Electricity Deregulation: High Cost, Unmet Promises

March 12, 2006
Washington Post
Terence O'Hara

Maryland and District consumers angry at the record electric bills they will receive this summer might want to recall the promises made by proponents of deregulation seven years ago. If they do, they'll be even angrier.

At the time, in 1999, evangelists for deregulation described a competitive, efficient and lower-priced system of energy delivery that, for the most part, remains a fantasy in the Mid-Atlantic region and other parts of the country today, according to industry experts.

The District, Maryland and Virginia, along with much of the nation, are wrestling with the ramifications of deregulation at the same time that the cost of producing electricity is skyrocketing. But as energy prices have soared, electricity rates have gone up more in deregulated states than in regulated ones.

Though Northern Virginia residents won't feel the full effects of deregulation until 2010, when rate caps expire, caps were lifted for Pepco customers in the District and Maryland several years ago, resulting in steady increases, including a 38 percent jump for suburban Maryland and 12 percent for the District announced last week.

Baltimore Gas and Electric Co. customers in Maryland have had artificially low rates for six years because of caps set in the 1999 deal that allowed deregulation to go through, so the sudden 72 percent increase announced last week is a rude awakening.

"With something of that magnitude, I thought, God, it can't be," said Don Dunn, a 77-year-old retired businessman in Howard County on a fixed income. "My gut reaction was, gee, the whole thing is an error."

Dunn, who spent about $700 on electricity last year, is wondering how he can afford more even as property taxes are rising. While he is worrying that he might have to give up the two-story brick home in Ellicott City where he has lived for more than 40 years, deregulation has turned out well for BGE's parent company.

Constellation Energy Group Inc.'s revenue has nearly doubled in two years, to $17.1 billion in 2005. Chief executive Mayo A. Shattuck III's cash compensation was nearly $5 million in 2004, up more than 176 percent from 2002. And shareholders are being rewarded with an $11 billion merger deal with a Florida power company.

Residential customers -- especially those in Maryland facing an average $743 yearly increase in their BGE bills -- are left wondering what deregulation was for, if not to reduce prices.

Under the old system, the price of electricity was strictly based on what it cost the power company to produce it. Now, prices are based on what several hundred highly sophisticated power suppliers and traders believe the market will bear, prices that can have only nominal relation to cost.

In Annapolis, the outcry from voters has sent lawmakers into a frenzy to respond to the rate increase.

Sen. Leo E. Green (D-Prince George's), a longtime opponent of electric deregulation, blamed its failure on false promises from energy companies in the 1990s.

"This whole thing was started with Enron," he said.

Enron Corp. envisioned a world in which power nationally would become a commodity, much like oil, and it could profit by being a supplier and trader of that commodity. Enron lobbied heavily in states, including Maryland, for deregulation. A little less than half the states embraced some form of deregulation in the late 1990s.

But Enron later succumbed to a wave of scandals, including one in which it manipulated the California wholesale electricity market in 2001, causing prices to soar.

Deregulation has not worked as envisioned in any of the 20 states that have undertaken it, said Kenneth Rose, an Ohio energy consultant who advises state utility regulators.

"Those of us who were in favor of the competition that deregulation promised, and I was one of them, haven't had our hopes realized," he said. "Not at all. It was Enron in California where I first thought something is not working here."

For state governments that bought into deregulation, the remorse has been acute.

"I think everyone is just looking at Maryland and getting sick to their stomach," said Elizabeth A. Noel, the D.C. people's counsel. "This is not what was supposed to happen...Nobody intended this."

Constellation officials are adamant in their contention that neither deregulation nor BGE is responsible for the rate increase. The fault lies, they say, in sky-high raw energy prices, particularly natural gas, which is used to generate about half the electricity used in this region.

"Price increases are driven by fuel rises, and gas prices have tripled since 1999, oil prices have doubled and coal prices have doubled," said Mark Case, director of regulatory services for BGE.

Rate increases have been higher in states that deregulated than in those that kept the old regulatory framework. Among the regulated, rate increases have varied widely -- 4.4 in North Carolina, 23 percent in West Virginia and a high of 32 percent in Oklahoma, according to Regulatory Research Associates. Among the deregulated, Delaware will have a 35 percent increase in May.

Experts say higher energy costs are only part of the reason for the jump in wholesale electricity prices, upon which residential rates are based.

Among the promises of deregulation was competition -- homeowners and businesses would be able to pick their own energy providers, creating price competition with local power companies. In Maryland, that has not happened. Part of the blame, experts say, lies in the way Maryland deregulated. The 1999 rate caps, which are coming off this summer, imposed a falsely low rate that no BGE competitor could match, preventing competition.

"We were sold a myth called competition," said Del. Patrick L. McDonough (R-Baltimore County). "We will find Jimmy Hoffa in Maryland before we find competition."

Kenneth J. Schrad, a spokesman for the Virginia State Corporation Commission, said the main guarantee of Virginia's deregulation was that its 3.2 million customers would be able to choose their own power suppliers.

"But that doesn't mean much because there isn't anybody to choose," Schrad said. Out of the entire state, only 1,450 customers have switched to a new provider since deregulation -- and they actually switched to a more expensive supplier only because it is environmentally friendly, Schrad said.

Another promise was that suppliers, freed from state regulation, would sell their power to the highest bidder, creating market incentives for increased efficiency and investment in new technologies. But since 1999, older, less-efficient plants have remained profitable, discouraging investment in new plants. The Mid-Atlantic region still has a shortage of capacity, and during much of the year must import energy from outside the area, often at high prices.

Deregulation was also supposed to encourage development of a national grid system. Utilities and their would-be competitors could buy from the lowest-cost producer, no matter where the producer resided. Pepco could, in theory, buy power from a plant in Oklahoma using cheap natural gas. But the national grid hasn't been improved because power producers -- the most logical source of capital to improve the system -- don't want the competition a robust national grid would allow. Today it is nearly impossible to move large amounts of electricity over long distances.

The Virginia General Assembly, getting nervous in 2004 over the lack of competition, extended the rate caps on Dominion Virginia Power -- which serves Northern Virginia -- until Dec. 31, 2010. Prices can be adjusted for rising fuel costs, though, in 2007, and analysts expect that to boost residential rates dramatically.

Under the regulated system, the power company owned both the power plants and the wires used to deliver the power. Seven years ago, regulators in Maryland, the District and Virginia effectively gave up control over the plants, handing that market power over to unregulated generating companies that were free to charge whatever they could.

Pepco sold all four of its power plants in the region in 2001 and became only a distribution company. While Constellation retained its power plants, it separated them for legal purposes from BGE, which now buys its power not only from Constellation but also from other producers. In Virginia, Dominion operates in the same way as Constellation.

Under this system, said Schrad and Rose, low-cost coal-fired and nuclear plants are able to sell power at the same price as much more expensive natural-gas-fired plants. The primary beneficiaries are, like Constellation, owners of coal and nuclear units.

Noel, the D.C. people's counsel, said lawmakers had assumed that energy companies such as Enron would be slashing prices to enter new markets, but after Enron and other energy companies collapsed, no one was interested in local energy markets.

"We opened the doors, and no one was there," she said.

Constellation has become one of the country's leading independent energy suppliers and marketers. Its Commodities Group buys and sells electricity and natural gas and is now the largest electricity broker in the country. It advises more than 10,000 companies on how to best use energy, including how and where to buy it. It owns 107 power plants at 34 locations in California, Illinois and Maryland.

With higher prices, more competition could still emerge. Last week, Washington Gas Energy Services Inc., a sister company to the District-based Washington Gas Light Co., began offering a 10 percent discount off BGE rates to Maryland customers.

Once deregulated, Rose said, it is nearly impossible for Maryland or other states to retreat.

"It's really just bad luck," Rose said. "A lot of these rate caps are coming off at a time when gas prices are sky high. While this does raise questions about the design of the wholesale market, there's actually very little any one can do about it at this point."

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