Shocking electricity prices follow deregulation

August 10, 2007
Paul Davidson

When Deborah Jackson opened her electric bill in February, she had no idea it would be a life-changing event.

She and her husband, Patrick, who live in a three-bedroom brick house in East St. Louis, Ill., owed Ameren (AEE) $600.82, up from $172 in January. In March, the tab floated into the stratosphere: $1,024.31.

Since the couple's budget billing plan lets them pay the same amount each month, the charges were eventually set at $538.

To keep the lights on, Deborah has returned her engagement ring to the jeweler until the Jacksons can afford the ring's $125 monthly payment. Patrick, a warehouse employee, works an extra day each week. The Jacksons and their two kids no longer eat out or go to the movies.

"It's frustrating because you can't do the things you're used to doing," Deborah says. "You're like, 'I'm just working to pay a light bill.'"

The Jacksons are among millions of U. S. residents reeling from the aftershocks of electricity deregulation in 17 states and Washington, D.C. After rate freezes in Illinois expired in January, bills soared up to 55% for Ameren customers and 26% for those of Commonwealth Edison. The Jacksons were hit with a much bigger increase because their house is among 170,000 Ameren dwellings that got big discounts for using electric heat. Those discounts also ended in January.

Deregulation was supposed to do for the power industry what it did in the airline and telecommunications industries: bring consumers lower prices and more competition. Instead, utility bills are rising sharply for residents in many states that unshackled their power markets as rate caps, the final remnants of regulation, expire.

Now, several deregulated states, fearing a public backlash, are turning back the clock and reinstating some form of electricity regulation. The Illinois legislature last month approved a $1 billion rate-relief package that would on average halve the increase that socked Illinois customers like the Jacksons. The pact also scraps a controversial wholesale-power auction system and sets up a new agency to buy electricity and build generators.

Virginia reregulated its power industry in July. Other states have partly reregulated or are weighing doing so before rate freezes are lifted. In Ohio, rate caps are scheduled to end in December 2008, when utilities would buy their power in the wholesale market.

"Some feel you should let the market take over, but based on what I've seen happen in other states, it's just not something I'm willing to tolerate," Ohio Gov. Ted Strickland said.

While average prices rose 21% in regulated states from 2002 to 2006, they leapt 36% in deregulated states where rate caps expired, according to a study by Ken Rose, senior fellow at the Institute of Public Utilities at Michigan State University.

Electric rates for Baltimore-area customers surged 50% in June after a 15% jump last year as rate caps came off. There have been similar surges in Connecticut, Delaware and Rhode Island. Meanwhile, little, if any, retail competition has materialized for consumers.

Deregulation, which affects regions with more than half the U.S. population, "hasn't panned out the way we had hoped," Rose says.

Rose and other industry experts largely blame wholesale power markets dominated by a handful of large suppliers. In some cases, these giants have been accused of manipulating prices in ways that echo complaints during the 2000 California energy crisis. Some economists say electricity isn't suited to competition because it's needed 24 hours a day and can't be stored, giving sellers too much leverage.

In the 1990s, deregulation was pushed by commercial customers rankled by utilities that built too many power plants and saddled customers with the tab. Deregulation was supposed to let customers buy electricity from more-efficient, competing suppliers. To prevent utilities from favoring their own plants, many had to sell the generators to unregulated affiliates or to independent power wholesalers.

The power-generation price on the bill was no longer regulated, but states continued to oversee utilities and the separate price they charged to maintain the wires to homes and businesses. Customers could buy from the new competitors or stay with their utility, which itself would have to purchase power from the wholesalers. To ensure instant benefits for consumers, states froze residential rates for five to 10 years.

But while 60% or more of commercial customers in many deregulated states switched to rivals and realized at least some savings, fewer than 10% of consumers have defected, says a study by Michigan State and Ohio State universities.

Richard Rathvon, head of the Retail Energy Supply Association, blames the rate caps, which kept prices artificially low and left rivals no room to undercut the utility. "Competition hasn't failed," he says. "It hasn't been allowed to work."

Proof, he says, lies in Texas, where utilities have been able to raise their rates in response to fuel price increases and this year were freed of all price restraints. About 60% of Texas consumers have chosen an alternative power supplier.

D'Lana Motta, 52, of DeSoto, Texas, switched from utility TXU (TXU) to Reliant Energy (RRI) earlier this year to light her home and clothing boutique. She's saving about 10% on her electric bill. "In running a business, you want to save money," she says. "And maybe it's a little more personal service."

'Deregulation has been disappointing'

Yet critics say Texas points up competition's failure: Average electricity prices still have surged 58% since 2002. "Deregulation has been disappointing," says Clarence Johnson of the Texas Public Utility Counsel.

The culprit, Rathvon says, is fossil-fuel costs, especially natural gas, which has tripled in price since the late 1990s. Even coal prices have risen 70%. That has driven up electric rates in regulated states as well.

Rose says fuel costs don't explain the bigger price increases in deregulated states. Echoing a sentiment voiced by consumer advocates, Rose instead points to wholesale electricity markets he says are far from competitive. Wholesale power suppliers have built few plants as they've been unable to obtain financing. And most big utilities and their generation affiliates have not built transmission lines to import out-of-state power or local plants because keeping supplies tight means higher prices, Rose says.

In a power sale last year, Baltimore Gas & Electric said it purchased 70% of its electricity from its unregulated parent company, Constellation Energy (CEG). BG&E sold its plants to Constellation during deregulation.

A Maryland Public Service Commission (PSC) report says BG&E conceded in hearings it "has no direct financial incentive to keep generation rates low for its customers." Constellation profit rose 50% last year to a record $936 million.

"There appears to be a conflict between Constellation's objective in selling electricity at the highest price and BG&E's obligation to get the lowest price," says PSC Chairman Steven Larsen.

Paul Allen, Constellation's vice president of corporate affairs, says Constellation is supplying much of BG&E's power because it's "the low-cost provider." Allen blames the rate increases on natural gas price increases after Hurricanes Katrina and Rita in 2005.

Natural gas represents a small portion of electricity generation but has a disproportionate effect on wholesale prices. That's because idle natural gas plants that rev up to meet excess demand on hot days charge high prices that all generators, even low-cost coal plants, receive. Such "spot market" prices also affect rates for long-term contracts. By contrast, regulated utilities must charge customers the average cost of all their generation.

Illinois officials cite a more sinister explanation for rate increases triggered by last year's wholesale auction. In a complaint to the Federal Energy Regulatory Commission, state Attorney General Lisa Madigan accused 15 wholesale suppliers of manipulating prices. One way that could have happened, the complaint says, is by prospective bidders withdrawing from the auction to drive up prices in exchange for winning bidders agreeing to buy their power in separate contracts.

"The short answer is, 'Bunk,' "says John Rowe, CEO of Exelon(EXC), one of the bidders named in the complaint and parent company of Commonwealth Edison.

The attorney general has agreed to drop the complaint if the rate-cut package is signed by the governor.

In Texas, state regulators have proposed a $210 million fine against TXU after a consultant's report found the company withheld power from the spot market in 2005 to push up wholesale prices.

Questions also have been raised about the regional power grid operators that manage the flow of electricity between states and oversee auctions, and whose members include utilities and suppliers. Joseph Bowring, who monitors power purchases for Mid-Atlantic grid operator PJM Interconnection, told FERC in May that PJM kept him from reporting that utilities paid $20 million more than necessary for power because of one generator's market dominance, among other problems.

To discourage manipulation of wholesale purchases, FERC has proposed new rules, including making suppliers disclose their bids to other bidders after a brief lag. Bids are now kept secret for six months. "We're trying to increase the transparency," says FERC Chairman Joseph Kelliher. He says FERC is closely monitoring power markets and, with a 2005 law, can now impose hefty fines for manipulation.

Meanwhile, states worried about rate increases have scaled back deregulation. A new Virginia law gives utilities fresh incentives to build power plants and ends retail choice for most customers to ensure a sufficient customer base to finance the generators.

Consumer groups say Dominion Virginia Power (D), the state's No. 1 utility, spearheaded the legislation and is unfairly benefiting from it. It can keep 40% of excess profits and earn an especially high rate of return for building nuclear plants, renewable power or "clean coal" generators. And Dominion can still sell power into the region's competitive wholesale markets.

"(Dominion) called the shots," says Irene Leech, head of the Virginia Citizens Consumer Council, noting the utility has long been the top corporate contributor to state lawmakers. "They want the benefits of competition, but they don't want to take any risks."

Dominion CEO Tom Farrell vigorously denies ramming the bill through the Legislature and says the new incentives are needed to prod the company to be more efficient and build plants that don't contribute to global warming. During the rate freeze, he notes, Dominion had to write off $1.5 billion in fuel costs.

Other states can't revert to regulation because utilities have sold their power plants. So they're taking baby steps back. Connecticut and Montana recently agreed to let utilities again build plants, which can take at least four years to complete. The extra supply is designed to temper price increases in the wholesale market. Officials in Maryland, Ohio and Michigan are considering similar proposals.

Pros and cons of a return to regulation

Yet officials say scrapping deregulation brings its own perils. Bill Massey, a former FERC commissioner and a lawyer for Compete, a group of wholesalers, utilities and customers, says free markets have led to more efficient and innovative plants. Now, rivals are best able to offer conservation and energy efficiency services to cut global warming emissions, he says.

Allen of Constellation warns that "ratepayers will be on the hook for cost overruns" if utilities such as BG&E are permitted to once again build and own plants. And David Crane, CEO of NRG Energy (NRG), worries that independent suppliers like NRG could be squeezed out if utilities that buy electricity can also produce it.

Unmoved by such arguments are consumers struggling under huge electric rate increases. Jackson, the Illinois customer, welcomes the price cuts included in the proposed plan to beef up state oversight.

"That would help me," she says. "Anything's better than $538."

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