Energy: The Future of Electric Power

Deregulation has come to the semi-monopolistic world of public utilities, with potentially far-reaching consequences for the environment and for energy efficiency, cost, and investors as well

IN THE LITTLE town of Doswell, Virginia, a futuristic power plant recently went into operation. Driven by natural gas, the facility uses less fuel than comparable stations, thanks to an advanced process called combinedcycle generation. It causes minimal pollution, discharging no water and only trace emissions to the air. A visit is an eerie experience, for even when the plant’s turbines are running at full throttle, it’s difficult to tell that the facility is operating. Tricks of acoustic engineering mask the deafening resound characteristic of power generation; no clouds of anything rise, not even steam.

But technical innovations are not what sets the plant apart, since progress in fuel conservation and environmental regulation assures that all new power stations will be cleaner and more efficient than those they supplant. What’s futuristic about the Doswell generating station is that it is owned by a subsidiary of Mitsubishi and operated by Bechtel. The plant is an independent, unregulated enterprise making free-market juice.

Power is one of America’s leading commercial sectors, nearly as large in revenue as the airline and telecommunications industries combined. Historically it is also among the most tightly regulated of commercial activities. Yet for all the ballyhoo that accompanied the decontrol of air and phone service, few people are aware that the electricity business is being opened up too. Over about a decade small steps have been taken in the direction of power deregulation. Last fall Congress dropped altogether most controls on new electricity production.

Whereas airline and phone deregulation produced mainly changes in pricing policies, the eventual result of utility deregulation may be utter upheaval in the economics of electricity, perhaps to the point that individual homes unhook from the grid and make their own power. Along the way may come energy savings, lower rates for industry and higher rates for homes, a second wind for nuclear power, commercial-scale renewable energy—and bankruptcies of apparently rock-solid utility companies.

Electricity is being deregulated at the same time that utility planners are perplexed by a central question: whether the United States needs more generating capacity, to avoid future brownouts, or less, because conservation will reduce demand. Whenever it dawns on the public consciousness that the power monopoly is ending, attention will focus on whether electricity rates rise or fall. The more important question may be what effect the unleashing of market forces will have on generation and consumption.

THE ELECTRICITY industry began with a period of intense competition. Around the turn of the century Thomas Edison and George Westinghouse, each hoping to become the John D. Rockefeller of the next great energy industry, engaged in a spirited “Battle of the Currents.”The two men bankrolled private power plants in various locations around the country. Aggressive marketing and price wars were common.

Westinghouse defeated Edison on technical grounds when Westinghouse’s favored concept, alternating current, was embodied in the first grand hydroelectric dam, built in 1895 at Niagara Falls—a project that captivated a nation then fascinated by material progress. But neither man succeeded in establishing a Standard Watts to emulate Rockefeller’s Standard Oil. As it became clear that the new form of power would be universal, lawmakers decided that the excesses of the oil trusts could be avoided if electricity were tightly regulated.

Most economists agreed. Like telephone service, electricity seemed to fit the notion of the “natural" monopoly, which combines exemption from competition with government-controlled prices. The power business thus became what securities analysts call low-risk, low-yield. Rate regulation implied that no utility would ever be a boom stock, but also that no dividend would be missed—a situation that is already changing and is likely to change further now that the industry is being deregulated. The system succeeded handsomely on the key measure, producing dependable power at costs among the lowest in the Western world. As a result, for decades there was no serious challenge to the concept of monopoly electricity.

In the 1970s, however, the consensus began to erode. First, deregulation was the hot topic of academic economics. Attempting to explain why GNP growth had slowed, a wide spectrum of intellectuals locked on to regulatory stagnation. Airline, telephone, trucking, banking, and rail decontrols were soon set in motion.

Second, by the 1970s utilities had begun to violate a premise of naturalmonopoly logic, that of declining cost. Roughly from the days of Edison and Westinghouse until the 1970s the realdollar cost of electricity fell regularly. This picture changed when utilities went overboard for nuclear plants. Suddenly the cost of watts began accelerating well ahead of inflation.

Third, the 1970s was the decade of energy shocks. Many people began to question the underlying mechanism by which utilities were paid: the more power sold, the more profit realized. This is a formula for ever-increasing fuel combustion, which after 1973 no longer seemed synonymous with progress.

In a sense it is a blessing that many reactor projects of the 1970s ended up as white elephants. They did because fossil-fuel supplies did not run out, which would have been much more harmful to society than a few wasted investments at places like Shoreham, on Long Island, and several reactors begun but never finished by the Tennessee Valley Authority. But the sequence of events that led to this point set the utility industry up for a fall. Once utility managers began to make significant blunders about matters like nuclear expansion, the public perception of them changed, from that of farseeing technocrats to that of fat cats with legal sanction to reach into people’s pockets. Economists argued that the presumptuous utilities needed competitors.

In 1978 Congress passed a lawknown by the acronym PURPA, which fostered experiments in nonutility power. PURPA specified that independents building unconventional power plants could sell electricity to utilities at a price that usually worked out to be high enough to make it attractive to enter the power business.

In the sort of legislative asterisk that can ultimately overpower the rest of a bill, PURPA also required that utilities buy from “cogeneration" facilities: fossil-fuel-fired plants where heat that would otherwise be vented as exhaust is recaptured for factory-process use. Cogen plants—which contractors began to build in many places across the nation—are basically power stations with steam lines attached. In the course of building them independent companies discovered that no magic wand was required to construct an electricity-generating system, and they began to cast their eyes on the rest of the business. A pro-competition lobby grew that included Bechtel and other heavyweight firms.

The executives of every industryfacing deregulation have been able to restrain their enthusiasm for the process, and the power business has been no different from the rest. The first exception to this rule was William Berry, who at the time was the head of Virginia Electric and Power Company (Vepco). Ten years ago some policy intellectuals were proposing the abolition of all controls on power, and may the best wires win. Berry thought that this sort of textbook laissez-faire notion would backfire in the muddle of the real world. He says, “I knew the academics could show that power was more expensive than it would be in the presence of competition. But some of the solutions being discussed were the kind that work only in a college economics course.”

Berry proposed that the production of power be deregulated but the distribution (the power lines) remain controlled. Anyone would be free to build a generating plant; its output would be sold to the highest bidder and “wheeled” through the grid wherever desired. But before delivery to customers, that power would pass to a utility whose rates were set by a public commission. This arrangement, Berrythought, would prevent independent producers from snatching up the largest industrial customers, leaving residential customers stuck with the cost of general overhead. Under the Berry plan utilities would become mainly service concerns. They could still make their own power, but only if they managed to be competitive, since regulatory commissions would direct them to shop for the best price.

Considering deregulation inevitable, Berry decided in the mid-1980s to conduct an experiment. Through legal sleight of hand he arranged for a bidding contest for new Vepco generating capacity to be open to all comers. One big contract was awarded to an independent later bought out by Mitsubishi, a transaction that was the origin of the Doswell station. In effect Berry had staged a unilateral self-deregulation. Other power companies were furious.

Berry maintained that his actions were in the interests of consumers. If private companies put up the capital for new plants, Vepco would not force its customers to share the risk; nor would it face the ire of utility commissioners and Wall Street if the projects went over budget. In self-deregulating, Berry also bowed to a reality of modern life: the not-in-my-back-yard syndrome. The syndrome is acute for regulated entities like utilities, since public-hearing requirements can mean years of delay even for innocuous ventures. Berry tired of taking this heat. “When we try to site a plant, we are the big bad utility coming to town,” Berry says. “When an independent power producer comes in, the image is that of a plucky underdog. There’s an automatic public-relations edge.”

A few other utilities took steps toward self-deregulation. Some awarded contracts to AES Systems, a new firm jockeying with Mitsubishi and others to be the first national power wholesaler. Three years ago Public Service of Indiana petitioned for permission to sell power out of state at market prices, not regulated rates. This petition in effect formally asked the federal government to end price controls on electricity. At about the same time, Cleveland Public Power began to compete for industrial customers of the nearby Cleveland Electric Illuminating. Years before, Cleveland Electric had settled a fight over a nuclear operating license by agreeing to transmit power from other sources to Cleveland Public, which in the early 1990s began buying surplus power from out-of-state utilities and undercutting the Cleveland Electric price by several cents per kilowatthour, a significant margin.

WHEN WORD of big electricity price cuts began to circulate, corporate power consumers responded by agitating in Washington for more of the same. Late last year deregulation of new power generation passed in both houses of Congress by wide margins, eliciting almost no controversy.

Once formal decontrol of generation begins, it may be only a matter of time before other aspects of the power monopoly decay. Douglas Houston, an economics professor at the University of Kansas, has predicted that public-utility regulation “eventually wall crumble under its own weight.”

What effect decontrol will have on electric rates is unclear. Most analysts expect society’s net cost for electricity to fall. But that does not guarantee direct benefits for the typical homeowner. Telephone deregulation cut largebusiness and long-distance rates while residential costs rose, because market forces channeled the savings in the direction of bulk purchasers.

Already utilities must price industrial power low enough that factories do not build their own generators. (Even now factories are free to “self-generate,” so long as they don’t sell excess power to another customer.) As it becomes practical for midsized commercial customers such as office parks and apartment blocks to make their own power, these accounts may win rate favors too, leaving more overhead to shift onto residential accounts. A new equilibrium may be reached only when individual homeowners can threaten to go it alone if they don’t like the price—a possibility I’ll get to.

Another anxiety about deregulation is environmental. Most utilities have decent environmental records, at least in the sense that they ploddingly comply with whatever the law requires: under regulation, pollution-control costs were easy to pass along to consumers. In some cases utilities have been environmental leaders. American Electric Power, in Ohio, is underwriting the development of the “E Lamp,” a bulb designed to run on very little juice. Pacific Gas and Electric, in California, the nation’s largest utility, has transformed itself from a company that built the Diablo Canyon nuclear station near a fault line into the nation’s largest user of wind power.

Some environmentalists think that decades of hammering utilities over the head with lawsuits and bad press has finally paid off: power companies now realize they can operate cleanly, and are committed to doing so. At the moment of this breakthrough comes deregulation, which may make it harder for utilities to pass along pollutioncontrol costs and may create competitive pressure that may cause environmental protection to be sacrificed in the interests of profit. For this reason the environmental community, once ardently anti-utility, has qualms about power deregulation, though it might seem a deliciously satisfying revenge against the crowd responsible for acid rain and Three Mile Island.

Yet there are reasons to suppose that power deregulation will have a positive environmental impact. One is that new producers are mostly building plants that burn natural gas, the cleanest fossil fuel. New power companies are also choosing to build numerous midsized plants rather than a few huge facilities, which is more in keeping with conservation logic than big expansions, which give utilities an internal need to promote power consumption. Finally, freewheeling market battles to generate power at the least cost are likely to inspire breakthroughs in energy efficiency, and energy efficiency, for both producers and consumers, is by several ways of thinking the most promising environmental “growth area.”

So promising, in fact, that some doubt whether any new electricity generation is needed. This leads to the great question of the power business— whether conservation is better than new production.

IN A 1976 ARTICLE in Foreign Affairs magazine, the physicist Amory Lovins declared that conservation could reduce energy needs so spectacularly that oil would not run out and energy prices would plummet as well. The article appeared at a time when energy doomsaying was the height of fashion; there were complaints that Foreign Affairs was off its rocker to dignify such unrealistic contentions. Today Lovins’s predictions seem conservative. Gasoline sells for less in real-dollar terms than it did in the 1960s. Since Lovins’s article was published, total U.S. energy use per constant dollar of GNP has declined 23 percent.

Recently the efficiency trend that began with gasoline has caught up to electricity. Despite the spread of airconditioning, growth in demand for electricity has slowed to around two percent annually, with declines experienced in some parts of the country. And Lovins now predicts electricity savings that are in some ways more outlandish than the gasoline savings he anticipated in 1976.

Lovins believes that the standard strategy of generating ever more power is backward. The focus should instead be on rendering the user of electricity ever more efficient and then reducing power generation to the level that customers actually need. This notion has acquired the clunky name “demandside management” (DSM).

Lovins thinks that the United States could support its industrial base and lifestyle using just 30 percent of current electricity-generating capacity, with the conservation investment needed to produce these savings available at a long-term cost of less than one cent per kilowatt-hour. Since new generating capacity costs about six cents per kilowatt-hour, investments decreasing the demand for power are dramatically less expensive than investments in new production, to say nothing of the fact that resources are conserved and pollution avoided.

Lovins proposes not sacrifice but technical advances and free-market efficiency. Americans will use fewer watts yet continue to enjoy “hot showers and cold beers,” in his phrase.

Most utilities now have DSM efforts, some of them substantial: Consolidated Edison, which serves New York City, plans to invest $4 billion over the next fifteen years to promote conservation. Some power companies have a financial incentive to favor DSM. Until recently utilities could improve returns mainly by selling more watts; the utility that urged consumers to conserve was almost violating its fiduciary responsibility to shareholders. In the early 1980s, though, rate commissions began to experiment with programs under which many companies whose customers became more efficient kept a percentage of the amount that those customers would otherwise have spent. Such deals, structured according to eye-glazing formulas arrived at by computer, allow the seller and the buyer of electricity to share the benefits of reduced consumption. And some power companies find DSM expedient as well as profitable. Between bond-market wariness of utility expansion and local barriers to locating large facilities, any way to avoid new construction suddenly looks appealing.

To a point, demand-side management and deregulation are in conflict. Advocates of DSM tends to presume that the United States already has too much generating capacity; deregulation presumes that new companies ought to jump into the business of generating electricity. But in a sense the ideas work in concert, because DSM gives utilities reason to be fuel-efficient, and fuel-efficiency will be essential to fending off new challengers. What’s more, no matter how much conservation is realized, it will remain necessary to build new power plants to replace aging facilities—necessary and good for society, because the new plants will be cleaner and more efficient. Free competition to build and operate those replacement plants may be desirable regardless of how energy use changes.

When DSM programs are put into effect, they may fail to produce the anticipated savings. Margaret Fels, a Princeton researcher, finds that such efforts often yield half the expected benefits. Power companies that assume that DSM will allow them to postpone new generating plants indefinitely, Fels fears, may be in for a rude jolt.

But suppose Lovins is too optimistic by a factor of two. That still leaves his the most attractive energy news of the 1990s, rendering him a sort of Professor Harold Hill of kilowatts, whose sales pitch is excessive but whose merchandise is nevertheless good for River City. Lovins calculates that if America as a whole simply improved electricity efficiency at the actual rate achieved in southern California during the 1980s, national power demand would fall by several percentage points annually even as the GNP rose.

IT’S LIKELY THAT the coming decades will see the wide application of several innovations that will reduce power consumption or increase generation efficiency. One is the E Lamp, which provides luminescence with radio waves. If perfected, the E Lamp should cost less to use than currently available compact fluorescent bulbs and should fit any existing fixture—an important consideration. Airconditioning, too, may make an efficiency leap if, as expected, machines are perfected that cool without compressors, the big power draw in conventional units.

As for generation, advances in plant design have pushed from about 30 percent to about 43 percent the thermal efficiency (roughly analogous to gas mileage) of fossil-fuel-fired power plants. As much as 55 percent may be possible for the next generation of power stations. If electricity demand is cut at the same time that the fuel required to produce power declines, substantial net energy savings will occur.

Deregulation may revive nuclear power, in the form of new reactors that incorporate passive safety features such as emergency cooling water fed by gravity, available even if all pumps fail. Under deregulation, reactor manufacturers such as General Electric and Westinghouse may build their own power stations and offer the electricity produced on the open market. In the current political climate a private-sector firm may have the best chance of winning lieensing approval to open a nuclear station, because voluntary shareholders, not ratepayers, will be on the hook for any cost overruns. Nuclear power, a highrisk but potentially high-return endeavor, should benefit from divorce from the low-risk, low-return realm of the public utility. By the early twenty-first century solar-electric conversion may become common. Assuming that affordable converters are devised, houses in the southwestern United States might satisfy all their power needs from roof-mounted solar systems, and houses in other areas of the country might make half their power.

Then there’s the fuel cell. This device is the ideal generator, making electricity from hydrogen and oxygen, with water as the by-product. Fuel cells have, however, proved expensive to build, and the hydrogen they consume is derived from natural gas, a losing proposition from the standpoint of overall efficiency. Advances in fuel-cell manufacturing now make it imaginable that costs will fall to a level at which hotels or office complexes might generate their own electricity with fuel cells; someday home fuel cells may appear. And some researchers, such as the Princeton physicists Joan Ogden and Robert Williams, think that a practical supply of hydrogen will be found. They envision, for example, vast fields of solar-powered converters in unpopulated areas which would separate hydrogen from water and ship the hydrogen back to cities.

Imagine a home with solar-electric panels on the roof and, out by the garage, a small fuel cell suggesting the Mr. Fusion appliance of Back to the Future. Such a structure might kiss the power grid good-bye, making its own electricity the way houses now make their own heat and cool air.

Our future house would still require a hydrogen supplier, but that company might be only one step up in stature from the local pool-cleaning service, the central electric utility having by this point crumbled under its own weight. Economic theory says that to stave off this day power companies should make electricity cheaper and electric services more user-friendly, so that consumers won’t mind staying on the grid. In other words, utilities should compete not just with each other but also with the prospect of being put out of business altogether. For an industry that has gone nearly a century with no competition whatsoever, that prospect is bracing.

—Gregg Easterbrook