Deregulation Done Right

How a different choice in the legal structure of electric deregulation has so far saved Pennsylvania from California's fate

This article originally appeared in the November/December edition of The Pennsylvania Lawyer.

Higher than average costs of electricity in both California and Pennsylvania, in part because of nuclear power, created the political pressures that put the two states among the first to legislate competition in the retail sale of electric power. Gov. Pete Wilson signed California's public utility electrical restructuring statute on Sept. 23, 1996. Gov. Tom Ridge signed the Pennsylvania "Competition Act" restructuring its electric utility industry on Dec. 3, 1996.

Now, five years later, California's privately owned electric utilities are in shambles, with the largest in bankruptcy. More than $13 billion in state money has been spent in stopgap efforts to purchase sufficient power to avoid rolling blackouts, with additional billions committed to long-term power purchase contracts at rates above the current market.

But Pennsylvania has thus far made the transition toward competition and lower retail prices without significant disruption, either to consumers or the commonwealth's public utilities.

Are the different effects of restructuring in California and Pennsylvania merely happenstance or do the contrasts result from conscious choices that were made deliberately by the executive, legislative and judicial branches of each state's government?

Only a longer test, perhaps over at least a decade, can give a definitive answer, but my opinion is that Pennsylvania made the correct choice on a single, but crucial, option in the creation of a deregulated electric-power industry, while California's choice of the opposite option had disastrous consequences.

That single difference in the legal structure imposed on the competitive electric industry is the most significant among the multiple causes of the California crisis. Recent events in Pennsylvania demonstrate that if the commonwealth had taken the California option, our utilities might also be on the verge of financial collapse.

Moreover, Pennsylvania selected the right option for the right reasons. Although the California option was superficially more sophisticated and had been espoused by influential economists, Pennsylvania instead concluded that the California option might undermine the most fundamental principle of electric-power regulation: that certainty of an adequate supply of energy, both gas and electric, is a governmental objective to which other policies must yield, a proposition reaffirmed by the U.S. Supreme Court in 1997.

In 1992, federal regulatory initiatives created the legal framework for a national wholesale market in electric power, including requirements that utilities allow use of their transmission facilities to move electric power owned by others. By late 1995, a consensus had developed in California that the benefits of wholesale competition should be extended to the retail market for electric power.

In contrast to the adversarial and partisan deregulation process that played out in Pennsylvania in late 1996, California's governmental leadership acted virtually without dissent to enact a comprehensive scheme, based on the best academic pronouncements, to create a legal structure for electric power that was confidently believed would assure Californians the benefits of lower-cost electricity.

The first step was the adoption of a comprehensive plan for deregulation by the California Public Utility Commission (PUC) in December 1995. Assembly Bill No. 1890, adopted unanimously in both houses of the legislature and signed by Gov. Wilson in September 1996, implemented that plan.

As in Pennsylvania, the California restructuring provided for payments to allow incumbent public utilities to recover so-called "stranded costs," especially the costs of building nuclear generating facilities. Following the near-meltdown at Three Mile Island in March 1979, the cost of completing nuclear facilities increased by many billions of dollars, as regulators imposed onerous safety requirements intended to prevent repetition of that disaster.

Under traditional regulation prior to restructuring, these costs would have been recoverable over time from the consumer-ratepayers in amounts approved by each state's PUC. Part of the reason for high retail electric prices in both California and Pennsylvania was the regulated return on investment required to pay for nuclear facilities, such as Diablo Canyon built by Pacific Gas & Electric (PG&E) and the Limerick project of Philadelphia Electric Co. (later renamed PECO Energy Co.). Under the new competitive regime, in which the price for electric power would be set by a competitive national market, the full cost of such facilities could never be recovered, hence the concept of "stranded costs" like a ship stranded when the tide goes out. Both in California and Pennsylvania, a portion of the stranded costs (also referred to as "transition costs") would be recoverable in an amount determined to be fair by the respective PUCs. They would be recoverable from the consumers in the geographical territory of a public utility through so-called "transition charges." These had to be paid even if consumers chose to purchase power from new...