EIA analyzes restructuring of electricity markets - Energy Information Administration's reports - The Statistics Producers' Corner - Column

Business Economics, Oct, 1998

Since 1993, the Energy Information Administration (EIA), the independent statistical and analytical agency within the U.S. Department of Energy, has prepared a number of reports about the restructuring of electricity markets occurring at both the federal and state levels. Two of the recent reports, The Changing Structure of the Electric Power Industry: An Update and The Changing Structure of the Electric Power Industry: Selected Issues, 1998, provide the background for the restructuring initiatives and the status of the transition to competitive markets. A third, Challenges of Electric Power Restructuring for Fuel Suppliers, discusses impacts on the nation's fuel supply and transportation infrastructure. Two others released in 1997, Electricity Prices in a Competitive Environment and Annual Energy Outlook 1998, address future electricity demand under fully or partially deregulated markets. Finally, Issues in Midterm Analysis and Forecasting 1998 updates the competitive price projections in Electricity Prices and presents a case study that examines whether market power exists in a restructured electricity market.

Background and Status

The electric power industry is undergoing a transformation from an industry primarily composed of regulated electric utilities that own generation, transmission, and/or distribution facilities and have designated franchise service territories to a competitive industry where retail customers will have a choice of their electric energy supplier. In addition, newly formed organizations, called Independent System Operators (ISOs), will operate the transmission networks to assure nondiscriminatory service, and some utilities will divest themselves of their generating plants. The transformation actually began in the wholesale market with the passage of the Public Utility Regulatory Policy Act of 1978 and continued with the Energy Policy Act of 1992 and the resulting Federal Energy Regulatory Commission (FERC) Orders 888 and 889 in 1996. These legislative and regulatory actions removed barriers to wholesale trade and made it possible for nonutility suppliers to enter the wholesale power market. In 1985, nonutilities generated 28 billion kilowatt hours (kWh) for sale to the utilities (who are responsible for ultimate distribution), and by 1996 those sales had increased to 229 billion kWh.

State legislative or regulatory actions will determine how and when retail competition will begin in each state. However, changes have already occurred in retail markets in response to competitive market pressures prior to the start of full retail competition. Most notably, the retail price of electricity for the industrial sector has been declining, falling from 4.9 cents per kWh in 1993 to 4.6 cents in 1996. As of July 1, 1998, twelve states had passed legislation for retail competition and six additional states had issued regulatory orders. Retail choice for all consumers began in California in March 1998 and will begin in Massachusetts and Rhode Island later this year. The other states that have passed legislation specified a date to start retail competition as late as 2002, and some adopted a phased-in approach to statewide retail choice of an electric energy supplier.

A crucial issue that the states have to address for the successful implementation of competition is the recovery of stranded costs. Stranded costs may be viewed as that portion of the value of a utility's existing assets (i. e., the unamortized portion of historical costs outstanding on the books of a utility) that would have been recovered under regulation but cannot be recovered through revenues in a competitive market. They result from high-cost generating plants (especially, but not exclusively, nuclear), high-cost power purchase contracts, nuclear decommissioning costs, and regulatory assets. Estimates of stranded costs nationally range from $100 billion to $200 billion. FERC established a precedent on wholesale stranded cost recovery in Order 888, stating that recovery of legitimate, prudently incurred and verifiable stranded costs should be allowed and that those costs should be recovered from the departing customer. Following the above lead, most states are providing the opportunity for the recovery of retail stranded costs contingent on adoption of appropriate mitigation strategies.

The process usually starts with the utilities submitting estimates of stranded costs that they seek to recover for review by the regulators. The states also designate the method and period of recovery that will be used to recover stranded costs. Two proposed methods are: (1) charging a fee as part of transmission or distribution charges that customers cannot bypass, or (2) securitization, i.e., securities are sold through a financial vehicle to lower the asset-related liabilities of a utility, and repayment will be made through future revenues collected as a competition transition charge.

Analyses and Projections

The restructuring of the electric power industry will also lead to changes in the financial risks and demands on the supply and transportation infrastructure of the fuels used to generate electricity. EIA has recently released a report, Challenges of Electric Power Restructuring for Fuel