregulated, trucks had
deregulated. Airlines, natural gas and
telecommunications had all deregulated. But
deregulation didn't pan out for the power industry.
The issue was so complex that a number of states
handled it badly -- California was a disaster -- and a
number of states balked.
"Some states headed down this path but many
states did not," Shuford says. "Some
states reversed course. You had this balkanized
landscape where some states to the south of us are
in traditional regulatory mode, and Virginia
and states to the north are not."
That
put Dominion in a difficult position. After
operating for years without building any new
base-load generating facilities, Dominion now
anticipates the need to spend approximately $4
billion on new capacity over the next 10 or so
years. Dominion will have to borrow most of that
money.
"If
everyone were deregulated, we wouldn't have to
compete against regulated entities in the capital
markets," Shuford explains. Under current
arrangements, Dominion would have to go into the
market as a merchant generator, with no guarantee of
payback. "It would be very difficult to go to
the capital markets and say, "Invest in us,
we're going to build a $2 billion nuclear power
plant. ... [Investors] will look at that option, and
they'll look at Duke [a regulated company with
guaranteed return on equity]. They'll invest in
those companies where they're guaranteed a payback.
Folks would look for a higher return on investment
[with Dominion]. It would be a more expensive
undertaking."
Translation:
Either
Dominion would have to pay a significantly higher
cost for capital, which would mean higher electric rates, or it would have to import electricity from
outside the region, which would require more
high-voltage electric lines -- assuming that that
wholesale power was even available.
As
Dominion headed into the current session of the
General Assembly, it wasn't anticipating any great
legislative initiatives, Shuford says. But
a bad experience with the lifting of rate caps in
Maryland led to massive rate increases and a seismic
political shock. Industrial customers, in
particular, were hard hit. Alcoa, which has
extensive operations in Virginia, had to shutter an
energy-intensive smelting facility in Maryland when
rates went through the roof. Legislators feared the
likelihood that electric rates would rise
precipitously when Virginia's rate caps expire Dec.
31, 2010. In Virginia,
there is a growing sense that "deregulation" was a
failure.
Rather
than wait for the axe to fall, Dominion took the
initiative: Pushing its own vision for
re-regulation, the company advocated a
"hybrid" model that strengthened SCC
oversight but corrected deficiencies of the old
system with a measure that would allow Dominion to
reap a share of the savings from innovative
cost-cutting programs.
That proposal was
taken up by the General Assembly commission to study
electric utility restructuring. Sen. Thomas K.
Norment, R-Williamsburg, turned the legislation over
to William C. Mims, deputy attorney general, and a
working group of stakeholders. After cramming 60
hours of work into two weeks, the volunteer
stakeholders reached consensus on several key
points, narrowed their differences on several more,
but left a number of questions hanging.
As
Dominion lobbyist Bill Thomas testified before the
restructuring commission, the revised bill was
"dramatically different" from the one
originally submitted by Dominion, but it still preserved
the features critical to the company.
Central
to Dominion's strategy is preparing for the
upcoming wave of construction projects -- three or more
new coal- and nuclear-powered power plants to meet rising
demand over the next 15 years.
Virginia,
especially Northern Virginia, is racking up some of
the greatest increases in electricity consumption
anywhere in the country. "We add about 50,000
customers a year," says David B. Botkins,
senior corporate communications representative. Some
of those customers are humongous energy users.
Northern Virginia has 14 giant server farms, each of
which guzzles as much electricity as a small town.
And “there are more on the drawing boards."
Dominion
met surging demand over the past decade without building more base-load plants by importing
electricity from other states. The key was joining
the PJM wholesale electric power pool, which serves a
13-state region mostly north of Virginia. "PJM
does a lot of things really, really well," says
Shuford. "They give us access to lower-priced,
base-load power, mostly coal power several states
away. ... In the old days, we would have run our own
power plant to serve our native load. Now, unless
ours is the lowest cost power, it doesn't get
dispatched. PJM ensures that the lowest cost power
flows to [Virginia]."
But
there are limits to how much Dominion can continue
relying on PJM's cheap electricity. One problem,
says Shuford, is that the transmission lines into
Virginia have limited capacity. Dominion needs more
transmission lines to import more power. A longer
range problem is that "at some point, western
states will start using up their own cheap
electricity. Nobody's building new base-load
generation in the PJM area. We need to build our own
for energy independence in Virginia."
Dominion's
preferred solution seems to be doing more of what it
already knows how to do well -- build more power
plants and electric transmission lines. Shuford
acknowledges that conservation, renewable fuels and
a distributed grid all need to be part of the energy
future, but it's clear that Dominion hasn't put much
thought into them.
Shuford
makes polite noises about conservation. "Twenty
years ago," he says, "there was a lot of
emphasis on load management and demand
response," in which customers would drop off
the grid during periods of peak demand to spare
Dominion the necessity of running its most costly
power generators. "But it's difficult to do it
on a large scale with residential customers. Once
you get past devices that automatically turn your
water heater down, you're not going to see people
adjust their behavior but so much. Are you going to
do your wash at on o'clock in the morning to shave
$2 on your electric bill?"
Shuford
says he's seen little evidence in other states that
variable rate structures will "obviate the need
for new power plants or transmission lines."
But
in a moment of candor, Shuford also concedes that power
companies don't have much incentive to push
conservation. "The problem has been ... the end
goal of conservation is for the utility to sell less
power. Utilities won't devote significant resources
to sell less of the product they make unless you can
figure out how to make it worth their time."
Figuring out how to "decouple" the power
company's profitability from the volume of
electricity it sells is a regulatory condundrum.
Distributed
generation also will be part of the energy future, Shuford
says. It makes sense to put small generators closer
to the sites where they are needed. But "it may
take a while for that to come into play. It's never
going to supply the larger needs of a statewide
population, but it could address certain
situations."
Shuford
did not say this, but it seems evident to me: Like
conservation, there's no profit in "distributed
generation" for Dominion. If independently
owned photovoltaic arrays, wind turbines and
cogeneration units start supplying electricity to
thousands of residential and commercial customers, that's less business for
Dominion -- especially if they sell their surplus power back into
the grid. In sum, the power company has every
motivation to say the politically correct things
about distributed generation while actually doing as
little as possible.
The regulatory regime contemplated in the
restructuring commission's hybrid
regulatory model is geared to helping Dominion and
other power companies build new infrastructure --
what I call "Big Grid," large power plants
in isolated areas with transmission lines to wheel
electricity to the customer base. Dominion's bill,
even as modified by the stakeholders, would put this
need front and center by
guaranteeing a Return on Equity comparable to that
of a peer group of regulated utilities in the
Southeast U.S., around 12 percent per year.
But
Dominion asked for no such incentives in the
original draft of its legislation to promote conservation,
distributed generation or renewable fuels. An
amendment proposed by Del. Clark N. Hogan, R-South
Boston, would encourage power companies to draw as
much as 12 percent of their power from renewable
energy sources in 2022 by increasing the company's
allowed rate of return by half a percent. It's not
clear, however, whether power companies could meet
such ambitious objectives even if they embarked upon
a crash program tomorrow, much less what such
efforts would cost or how well electric customers
would embrace the idea of paying for them with
higher rates.
This
year, the main issue likely to be resolved centers
on how to ensure the construction of massive new
generating capacity in Virginia without sparking a
ratepayer revolt. The renewable fuels issue is in
play, though the current proposal does not look
practicable. As for conservation, energy efficiency
and opening up the system to micro-generators, those
look like topics for a future generation.
-- February
5, 2007
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