Electric restructuring and consumer interests: lessons from other industries

Electric Restructuring and Consumer Interests: Lessons from Other Industries Experience with other industries that moved from regulation to competition shows that reform does not simply redistribute costs from one group of customers to another, but unleashes waves of entrepreneurial ingenuity that are difficult or impossible to predict in advance. Robert Crandall is a senior feIIow in the Economic Studies Program at the Brookings Institution. He has authored or co-authored numerous scholarly articles and books on the effects of regulation and deregulation. He received a B.S. in economics from the University of Cincinnati and an M.A. and Ph.D. in economics from Northwestern University. Jerry Ellig is a senior research fellow at the Center for Market Processes and the Institute for Humane Studies at George Mason University. He has published numerous scholarly articles on energy, transportation regulation, and market-based management. He received a B.A. degree in economics front Xavier University and an M.A. and Ph.D. in economics from George Mason University.

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Robert Crandall and Jerry Ellig ......... i

s major industry players rush to accommodate electricity restructuring, some also rush forward with speculations about how regulatory reform will affect consumers. Advocates of restructuring promise lower rates and better service; critics warn that retail competition will be a boon only for large, sophisticated customers. Fortunately, the United States has a decade or more of experience with regulatory reform in a variety of industries that share some similarities with electricity. Natural gas, telecommunications, airlines, railroads, and trucking

A

are all industries in which competing producers use a network of wires, pipe, roads, or rails to reach their customers. Economists have analyzed the effects of deregulation and restructuring in these industries in great detail, aided by a wealth of data collected by regulators and trade associations. An overwhelming consensus emerges from these scholarly studies: Real-world competition, though not necessarily perfect, is far better for consumers than economic regulation. Our reading of the record suggests that the results in electricity should be no different.

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1. Examining Analogous Industries From an economist’s perspective, these five network industries share a number of similarities with electricity. Like the electric industry, all five have a production, transmission, and distribution stage. Gas wells, telephone equipment, trains, airplanes, and trucks are the production stage, analo-

electric wires into highways that

cific cases. Airlines and trucking

would allow customers to deal di-

companies, meanwhile, both use

rectly with producers of the elec-

publicly-owned infrastructure

tric power. The production side of the other

petitors.

network industries was deregulated in the late 1970s and early

that is generally open to all com-

N

one of these industries is identical to the electric in-

1980s. Most natural gas wellhead

dustry, but neither are they identi-

prices were deregulated between

cal to one another. If common pat-

1978 and 1984. Competition in

terns emerge in all of these

telephone equipment came in the

industries as a result of regulatory

gous to power plants. Interstate

reform, we can be reasonably sure

gas pipelines, long-distance

that similar results will occur in

phone lines, railroad trunk lines,

electricity.

airways and air traffic control, and interstate highways offer long-distance transportation similar to high-voltage transmission lines. And local gas pipes, local telephone lines, rail sidings, airports, and local streets are economically similar to electric distribution lines.

B

ecause these industries have several stages, discus-

In natural gas, teleGove airlines, failroads, and trucking, regula to y reform produced signifi’cant customer benefi’ts-s tarting wits price-teat grew over time.

II. Significant Customer Benefits In all five industries, regulatory reform produced significant customer benefits that grew over time. Consider prices. As Table 1 shows, inflation-adjusted

prices

fell within two years after regulatory reform-often

by 10 percent

or more.’ Within ten years, prices

sions of “deregulation,” “regula-

were at least 25 percent lower,

tory reform, ” “customer choice,”

and sometimes 50 percent lower. Regulatory reform did not

“restructuring,” and similar topics can get quite confusing. In eco-

late 1970s. Airline route and rate

cause all of these price reductions,

nomic terminology, “deregula-

regulations were phased out be-

but it is worth noting that most

tion” means the partial or

ginning in 1978, and surface

predictions of price reductions

complete elimination of govern-

freight companies were partially

from electric restructuring fall

mental restrictions on prices and

or fully deregulated in 1980.

entry. The other terms may de-

Large segments of these indus-

comfortably within this range. In an August 1997 report, the U.S.

tries are also subject to some form

Energy notation

of the industry, but they also may

of open access regulation. Inter-

tion estimated that in the next 2 to

characterize changes in regulation

state natural gas pipelines became

3 years, competition would lower

of one stage of the industry

open access transporters during

the average retail price of electric-

thought necessary to facilitate

the late 1980s. When AT&T was

ity by between 6 and 22 percent;

competition in other parts. Thus,

broken up in 1984, local phone

by 2010, the price would be

“customer choice” means the

companies were required to allow

roughly 11 to 28 percent lower

elimination of price and entry

competing long-distance compa-

than it is today. The now-famous

regulation in electricity genera-

nies to use their lines to reach cus-

1995 study by Citizens for a

tion, coupled with “open access”

tomers. The federal government

Sound Economy Foundation,

regulation that would turn the

has long had authority to impose

meanwhile, projected that retail

open access on a railroad in spe-

competition would reduce the

scribe dere~lation

of some parts

Administra-

i

price of electricity by 13 percent in the short run and 42 percent in the long run} tatistical studies of transportation industries that control for other factors affecting prices have consistently shown that regulatory reform produced more than $50 billion annually in price reductions and other consumer benefits. 3 A significant portion of these benefits came in the form of improved quality of service. In the airline industry, for example, one study found that increased flight frequency accounted for more than half the value of consumer benefits. Surface freight deregulation also generated billions of dollars in shipper savings due to improved reliability of rail and truck transportation.

S

A. Benefits Were Widespread No one can reasonably claim that regulatory reform benefited every single customer in the United States. That standard is impossible for any public policy to meet. Nevertheless, regulatory reform did benefit all major customer groups. Natural gas provides a good case in point. As Figure I shows, the average wellhead price fell by $2.32/mmcf in the ten years following 1985, when most wellhead prices were deregulated. Prices paid by every customer class fell by even more: $2.93/mmcf for residential customers, $3.13/mmcf for commercial customers, $3.53/mmcf for industrial customers, and $3.41/mmcf for electric utilities. The additional price reductions came largely out 14

of the margins earned by interstate pipelines for transporting gas. Despite such figures, even executives in the gas and electric industry sometimes speak as if large industrial customers got most of the benefits of wellhead deregulation. This misperception survives because the savings are often expressed as percentages. Since residential gas rates are higher than industrial and electric utility rates, residential customers received only a 32 percent saving, compared to 57 percent for industrial customers and 63 percent for electric utilities. This pattern stems from the fact that the local gas utilities' share of residential and commercial gas bills is much greater than their share of industrial and electric utilities' gas bills. Distribution, metering, and billing expenses

per mmcf are higher for residential and commercial customers, and thus the total cost per mmcf is higher. As a result, even an equal price reduction for all customers would amount to a smaller percentage of residential and commercial bills. irlines provide another example of where the conventional wisdom is just plain wrong. Few people dispute that deregulation lowered air fares on average, but most simply believe that airlines are gouging passengers unlucky enough to travel to "fortress hubs" or on routes where one airline carries most of the traffic. Less well known is that even "captive" markets enjoy lower fares than under regulation. For example, in "hub" cities dominated by one carrier, real fares were 19 percent lower in 1995

A

Table 1: Summary of Trends Following Regulatory Change i

Industry

Gas - Long Distance Telecom Airlines Trucking

Percent real price reduction a f t e rL:. L . . . . . ... 2 years ... 5 years ... 10 years 10-38% (1984-86) 5-16% (1984-86) 13% (1977-79) N.A.°

Railroads

23-45% (1984-89) 23-41% (1984-89) 12% (1977-82) 3-17% (1980-85) 20% dj_9_80-85)

27-57% (1984-94) 40-47% (1984-94) 29% (1977-87) 28-58%(1977-87) 44% _.(!_%0-90)

Annual value of consumer benefits from deregulationa N.~,Y

--

$5 billion $19.4 billion $19.6 billion

4% $9.10 billion (19.80-8_ 2) ................ a, All figures are real, in t995 dollars. b. For natural gas, no controlled studies quantify the separate effect of deregulation on gas prices. c. For trucking, no studies have documented the effects for the first couple of years, d. No trucking figure is available for 1980-90; figure quoted is for 1977-87. Because regulation made it difficult to cut trucking rates, the bulk of these rate reductions occurred after 1980. Source: Robert Crandalland Jerry Ellig, Economic Deregulation and Customer Choice: Lessonsfor the Electric Industry

(Fairfax, VA: Center for Market Processes, 1997).

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than they were in 1979. On routes dominated by a single carrier, fares were 27 percent lower. Fares

4

3.5

for small, medium, and large cities were all lower in 1995 than in 1979.” ft is true that fares for some cities and routes dominated by one carrier are generally higher than for other cities and routes, but most of these fares are still lower than they would have been under continued regulation. B. Low-Cost Customers Still

3

2.5

2

1.5

1

0.5

0

L

SavedMoney Another major fear about electric regulatory reform is that

Source: Energy Information Administration

lower prices for high-cost regions will come at the expense

Figure 1: Reductionin Natural Gas Prices, 1984-95, $/mmcf (1995 $)

of higher prices for low-cost regions. After all, common sense

products and higher rates for bulk

by 35 percent, while the cost for

suggests that electricity produc-

commodities.

truckload shipments fell by 75

ers in the Pacific Northwest and

In reality, all rail rates fell.

Kentucky will ship their power

Within two years after deregula-

to California and New York if

tion, average inflation-adjusted

they can get a better price for it

rail rates had fallen by 4 percent,

there. The experience of other in-

coal rates had fallen by 1 percent,

percent.6

III. What’s Seen and What’s Not? A great deal of the electricity de-

dustries, however, demonstrates

and rates for farm products had

bate focuses on how an existing

that high-cost customers’ relief

fallen by 18 percent. Within ten

pool of costs will be divided up

does not come at low-cost cus-

years, coal and farm rates had

among arbi~arily-defined

tomers’ expense. Rather, all cus-

fallen by 38 and 50 percent, re-

of customers-industrial,

tomers gain as increased effi-

spectively Low-cost and high-cost

tial, captive, low-cost, high-cost,

ciency and productivity

shippers alike got lower rates, be-

and so forth. From a consumer

cause railroad productivity more

perspective, this debate is highly

than doubled in the ten years fol-

misleading, for two reasons.

make it

possible to reduce rates for all.

R

ailroads provide several prominent examples. Prior

to 1980, the Interstate Commerce Commission’s “value of service” pricing dictated that bulk com-

lowing deregulation, after a decade of stagnation.5 Trucking provides a similar ex-

F

groups residen-

irst, even if some big customers receive the lion’s

share of deregulation’s benefits,

ample. “Less-than-truckload”

that does not mean the rest are left

modities, like coal and farm prod-

shipments are more expensive to

with a pittance. If Ford, McDon-

ucts, paid relatively low rail rates

haul than truckload shipments,

ald’s, or Safeway receive lower

compared to “high-value” prod-

but the cost of both fell following

utility bills, they do not get to

ucts like automobiles and other

trucking deregulation. Between

keep all of those savings as prof-

manufactured goods. Deregula-

1977 and 1993, the inflation-ad-

its. Their competitors will also

tion, it seemed, would lead to

justed operating cost per mile for

save money as a result of deregu-

lower rail rates for manufac~red

less-than-~ckload

lation, and competition will force

Janunry/Tebrt~aty 3998

shipments fell

15

them to pass some or all of the

hubbing airlines with a distinctly

SALJER, CUSTOMER

savings on to their customers. For

different route strategy and corpo-

VALUE: AN ANALYSIS

this reason, consumer advocates

rate culture. Such innovations

who focus only on residential elec-

were difficult if not impossible to

tric rates overlook many of the

predict in advance.

more significant consumer benefits deregulation could produce.

S

portant regulatory reform lesson

CONSUMER

OF RETAIL COMPETI-

TION IN AMERICA’S

EI.ECTRIC

(CSE Foundation,

1996).

3.

ROBERT CRANDALL

ECONOMIC

For these reasons, the most im-

CHOICE,

INDUSTRY

AND jERI
DEREGULATION

AND CIJS-

TOMER CHOICE:

LESSONS FOR THE ELEC-

TRIC INDUSTRY

(Fairfax, VA: Center for

econd, experience shows

is also the oldest lesson of eco-

Market Processes,

that regulatory reform does

nomics. When considering alter-

4. Airline deregulation legislation was enacted in 1978, and the Civil Aero-

not simply redistribute costs from

native policies, it is crucial to con-

one group of customers to an-

sider not just the obvious things

other. Instead, competition un-

that are seen, but also the secon-

leashes waves of entrepreneurial

dary effects that are not easily

ingenuity that we simply do not

foreseen. W

find in highly regulated indus-

1997).

nautics Board took some steps toward deregulation

as early as 1976. Unfortu-

nately, the Department of Transportation’s annual fare data for hubs and particular routes begins in 1979. Since fares were higher in 1978, our percentages understate the effect of deregula-

tries. Exposed to both increased

Endnotes:

competition and greater risk, gas

1. Unless otherwise noted, all figures in this article for industries other than

from data drawn from DOT Data Bank 4.

electricity have been converted into 1995 dollars to adjust for inflation.

5. Rail rate data were supplied by the

2.

Our productivity measure is the Bureau of Labor Statistics’ rail productiv-

pipelines increased their operating efficiency, railroads doubled their productivity, and truckers found ways to move more freight with less resources. Airlines deployed hub-and-spoke

route net-

tion on fares. All figures are calculated

U.S. ENERGY INFORMATION

TION, ELECTRICITY TIVE ~NVIR~N~~~N~

MARGIN.41

PRICING OF GENERATION

COST

SERVICES AND FI-

works, and then Southwest Air-

NANCIAL STATUS OF ELECTRIC

lines challenged the dominant

(h.lfZ,.

1997);

ADMINISTRA-

PRICES IN A COMPETI-

UTILITIES

MICHAEL T. MALONEY,

ROBERT I?. MCCORMICK

AND RAYMOND

Association

of American

Railroads.

ity index, which rose from 54.6 in 1980 to 118.5 in 1990. 6. Authors’ calculations. data sources, see Crandall Appendix.

For original and Ellig,

Earlier deregulations have brougkt a banquet of benefits for consumers. 26

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