Electric Reform Needs a Pro-Market Voice (unopposed politicization must cease)

By Ken Malloy -- May 14, 2014

“When I attend NARUC meetings and other topical meetings, I am absolutely astounded by the number of rent-seeking non-profit organizations that are advocating for changes to shape the electric industry in ways that accommodate their interests (where do they get all that funding?).

Not all of them are wrong! But most assuredly, many of them are!”

The electricity regulatory framework is broken.

The long list of market distorting policy includes subsidies, mandates, mispricing, costly but ineffective regulations, entry restrictions, political vs. evidence based decision-making, social vs. market emphasis, and just plain anti-market bias. Add to this a gaggle of well-financed crony capitalists that can attend endless meetings to advocate for more of these misguided efforts.

The myriad reforms, just another layer of politicization, will take us even further from an economically coherent electric services industry to one that is full of command and control. Yet the voice of those of us who believe in rigorous market-reliance is non-existent in the debate.

We need to organize an effort to bring such a voice to the table.

The existing policy framework has a jurisdictional allocation that made sense at the inception of the electric industry when electricity was an island in each city or municipality.

Thus, like the blind men in the Indian parable, today literally hundreds of regulatory authorities hold a piece of the elephant, but no one yet fully sets policy consistent with the full interstate commerce reality of the essentiality of electric services to our lives (“Though each was partly in the right, And all were in the wrong!”).

Our increasingly digital economy, the age of our grid infrastructure, the environmental implications of generation, and the very real threats of security to the grid unquestionably require that policy be reevaluated to permit the necessary adjustments to modernity.

At its inception, it was reasonably well understood (if incorrectly executed) that some electric services were natural monopolies and that the goal of policy was to ameliorate monopoly abuse and the attendant waste of duplicative infrastructure. (While Samuel Insull no doubt had more nefarious motives, his success in promoting regulation had strong support in well-grounded economics.)

Today, the goals of electric utility regulation bear little resemblance to the traditional aim of preventing monopoly abuse. Public utility regulation is now the vehicle for a host of special interest social experiments at the expense of the diffuse interests of the consumers who will have to pay for any failures in these flights of fancy, both in terms of quality of service and its costs.

The Electric Debate Begins/Continues

Both New York and Hawaii recently released their respective visions on the electric utility of the future. Recently, there has been a spate of reports from organizations hither and yon about the need for and the recommended structure of the utility of the future (see the eight page bibliography to the NY Staff Report).

When I go to recent NARUC meetings (the trade association of state public utility commissioners), there is a palpable frenzy about reshaping electric policy to accommodate the wish list of every special interest imaginable.

I have spent the better part of several days talking to experts (most whom were not market freaks) about the forces arrayed in the debate over reform of the electric utility industry. I have asked the question: “Is there a group that is advocating a framework of reform of electricity policy that is comprehensive, rigorously market-oriented and heavily grounded in sound economics, much like the natural gas, telecom, airline, and trucking industries had?”

The answer is a resounding NO! Nearly all will readily admit that the advocates of change are motivated by a progressive view of the social role that electric utilities should play in the future, animated most pointedly by climate-change ideology. The “malcontents” opposing them are for the most part the utilities themselves.

But the utilities are subservient to the State, beginning with their franchise. Their bottom line is not necessarily affected by success in the market; it is driven by a half-point difference in the return on equity set by a public utility commission.

While utilities are not completely impervious to the implications of many of the shiny objects being dangled before them, they cannot aggressively oppose the dumbest ones (did advocates of renewable portfolio standards learn nothing from the natural gas restrictions of the Fuel Use Act?). They must live in the real world, and that is a very political world.

Where Are the Good Guys?

When I attend NARUC meetings and other topical meetings, I am absolutely astounded by the number of rent-seeking non-profit organizations that are advocating for changes to shape the electric industry in ways that accommodate their interests (where do they get all that funding?). Not all of them are wrong! But most assuredly, many of them are wrong!

What is missing is any coherent vision from analysts driven by rational economics to counter the march of the control-oriented progressives. The natural opponents of many of the ideas being foisted on utilities are the utilities themselves. But they are easily dismissed as self-interested Neanderthals that only want to pollute the environment, exploit the poor, manage an antiquated electric grid, and deliver a stable rate of return to shareholders. (Hey, even a broken clock is right twice a day!)

Well, I have had enough.

Guiding Principles and Approach

Sound policy requires that the default be reliance on markets to order our goods and services. Intervention into the natural outcome of market-reliance is justified when there are serious market failures. Broadly speaking, there are both monopoly and externality failures in the provision of electric services, both of which justify “some” intervention into pure market outcomes. The question is how much and what type?

Think of the current regulatory framework as a Christmas tree. The special interests are each trying to put their ornament on the tree that has grown over the last century: distributed generation, cybersecurity, roof top solar, renewable portfolio standards, net metering, microgrids, war on coal, ocean wind, electric cars, cap and trade, carbon tax, and on and on.

And with each “patch,” we risk another level of dysfunction and distortion that merits yet more control and intervention (what I call compounded regulation). There are some heroic market minded people that are fighting trench battles on each of these “micro” issues, and more power to them (no pun intended).

I do not propose to fight such battles on their own terms, as this is incredibly resource intensive. Rather I am suggesting that we need to fight the macro battle. What are the right policies that should shape the future of this tree? What framework should guide how electric services will be delivered in the 21^st Century assuming we could write on a tabula rasa?

Try this thought experiment. Assume that law, political feasibility, history, and industry institutions are all malleable. Assume only the immutable physics of electricity, laws of economics, and geography of the United States.

What policies would we establish under those conditions to rectify serious market failures? Though little known, this is the approach used at FERC in 1984-1985 for coming up with the new blueprint for the natural gas industry.

Once we have the “right” model of intervention then we will be able to evaluate the consistency or appropriateness of the different ornaments that are proposed for the tree. Methinks that the right economic model of intervention would solve many disputes and allow for market participants to let a thousand ornaments adorn.

While there is no “one size fits all” for all electric services (some want low cost, some want reliability), there must be a single framework of policy rectifying market failures so that the unregulated market participants can optimize their services around that approach of intervention.

Note: I generally believe that the electric grid is a natural monopoly and thus some form of government control is necessary. While I respect the libertarian opinion that we should deregulate the wires, I am skeptical about pushing that view. It is both analytically debatable but more importantly it is politically flawed (yes, I realize I just violated one of the assumptions of the thought experiment) and thus a waste of scarce resources).

Network Restructurings: Been There, Done That

I was a participant in the natural gas reforms of the 80s and 90s (FERC and DOE). I had a bird’s eye view that when “reform” is in the air every special interest jockeys for position to tweak the rules to enhance their economic bottom line.

But this was the Reagan Administration and there was a core of market freaks that were technically adept, ideologically mature, and politically well-positioned to put in place a regulatory regime that 25 years later has made analysts positively giddy with the potential for natural gas to revolutionize our energy policy. (See Dr. Paul Joskow’s recent article or Stephen Moore video on energy boom.)

I also closely watched as the Justice Department convinced Judge Greene that the old model of telecommunications was preventing the potential for competition in many sectors of the telecom industry and the refinements made by the Telecom Act of 1996. While by no means perfect, these competitive principles gave us the technological miracle that is the modern communications industry. (See Ma Bell’s Breakup: 25 Years Later, Everything Old Is New Again).

I might also give a nod to the Democrats in the late 70s (current Supreme Court Justice Stephen Breyer was the special counsel to Senator Edward Kennedy, Chairman of the Senate Judiciary Committee) for deregulating the airline industry in 1978 (with an assist from Dr. Alfred Kahn). (A History of US Airline Deregulation) President Carter and Senator Kennedy also were instrumental in the deregulation of the trucking industry in 1980 (World Bank Article on Trucking Deregulation). Railroads also experienced significant deregulation during President Carter’s Administration. (Rail Deregulation in the United States)

These massive market-oriented network industry restructurings have had a profoundly positive impact on the US economy. (Extending Deregulation: Make the U.S. Economy More Efficient; Macroeconomic Effects of Regulation and Deregulation in Goods and Labor Markets) Thus we have seen massive industry restructurings that have been done well.

We have also seen massive restructurings that have had less stellar impacts on the economy in the financial services industry, housing, and more recently in health care. So the lesson is that if massive restructuring is done right good things happen. If done wrong, bad things happen.

So let’s do electric services right.

Proposal

I am here proposing that we organize a group of market-oriented technical experts to fight the good fight. I have no objection to getting advice from economically self-interested organizations but I believe the group should not include or be financially supported by special interests. (You can view some of my prior posts on electric issues on Master Resource here and here.)

There are enough academics, retired executives, think tank employees, and independent consultants who can make up the critical intellectual mass of the group. We can seek crowdfunding, personal tax deductible contributions, and foundation funding from organizations that do not have an economic dog in the fight (i.e., no Koch Foundation funding). Our primary objective will be to develop comments and reports on sound policy and critique unsound policy.

I have even come up with a proposed name and acronym for the organization: Coalition for Economic Rationality in the Regulation of Electric Industry Services (CERREIS pronounced serious).

I am prepared to go all in if I can get enough show of intellectual support for the effort. I envision it will be a long haul effort rather than a focus on the NY/HI. Literally every state and utility is grappling with the same question.

Additionally, all the successful restructuring efforts mentioned above had a strong commitment at the national level to increasing competition and market-reliance that was in some sense forced on the states. At least today, we have no such commitment at the national level on electric services, in fact quite the opposite. But we should be prepared with a coherent plan in the event that things change in 2017.

Inspirational Closing

I know the Nation needs a voice of market-oriented rationality in the electric debate and I know it will not be there if we don’t make it happen.

I close with a quote from a 1981 Ronald Reagan speech.

All of us came here because we knew the country couldn’t go on the way it was going. So it falls to all of us to take action. We have to ask ourselves if we do nothing, where does all of this end. Can anyone here say that if we can’t do it, someone down the road can do it, and if no one does it, what happens to the country? All of us know the economy would face an eventual collapse. I know it’s a hell of a challenge, but ask yourselves if not us, who, if not now, when?

Let me know in your comments what you think, or feel free to email me at km@caem.org.