Deregulation of the US electric utility industry continued its halting, uncertain march across the US in 2000, but at yearend it appeared that larger steps had been taken backward than forward. While a handful of states, most notably Pennsylvania, seemed to be finding success with restructured retail electric markets, any good news was greatly overshadowed by bad news out of California. There, low power reserves, threats of rolling blackouts, distraught customers, and financially strapped investor-owned utilities (IOUs) grabbed newspaper headlines almost daily throughout the latter half of 2000.

California's troubles had far-reaching impacts on legislation and regulatory decisions in other states. As the first state to deregulate its electricity market, California became the standard by which other states could judge the value of restructuring. By the start of 2001, it had set a less-than-shining example. Carl Wood, a member of the California Public Utilities Commission, was quoted in a late-November issue of the Albuquerque (NM) Journal as saying, "I would advise other states to take a careful look at experiences chalked up in California and other states. We have been the guinea pig, and guinea pigs don't fare well."

Other states did take notice of California's problems. Several states, generally those that historically had enjoyed lower-than-average electric rates, began calling for delays or halts to their restructuring processes. In some states further along in their restructuring efforts—including California itself—consumer advocacy groups and lawmakers opposed to deregulation began to call for reregulation. The concept of a deregulated US electric market had taken serious hits by yearend 2000.

Price differentials

Prior to the push for deregulation in the US, electric utilities owned the generation, transmission, and distribution functions and operated within their areas as essentially regulated vertical monopolies. After deregulation, transmission and distribution would remain as regulated functions, but generation would be subject to much less regulation.

One of the main reasons behind the push for deregulation in the electric utility industry was the conventional belief in the US that an industry's customers could be served better by a competitive market than by a monopoly. Throughout the 20th century, utility customers had felt comfort and security with the regulated electric industry, but by the end of the century, some consumers—particularly large commercial and industrial customers in high-energy-cost states—had joined the push to restructure one of the country's last major regulated industries.

With the Energy Policy Act of 1992, Congress set the industry's deregulation in motion by encouraging competition in generation. While restructuring of electricity's wholesale markets was a federal matter, retail restructuring was left up to the states. By December 2000, 24 states and the District of Columbia had taken steps to open their retail electric markets to competition by enacting legislation or issuing regulatory orders (Fig. 1).

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While consumer prices were relatively stable under regulation, the price of electricity varied substantially from state to state (Fig. 2). The intended result of deregulation would be to stabilize those prices. Generally, states with higher average electric rates (such as New York, New Jersey, and California) made a stronger push toward deregulation. Lower-cost states (such as Kentucky, Alabama, and Oklahoma) had been much slower to embrace the ideals of a restructured industry. If one of restructuring's main goals was to even out prices across the nation, low-cost states often saw themselves as potential losers in the deal.

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Also at the core of industry restructuring was the concept of consumer choice. Under deregulation, consumers in many locales would have a choice of electricity supplier. The electric power would still travel the wires owned by the traditional utility, but consumers would have a choice as to the origin of that electric power. By the end of 2000, 14 states had opened some form of electric supplier choice to customers, giving about 21% of customers the right to choose their electric power supplier, according to a report released in late 2000 by Cambridge Energy Research Associates. However, it was estimated that only about 1% of customers, representing about 1.5% of the electric load, had switched to a nontraditional electric supplier (Fig. 3).

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According to the Cambridge Energy Research Associates report, the relatively low number of customers opting for choice was the result of a lack of price competition among suppliers. Pennsylvania was one of the few states that had seen a significant number of electric customers opt for an alternative supplier, and that was attributed to default pricing mechanisms set to encourage competition.

California's problems

In 2000, California, which had been the first state to deregulate its electric industry, provided an almost perfect picture of what potentially could go wrong in a restructured utility market.

In 1996, the average revenue per kilowatt-hour of electricity in California, a reported value representative of price, was 9.48¢, the 10th highest rate in the US, according to the US Department of Energy's Energy Information Administration (EIA). When California wrote and passed legislation in 1996 to deregulate its electric industry, one of the main goals was to lower rates to consumers. However, in 2000 it appeared that the opposite would be the case.

The first and most obvious signs of serious problems in the restructured California market came out of San Diego in the summer of 2000. Since San Diego Gas & Electric (SDG&E) was the first of the three major California IOUs to pay off its stranded costs, it was consequently the first major US electric utility to offer true market prices to its customers.

SDG&E began charging those market prices in summer 1999. In that first summer of full-scale deregulation customers fared well. But in summer 2000, when SDG&E passed on high wholesale prices to consumers, SDG&E customer bills doubled and in some cases tripled what they had been in 1999.

In response to the skyrocketing bills, the California Independent System Operator (ISO; the not-for-profit corporation set up to manage the flow of electricity along the power lines that make up the bulk of California's transmission system) instituted a $750/Mw-hr price cap on wholesale power, which was later reduced to $250/Mw-hr. The ISO's price cap was derided by some who saw such an intrusion as a further impediment to the market's natural transformation. Even with the wholesale price cap, SDG&E customers were subject to higher prices than they had been accustomed to before full-scale deregulation.

Consumers took the brunt of high wholesale electric prices in SDG&E's service territory, but that was not the case for California's two other major IOUs. As 2000 came to a close, Pacific Gas & Electric (PG&E) and Southern California Edison (SCE) revealed their own deregulation horror stories.

PG&E and SCE at the end of 2000 were still in a regulatory transition period, which, in accordance with California's deregulation rules, meant the rates they could charge customers were frozen. Despite the frozen customer rates, PG&E and SCE were not immune from rising wholesale costs. Unable to pass on even a portion of those rising costs to customers, PG&E and SCE by yearend were claiming to be near bankruptcy. The combined debt of PG&E and SCE as a result of wholesale price spikes was reported to be between $9 billion and $11 billion as 2000 came to a close.

Under that duress, both utilities were asking permission to be absolved of deregulation's constraints and sharply raise their customers' rates. At year's end, California Gov. Gray Davis was attempting to broker a compromise between the two utilities and consumer groups who, not surprisingly, opposed any mention of rate hikes.

At yearend 2000, established IOUs and their customers were not the only market participants weakened by California's ills. Alternative energy marketers were also showing signs of fragility. New West Energy, an affiliate of Salt River Project, announced in late December 2000 that it would suspend commodity sales in California and return its customers to PG&E and SCE. According to a New West Energy press release, "Recent regulatory actions in California, coupled with current supply shortages and price volatility, have had the effect of imposing unmanageable financial risks to energy service providers."

New West Energy's exit from the California market was an especially troubling event, as competitive choice was at the basis of California's, and most every other state's, restructuring efforts. New West Energy was one of the first energy service providers to enter the deregulated California market.

Most of the blame for California's myriad problems in summer 2000 was placed on a lack of supply. According to the California Energy Commission, supply in the California market had grown only 1% since 1995, while demand had expanded by 11.5%. No significant generation or large power plants had been added to the California market for more than 10 years. That lack of generation led to the high costs of power incurred by utilities, and in the case of SDG&E, utility customers.

Low supply and its effects on the California market had left Davis, the governor, unsure of California's deregulated future. In a Dec. 28, 2000, Associated Press article, Davis had this to say to reporters after meeting with then-Pres. Bill Clinton to discuss the crisis: "It's going to be a good 2 years before we can have enough additional supply to balance out demand. When we have that, deregulation may work. But it's clearly not working now. It's an experiment that, at best, was prematurely launched in California."

Deregulation elsewhere

In the latter half of 2000, the problems California was experiencing with its restructured electric markets—and the lack of any definitive solutions to those problems—were affecting state legislation and regulatory orders across the US. Serving as deregulation's bellwether state, California had offered a glimpse at the dark side of a competitive retail electric market. Regulatory bodies across the nation approached the issue of electric deregulation with a far greater degree of trepidation than had been displayed prior to summer 2000.

As a result, a number of states in late 2000 had delayed the opening of their retail electric markets. In other states, legislators and consumer advocacy groups made calls for a return to the regulatory structure to which utilities and their customers had grown accustomed through much of the 20th century.

The EIA reported that the following states were expressing significant concerns about industry restructuring by late-2000:

Alabama. A study released in early 1999 by the University of Alabama and Auburn University indicated that customer electric rates in Alabama could rise as much as 6% if retail competition were enacted in that state. As was the case in many states that historically had enjoyed low electricity rates, it was believed that Alabama would be slow to enact restructuring legislation. That assertion held true through 2000.

In late 1996, a report issued by the Alabama Public Service Commission's advisory staff led to the formation of a Staff Electric Industry Restructuring Task Force, which was charged with studying the implications of restructuring Alabama's retail electric industry. In October 2000, after reviewing the task force's "Report on the Public Interest and Role of Commission," the Alabama PSC decided to close formal inquiry into restructuring Alabama's retail electric markets. The report stated that it had not been demonstrated that Alabama consumers would receive reliable and efficient electric service at a reasonable price in a restructured retail market.

Arkansas. Although restructuring legislation originally dictated that Arkansas would begin opening its electric industry to retail access in January 2002, concern over the crisis in California resulted in the likelihood of a revised time frame. In October 2000, the Arkansas Public Service Commission opened a docket to study events in California's tumultuous market. In late November, the Arkansas PSC released its "Report on Electric Restructuring to the Arkansas General Assembly." In that report, the PSC recommended extending the dates for deregulation from the originally legislated period Jan. 1, 2002-June 30, 2003, to Oct. 1 2003-Oct. 1, 2005. The EIA reported that the extension was requested to allow more time for the wholesale market and new federally regulated transmission organizations to develop.

Minnesota. Efforts to restructure the Minnesota electric industry were at a standstill at yearend 2000. In a report titled "Keeping the Lights On: Securing Minnesota's Energy Future," the Minnesota Department of Commerce in September 2000 warned against full retail electric competition in the state. The department cited potential shortages in available energy, not unlike those experienced in California, as being the reason for its recommendation. The Department predicted that by 2006, the US Midwest could experience an energy shortfall of 5,000 Mw. While recommending against retail competition, the department did recommend a change in the tax structure to encourage new power plant construction.

Mississippi. Mississippi's Public Service Commission concluded in 2000 that electric competition would not benefit consumers. PSC studies indicated that consumer electric rates, which were below the national average, were likely to rise under competition. Mississippi's PSC reached its conclusion in May 2000, before concerns over deregulation came to a boil in California.

Montana. In late December 2000, the Montana Public Service Commission issued an order extending Montana's restructuring transition period for 2 years. Citing price surges in the spot market and predictions of prolonged supply shortages, the PSC voted on Dec. 21 to delay full retail open access until July 2004. Montana had originally set July 2002 as the date by which all IOU customers were to have moved to choice.

Nevada. The deadline for the start of competition in Nevada had been delayed numerous times by the end of 2000. Rumblings in the state legislature were that legislation was planned for introduction in 2001 that would return Nevada's utilities to a traditional regulated structure.

New Mexico. In late summer 2000, increasingly evident problems in the California market prompted New Mexico's attorney general, the New Mexico Industrial Energy Consumers, and the New Mexico Rural Electric Cooperative Association to ask the New Mexico Public Regulation Commission to postpone a decision that would authorize the state's IOUs to unbundle their operations. Earlier in 2000, the state's IOUs cited inadequacies in their billing and customer information systems and asked the PRC to delay the start of competition. In response to the request, the PRC delayed retail access for schools, small businesses, and residential consumers for 1 year to Jan. 1, 2002.

North Carolina. No restructuring legislation had been enacted in North Carolina as of December 2000, but a legislative study commission had made recommendations to open the state's retail electric markets to half of the state's consumers by January 2005 and to the other half by January 2006. It was believed that legislation might be enacted in the 2001 legislative session.

Despite the lengthy timeframe of North Carolina's proposed restructuring, in December 2000 a group representing North Carolina's municipal power systems called for lawmakers to delay the deregulation plans. The group, ElectriCities, cited California's problems and rising wholesale natural gas prices as reasons to slow down decision-making. The group originally supported deregulation of North Carolina's electricity industry, but ElectriCities Chief Executive Officer Jesse Tilton told the study commission that because of problems "in other states," the group had reevaluated its position.

"ElectriCities is still in favor of deregulation if it benefits the consumer," Tilton told the legislative study commission in late December 2000. "But our analysis of the numbers shows that consumer benefit isn't there right now."

In a newspaper article published in The News & Observer (Raleigh, NC), Sen. David Hoyle, cochairman of the study commission, admitted that California's summer 2000 experiences had slowed the momentum of deregulation in North Carolina. But he said that despite California's problems, "Deregulation is going to occur."

Oklahoma. In early 2000, legislation that would have set the rules for restructuring in Oklahoma was narrowly defeated in the state's House of Representatives. The proposal was expected to be reintroduced during the 2001 legislative session.

The Electric Restructuring Act of 1997 set the deadline for deregulating Oklahoma's retail electric market as July 2002. In November 2000, Oklahoma Atty.-Gen. Drew Edmondson recommended postponing the July 2002 deadline to allow time to study the economic impact of electricity restructuring. Like in Alabama, Minnesota, and Mississippi, Oklahomans historically had enjoyed relatively low electric bills. It was thought that deregulation would raise Oklahoma's residential rates to be in line with regional averages.

Hope in Pennsylvania

In contrast to problems in California and delays in several other states, a handful of states, led by Pennsylvania, offered hope that a restructured market could work.

By yearend 2000, all Pennsylvania electric customers were eligible to choose their suppliers of electricity. According to the EIA, Pennsylvania's restructuring program was the most successful in the nation in 2000 in terms of the numbers of customers who had switched energy suppliers. During the year, EIA said, 52 suppliers were licensed to sell electric power in Pennsylvania, and 408,414 (or 8%) of Pennsylvania's residential electricity customers had switched providers. Figuring in the commercial and industrial segments, the number of customers being served by alternative providers in Pennsylvania was well over 500,000, according to the Pennsylvania Office of Consumer Advocate.

A study of 2,068 residential electricity customers released in late November 2000 by Power Perceptions, a firm specializing in electricity consumer research, showed that 31% of Pennsylvanians were "completely satisfied" with their electric service, compared to 24% nationwide. Stephen K. Carter, Power Perceptions executive director and the study's principal investigator, suggested that the key to Pennsylvania's success may have been the state's high default service pricing, which, he said, had encouraged competition among electricity suppliers.

"Most states set the default prices so low it's almost impossible for alternative companies to compete," Carter said. Pennsylvania's higher default prices allowed alternative companies to offer more-competitive prices than they might have been able to in other deregulated states, Carter said. "If what happened in California (in summer 2000) shows what can go wrong with deregulation, what's happening in Pennsylvania shows that competition can succeed."

While California's troubled electricity market elicited alarm, the apparent success of a restructuring electricity market in Pennsylvania provided a measure of reassurance for a nation largely soured on the idea of deregulation. The outlook in several other states was positive as well.

Although full competition in Texas would not begin until January 2002, a total of 11 companies by yearend 2000 had filed with Texas' Public Utilities Commission to provide energy. Texas would be the second large state (after California) to open its electric industry to competition, and industry watchers were hopeful for a more successful showing than had been displayed in California.

State legislators laid the foundation for Texas' restructuring efforts in 1995 with Senate Bill 373, which ultimately became the Public Utility Regulatory Act of 1995. That act restructured Texas' wholesale electricity market consistent with FERC requirements and required the establishment of an ISO. According to an EIA report titled "The Changing Structure of the Electric Power Industry 2000," the Electric Reliability Council of Texas (ERCOT) ISO "does not participate in generation dispatch, in power exchanges, in providing ancillary services, or in establishing prices other than determining the cost of any redispatch needed to allow transactions to occur."

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p--California ISO operators monitor the status of California's transmission system. The California ISO assumed responsibility for managing the flow of electricity through the state's transmission system in March 1998, when California opened its energy markets to competition.

In 1996 legislation was enacted in Texas to allow open access to the state's transmission system. According to the EIA report, "The Texas approach to implementing competition has been cited as a good model for restructuring." The report specifically pointed out that Texas' decision to deal upfront with wholesale issues and equal access to the transmission system was seen as a positive step toward a strong retail market.

Texas also appeared to be avoiding the supply problems California faced in 2000. According to Texas PUC chairman Pat Wood III, 23 new power plants had been built in Texas since 1995. Twenty-four more were under construction in late 2000, and plans for another 28 had been announced. Those 75 new or planned facilities stood in sharp contrast to a lack of generation in California, where no significant new generation had been built in a decade.

Likewise, the future seemed bright in Virginia, where in late December 2000 regulators, although cognizant of California's woes, were confident enough in their state's market to release a proposal to accelerate restructuring efforts by a year.

Hope remained for a restructured electric utility industry as 2000 came to a close. But all signs of it appeared east of California.