Electricity Policy Prime Time: Part II–Analytical, Process & Supply Issues

By Ken Malloy -- August 22, 2012

In an earlier post, I asked readers to consider four thought experiments regarding the reprioritization of our public-policy work on energy. Here is my response to your much-appreciated comments and a proposed path forward.

Thought Experiment 1. Let’s demote oil and climate change to secondary status as analytical issues.

To my surprise, no one seemed to disagree with my proposal. Yet popular media coverage of these issues is probably 90+%.

Thought Experiment 2. Let’s elevate the dialogue about fundamental electric industry reform to primary status.

Again to my surprise, no one seemed to disagree with my proposal, which leads me to wonder why this issue does not get the attention it deserves. My best guess is you cannot boil the solution down to a three word sound bite (Drill Baby Drill! or Climate’s Always Changing!). Maybe it will take a major catastrophe to get our attention à la India.

I make many analogies to other major, successful industry restructurings from statist to market models: airlines, railroads, natural gas, telecommunications, and trucking. I don’t remember that they were either reduced to a three-word slogan or needed a catastrophe to get D.C. moving.

Why is electricity different? Is it possible that we free market fetishists have not put forth a coherent model?

Thought Experiment 3. Let’s debate what is wrong with current electric industry policy.

This will be the subject of this post, more later.

Thought Experiment 4. Let’s identify the set of policies needed to permit the electric industry to enter the 21st Century.

This will be the subject of future posts after we have carefully defined the problem.

A Process Suggestion

Although not widely known, at the outset of the natural gas restructuring, the intellectual leader (Charles Teclaw, Director of the Policy Office) imposed a simple test on the ten or so analysts that had been gathered to “solve” the problem. (Full disclosure: I was a market advocate at FERC when the blueprint was developed and at DOE when much of the blueprint was implemented.) I have come to call it the Tabula Rasa Approach, in contradistinction to the Compounded Regulation Approach, described below.

Tabula Rasa Approach: This approach starts with the simple constraint of using only economics and the physics of natural gas (and being informed by the historical failures of policy) to determine what policies would we adopt if we were writing on a tabula rasa, starting completely from scratch?

Questions of legality, political feasibility, harm to incumbents, history, impact on existing institutions, ruined careers, etc. were explicitly ignored. (Indeed, if one made a recommendation that could be shown to rely on these prohibited lines of analysis, they were literally asked to leave the group.) One could rely only on economics and physics in making recommendations.

Once the policy maker developed an understanding of the Tabula Rasa Solution, then and only then can one make judgments/compromises as to legality (laws can change), political feasibility (political calculus can change), existing institutions (institutions can innovate, creatively destruct, or be newly created in response to changes in incentive structure), always with the goal of doing the least damage to the Tabula Rasa Solution.

Compounded Regulation Approach: This approach, on the other hand, was the approach that is overwhelmingly used in public policy reform. Assume the history, institutions, political impact, and existing laws and make an incremental change that fixes today’s problem even if it was caused by yesterday’s compounded regulation and will cause more compounded problems in the future. Thus, my process suggestion is to adopt the Tabula Rasa Approach to the exercise of envisioning a 21^st Century Electric Industry first, and then make compromises to the “perfect” later on.

Why is this a wise approach? An interesting example of kismet is that we began the Tabula Rasa Analysis of natural gas at FERC in November 1984. Our “Foundation Paper” (as it was internally called) was perceived as hopelessly naïve when circulated internally circa March of 1985. All the typical roadblocks were thrown up against its vision.

Then on April 21, 1985, the DC Circuit handed down the Maryland Peoples Counsel case which declared several previous compounded regulation fixes to be illegal (DC Case). FERC went into sphincter shock.

But nine days later (yes 9 as in nine–days as in not weeks), FERC issued a two hundred page proposal, RM 85-1, not a word of which was written prior to April 21. This proposal, based heavily on the Foundation Paper, was possibly the most proposed radical restructuring of an industry in regulatory history. Right place, right time, right answer!

With 25 or so years of hindsight, the natural gas reforms were spectacularly successful. Today, we are blessed with abundant supply of a clean burning fuel at very reasonable prices. Where would we be today without the natural gas option?

With the November election looming large as a “vision” election, I don’t assume anything is politically impossible if the fundamental economics and physics are right.

Fundamental Electric Industry Reform—Statement of the Problem—Supply

Analytically tackling the electric industry all at once would be like trying to eat an elephant in one bite. Let’s break down the discussion into bite size pieces. I propose that we first concentrate on defining the problem in 4 bites: supply (this post), transmission, distribution, consumption. After we have come to some agreement on the problems in these four areas (or more if that is necessary) then we can concentrate on the 4^ththought experiment—Tabula Rasa Solutions.

My List of Supply/Production/Generation problems:

1. Fifty-one different state government organizations are required to give permission both as to need and siting to build new supply on the mistaken assumption that there is a natural monopoly in generation;

2. Federal government permission is required to build a nuclear power plant, leading to paralysis for fear of an accident;

3. The federal government made itself responsible for disposal of nuclear waste and thus politics plays a significant role in effectuation;

4. Many states mandate renewables by some percent by some year (renewable portfolio standards) (ironically, natural gas was once outlawed from uses in generation and boiler fuels by the Fuel Use Act; government’s crystal ball on mandates relating to generation is a bit cloudy);

5. Government imposes inefficient environmental policies to deal with otherwise legitimate environmental externalities (EPA standards have created a veritable war on coal);

6. Government provides a myriad of subsidies for different generation fuels that terribly distorts any attempt to achieve economically efficient outcomes for supply (samples: Price Anderson limits a utility’s damages in the event of a nuclear accident and requires the taxpayer to absorb anything above that limit; nuclear has a cents per kwh subsidy for any plants constructed by a date certain; wind and solar subsidies; clean coal research and development, bias against thorium for national security reasons);

7. Costs for much generation is put into “rate base” using regulated utility accounting standards and is amortized based on non-market criteria making level playing field competition impossible;

8. Many states have barriers to self-generation and impediments to reselling self-generated power;

9. Governments own a lot of generation (municipalities and federal power marketing authorities like TVA);

10. Nine states in the Regional Greenhouse Gas Initiative (RGGI) and California have adopted meaningless cap and trade requirements for generation.

That seems like a good start. Does anyone disagree that these all lead to inefficient outcomes? Are there more that should be added to the list?

Quick Responses to Comments on Part I

rbradley { 08.09.12 at 8:13 am }

“Exit contracts” are a Compounded Regulation Solution. I suggest that we first define the “whole problem.”

Tom Tanton { 08.09.12 at 8:19 am }

“Consumer Choice” is a Compounded Regulation Solution. There are lots of moving pieces to “choice.” How does choice fit into a Tabula Rasa Solution?

Ed Reid { 08.09.12 at 8:46 am }

Unfortunately, much of the audience we must convince is too young to get the reference to Casa Blanca. But great laugh for those that did.

Eddie Devere { 08.09.12 at 10:00 am }

Many argued that the natural gas reforms were not legal, i.e. not in the “public interest” or not “just and reasonable.” Admittedly, there was some two steps forward one step back on the legal front but ultimately we were successful in implementing major reforms. I adopt the axiom that law will eventually out to good policy. Remember we have a “vision” election coming up. Anything is possible.

Jon Boone { 08.09.12 at 10:46 am }

I disagree that the “fundamental” problem is lack of consumer choice. There are many much more fundamental problems with the electric industry than lack of choice. Many states do not give their consumers choice but nonetheless have low rates and reliable delivery. Choice may only be a safety valve to circumvent other policy errors. Choice/competition will no doubt be part of the Tabula Rasa Solution, but it is an overstatement to focus on choice alone.

Kent Hawkins { 08.09.12 at 10:50 am }

“Electricity is so imbedded in everything that we do that I do not recommend we think in terms of radical or revolutionary changes at the policy level, but well-thought out evolutionary approaches.”

Sorry, but I disagree. If we “know” what to do, then do it if we have the opportunity. Rip off the bandage and let everyone make efficient adjustments to the new regime. Incremental changes merely create new rent seekers, making “evolving” policy much more difficult. We may never have such a chance again.

Al Fin { 08.09.12 at 1:04 pm }

Maybe we were lucky that health care precluded a full scale green assault. But as we learned with Natural Gas Policy Act of 1978, sometimes bad policy can create conditions that allow for good policy (in that sense Rahm Emanuel is not completely wrong about not letting a “serious crisis to go to waste.”)

Kermit { 08.09.12 at 5:00 pm }

I won’t disagree that many worthy oil and natural gas projects are not undertaken. It’s just a question of priorities. Should I get a face lift or lose 100 pounds? Nothing wrong with face lifts but losing weight is probably a higher priority if you are 100 pounds overweight.

Donald Hertzmark { 08.09.12 at 5:43 pm }

I agree that we have moved in the right direction to some extent. But to reuse my metaphor, don’t declare victory after losing 10 pounds if you need to lose 100. Can we not conceive of better solutions than RTOs, i.e. where is there any analog to dispersed ownership being divorced from operational control that is an effective model?

tfisher { 08.09.12 at 5:57 pm }

Here is your “future post.”

Jim Clarkson { 08.10.12 at 7:41 am }

Jim’s Comment is so good that I will repeat it:

THE UTILITY’S 23RD PSALM

Regulation is my shepherd I shall not want.

Thy maketh me to lie about green programs;

Thy mis-leadeth the stilled public opinion.

Thy restoreth my territorial protections;

Thy leadeth me down paths of monopoly for thy name’s sake.

Yea, though I walk through the valley of the shadow of nuclear debt, I fear no evil cost over-runs: for thou art with me;

Thy guaranteed pass-thrus and thy cover-ups they comfort me.

Thou approveth sweetheart affiliate deals before me in the presence of my potential competitors;

Thou anoinest my balance sheet with inflated assets;

My earnings runneth over.

Surely excess profits and cronyism shall follow me all the days of my life and I shall dwell in the house of regulation forever.”

Blasphemous but unfortunately all too true.

Robert Hargraves { 08.10.12 at 9:26 am }

Great comment. I agree with much of it but I tend to agree with Jon Boone’s response. I am usually most in favor of the “objectivity” of market outcomes rather than placing decisions in the hands of people with mixed motives. Please continue to remake many of these points as they become relevant to the exercise.

Jon Boone { 08.10.12 at 4:37 pm }

Tend to agree with you on your response to Hargraves. Thanks.