Power markets: restructuring electricity

Contemporary Economic Policy, Jan, 1999 by Richard A. Bilas, Kenneth L. Lay, Gordon R. Smith, Michal C. Moore, Robert J. Michaels

Editor's Note: This is an edited transcription from the general session of the 73rd Annual Conference of the Western Economic Association International, held in Lake Tahoe, Nevada.

Richard A. Bilas, Moderator: This year I happen to be President of the California Public Utilities Commission, and I'm here today to act as the moderator for this General Session on Power Markets.

As an historical aside, I was a commissioner with the California Energy Commission from 1987 through August 1995. I took a sabbatical from August 1995 through the end of 1996 when I held the Brock Chair in Energy, Economics, and Policy at the University of Oklahoma. I returned to California to serve on the California Public Utilities Commission (CPUC) in January of 1997.

That sabbatical from California was very important. Those of you who are familiar with the restructuring process in California will realize that I was absent during what has become known as the "August 1996 Death March" in Sacramento when legislators hammered out - Assembly Bill 1890. The stake holders were all invited in the hottest time of the year to the hottest city in the Central Valley of California to put together the implementing legislation to bring about restructuring. Fortunately, I was not in attendance at that Death March.

Let me introduce today's discussion by giving a brief history, albeit Bilas' interpretation of history, as to what has been happening in electric power markets in California and why. Then, the panelists will fill in the blanks.

In the late 1980s and early 1990s, there was an important debate involving the measurement of external costs due to power plant pollutants. Part of that debate centered on substituting conservation measures and renewable resources (wind, solar, geothermal, and biomass) for fossil generation. At that time, electricity rates in California were about 50% above the national average.

Emphasizing the need for development of conservation and renewable resources might make one think rates would only go higher. However, electricity bills were about at the national average. In addition to the externality debate, a second debate arose: "rates versus bills - what's more important."

Now while it may be true that bills are what concern residential rate payers and perhaps small commercial rate payers, rates also are important to industrial consumers and to large commercial consumers. Given technology, an industrial facility can cut its energy cost by locating in a jurisdiction with low electricity rates. Given the high rates in California, businesses were leaving very rapidly.

The CPUC, at about that same time, began to examine possible regulatory changes that would effectively lower rates, provide real consumer choice, and permit innovation on the supply side of the market. The CPUC simply asked the following question: How can we break up the vertically integrated monopoly and provide, where possible, the benefits of competition?

The two-plus-year debate resulted in the December 12, 1995, Preferred Policy Decision of the California Public Utilities Commission. That landmark decision set in motion formal industry restructuring to begin on January 1, 1998. The Legislature, during its Death March in August of 1996, codified much of the proposed policy decision and added a few very important elements in that restructuring bill known as Assembly Bill 1890.

AB 1890 passed both houses of the California Legislature unanimously without a single dissenting vote and was signed into law by Governor Wilson in September of 1996.

Some of the high points of the Preferred Policy Decision and Assembly Bill 1890 include the following:

1. The establishment of an Independent System Operator (ISO) to provide for system reliability.

2. The establishment of the Power Exchange (PX) to provide a commodity market for the buying and selling of electricity. Investor-owned utilities are required to sell their generation into this market and must purchase from the Power Exchange. In addition, bilateral contracts between buyers and sellers are permitted. This is generally known as "direct access."

3. Uneconomic assets of the investor-owned utilities are to be completely paid for by a non-by-passable competition transition charge (CTC). These stranded assets amount to something on the order of $28 billion (present value).

4. A 10% rate reduction was to go into effect for small commercial and residential consumers on January 1, 1998. That rate reduction did go into effect at that time. Rate reduction bonds could be sold to help curtail the costs of this rate reduction. Some $7.4 billion in rate reduction bonds might be sold.

5. Rates were frozen until January 1, 2002. Utilities were encouraged to divest themselves of their fossil assets but not ordered to do so. The Legislature and the CPUC stayed away from using the nasty D-Word - "divestiture." The three investor-owned utilities are all in the process of "voluntarily" - if you will - engaging in this activity of divestiture.

6. Revenue cycle services (billing, metering, etc.) were to be unbundled and sold separately. These will be itemized on the bill beginning January 1, 1999.