Pulling politics out of power
Electricity deregulation will give consumers choice and open the market to green power, but getting there will be anything but easy
(An edited version of this article appears in the October 2001 issue of Atlantic Progress.)
Rolling black outs. Sky high power rates. Energy shortages. Political controversy. Few major policy changes can have been accompanied by as much confusion, angst and scrutiny as recent attempts to deregulate the market for electricity.
Maritimers (Newfoundland, for a variety of reasons, including its geographic isolation from the Maritimes and connection to continental electricity markets through Quebec, would require a whole article of its own), including policy makers, look at the messes in California, Alberta and Ontario, and think that the old tried and true methods look pretty good. Deregulation in the electricity industry seems to have created nothing but grief for those who have tried it, and the benefits seem elusive. The old local monopolies that serve captive provincial markets have brought stability of supply and reasonable reliability of service. Our power bills tend to be high in Canadian terms (though lower than New England), but maybe our watch word, like former British Prime Minister Stanley Baldwin’s, should be “Safety First”.
Yet safety does not lie in resisting the changes that are sweeping the electricity industry, but in steady deliberate movement toward deregulation, in order to capture the technological, economic and industrial benefits that it offers. Reform of the electricity market is an idea whose time has come, and the Maritimes, like the rest of the country, have a great deal to gain from it. But the reasons why electricity liberalization is worth doing remain obscure to most people, mesmerized as they are by the disaster stories.
The trends that are driving electricity deregulation are the same ones that are driving globalization more generally: convergence of technologies; opening of borders; competitive pressures; separation of production and distribution; and opportunities in the US market.
In communications the barriers between technologies are falling. Telecommunications companies are buying newspapers, Internet portals and television networks in the hope of providing not merely the means to transmit information, but the information (content) itself.
Something similar is happening in the delivery of services through pipes and wires to homes and offices. According to Ken Malloy, President of the Washington-based Center for the Advancement of Energy Markets, the main benefit of deregulation in natural gas, telecommunications and, soon, electricity, is not just cheaper power. It is the creative re-bundling of previously separate services. The old regulatory silos that kept these services apart are crumbling.
Very soon a handful of companies throughout North America will be offering competing packages of bundled services for the home. Each of these competing companies, will sell you, for one monthly payment, power, heat, telephone, cable, internet, security and a host of other services currently offered separately.
The advantages (and economies) will be significant. Think about how you heat your home at the moment. You have to make the choice between electricity, wood, oil and natural gas? Should you have forced air, hot water baseboard or electrical heat? What about new technologies, like heat pumps? If you are considering switching from one fuel to another, is it cheaper to run the old system for another year, or convert to the new one now? What kind of temperature controls do you need? Is your insulation adequate?
Now suppose that you had four or five large companies all trying to get the contract to deliver to you a bundle of household services, including heat? You wouldn’t need to get into any of these calculations. You would simply sign up with a company for a stated temperature within the house. You’d pay a flat fee for that level of service and transfer the responsibility for all those decisions about fuels and insulation and depreciation to a company that pays many clever people to manage your heating effort, and those of thousands of other homes and businesses.
But this will only work where there can be competing suppliers of these commodities flowing through various kinds of pipe and wire into homes and offices. The old monopoly model cannot survive this challenge.
Deregulation of electricity is essential to full participation in this revolution, a revolution that will lower costs through economies of scale and application of management expertise, but also widen consumer choice. And based on international experience, electricity deregulation unlocks not just important consumer savings, but also improves incentives for new technological innovations to improve service quality.
According to electricity guru Tom Adams, of Toronto-based Energy Probe, “Customer choice among power suppliers is not just a competition issue but a competitiveness issue. Increasingly, advanced technology manufacturers, for example, require a higher standard of power quality than traditional utilities…provide. The obvious way for businesses requiring extra clean power…is to self-generate and use the grid for backup.”
But before any business can make the necessary investments, the rules must be clear. Not only will high-end manufacturers require higher standards of power, but there is significant potential for many industries to co-generate power. Industries such as Stora-Enso forest products in Cape Breton or the Irving oil refinery in Saint John, can generate large amounts of electricity from their existing industrial processes, meet their own power needs and sell the surplus to the grid. But this kind of generation will only be maximized in a competitive market where consumers and producers know their rights related to plugging into the transmission system, their opportunities to sell surplus power, and their cost exposure for back-up power.
Opening of borders
In the old protectionist world, countries tried to keep out imports but to export as much as possible. The result was higher costs and poorer quality for consumers, and severely restricted economic growth around the world.
In the new model, products are no longer “American” or “Japanese” or “Canadian”. They are an amalgam of expertise, work and investment by people from every nook and cranny of the world.
Electricity’s monopoly status has hampered its globalization. Once upon a time, electric power was seen as a natural monopoly, with each province or state running its local power company, either by owning it, or regulating a private company. Investment and service decisions were made largely on political criteria, which had its advantages, such as ensuring that electricity reached even the most remote rural consumer.
But the disadvantages were legion. Instead of being run as a business, electricity became in many places a government boondoggle. Generation mega-projects were undertaken because of the short-term employment they generated. Expensive or dirty local fuels were used, boosting employment, but driving up costs in the local economy. Power rates were manipulated according to the political imperatives of the hour, whether to reward favoured industries, or to bribe voters by making electricity artificially cheap.
Borders open to trade make it harder to sell shoddy local goods, because consumers have choices. The same is true in electricity: open borders chase out politicization and other bad practices, because their true costs are revealed.
Indeed, the international trend toward liberalized electricity markets is often referred to as “deregulation”. But in many Canadian jurisdictions, a better way to describe it is “depoliticization”. Nova Scotia has already made great progress in depoliticizing its electricity sector through the privatization of NSPI, a move that, according to Tom Adams, has been very successful in containing rates, enhancing efficiency, and eliminating taxpayer liabilities. Nova Scotia has not yet introduced competition to its electricity market, but a sound business foundation has been established on which to build.
New Brunswick has a thoroughly politicized power sector, making the hurdle to achieve a liberalized market much greater.
Six years ago, Prof. Norman Betts, then a prominent academic, now New Brunswick’s finance minister, published a report on the state of the provincial Crown utility, NB Power. He concluded, “NB Power is in a financial crisis, resulting primarily from the financing and fixed cost burden of excess capacity.”
This analysis, though dismissed by the utility at the time, has proven far-sighted. Ever-rising rates and better debt management have given NB Power adequate day-to-day financial performance, but warning flags are being raised about its long-term financial sustainability. Recently, NB Power wrote down $450 million of its investment in the Point Lepreau nuclear station. This followed an earlier analysis for the utility indicating that the useful life of the station should be shortened from 31 years to 25. A Grant Thornton financial report for the Lord government confirmed the appropriateness of the write down, and suggested that more may be to come.
Separation of production and distribution
But for bad practices to be squeezed out of the electricity industry, suppliers beyond the monopoly must be able to sell into the system. Under deregulation we are witnessing the slow emergence, particularly in the United States, of a power grid that is not merely a connection between regional monopolies indifferent to market signals. Instead competing suppliers, traders and willing buyers dominate.
What is happening in the US in electricity is largely based on the successful deregulation of natural gas. There, the companies that owned the pipelines had a lock on gas sales. Then in 1978, the Federal Energy Regulatory Commission in Washington DC started its deregulation plan. For the first 5 years or so, virtually nobody bought gas from the new ‘third party’ suppliers who were also putting gas into the pipelines. By 1986, one half of gas sales were by third parties. And today, while gas deregulation is still being tweaked, third party sales cover virtually the totality of natural gas sales in the US.
According to the US Federal Energy Information Administration, competition in natural gas has been a boon for consumers. Between 1983 and 1999, prices to residential consumers have declined by 35%, and by 58% for industrial consumers. The wellhead price paid to producers fell by 61% over the same period.
Nor is the electricity trading model, whatever may be happening in California, a failure. The experiences in jurisdictions such as the State of Victoria in Australia and the U.K. suggest that electricity sector liberalization can be an attractive route. There, liberalization has stimulated investment, encouraged modernization, introduced efficient pricing, spurred conservation, enhanced accountability, and reduced costs for consumers. Despite the misfortunes of liberalization processes in places like California, progress in the US has also been significant.
Ken Malloy’s Center for the Advancement of Energy Markets in Washington (www.caem.org) does an annual rating of the 50 states’ progress toward a workable system of electricity market opening called the RED Index, for Retail Electricity Deregulation. The World Bank calls the Index “the most sophisticated scorecard for measuring power sector reform.” California scores a poor 38 out of 100.
On the other hand, this year the CAEM awarded Pennsylvania, which scored 66 out of 100, the 2000 “RED Carpet Award” for furthering “an effective transition from the monopoly model to the choice model.”
“We have delivered approximately $3 billion in savings, due to guaranteed rate cuts, savings from shopping, and avoided fuel costs,” says Pennsylvania Public Utility Commission Chairman John Quain. “Before electric choice, Pennsylvania electric rates were 15 percent above the national average, and now our rates are 4.4 percent below the national average.”
The state projects that electric competition will create more than 36,000 new jobs in Pennsylvania by 2004.
Governor Tom Ridge led the push for electric competition. In 1997, Pennsylvania launched the country’s largest electric-choice pilot program. Through the pilot, Pennsylvania had more customers buying their electricity competitively than any other state. By January 2000, choice of electricity supplier was extended to everyone. A year later, more than 560,000 Pennsylvania electric consumers had selected a new electricity supplier.
The latest RED Index update, reflecting the fact that Alberta’s deregulation teething problems are now behind it, scored even higher than Pennsylvania, and was rated the best deregulatory system in North America, with 68 points.
Nationally, however, the RED Index Canadian average is 2 out of 100, compared to the U.S. national average of 17. This demonstrates that a majority of Canadian provinces and territories, with significant government ownership of their energy facilities, have not got retail restructuring underway. Nova Scotia and PEI both get 0 points, whereas New Brunswick gets a -6!
But that may be changing. According to New Brunswick’s January 2001 white paper: “There is little option but to become part of what is developing into a fully integrated, North American electricity supply and marketing grid. In order to participate and to continue to capture the benefits of a competitive market, New Brunswick must operate by rules and procedures compatible with those established by the FERC [Federal Energy Regulatory Commission].”
That means that even New Brunswick, wedded as they have been to the old government-dominated model, recognizes that change will come, and that it will be driven by the emerging continental electricity market where competing power generation companies use a common, arm’s length distribution system to deliver choice to consumers.
Opportunities in the US market.
The opportunities for the Maritimes are not just in what deregulation may bring to our doors and factory gates by way of cheaper power and rebundling of services. There are also opportunities for us in markets in the US.
New England and New York, like California, suffer from some energy supply problems. The difficulties lie less on the generation side, where new capacity has recently been coming on stream. The bigger challenge is that it can be very hard to get the regulatory approvals needed to build the transmission capacity to move power to consumers. Residents fight those overhead wires and pylons with a daunting fury.
Yet consumers want and expect their power supply to be reliable and to expand to meet demand. Therein lie some opportunities for the region. When Point Lepreau is operating, New Brunswick has significant electricity for sale, and Nova Scotia now has an abundant supply of the feedstock with which much of any new electrical supply will be generated: natural gas.
Companies like Emera, the holding company that owns Nova Scotia Power, recognize where the future lies. Not only has Emera moved confidently into the natural gas market, but it has bought a utility in Bangor, Maine and has hired a prominent Washington energy consultant to help them navigate their way into the continental energy business.
Stodgy parochial New Brunswick Power remains an obstacle to the emergence of a nimble Maritime energy company that could capitalize on the opportunities available in the US Northeast, but it is no secret that Emera has made repeated attempts to buy at least some of the provincial Crown corporation’s generating assets, and that the pressures for a market-driven regional company will only continue to grow. Maritime Union will not be a political act, but rather the result of getting politics out of things like electricity, telephone service and transport policy.
The opportunities are significant. Beyond the possible expansion of the Maritimes and Northeast Pipeline to perhaps as much as 2 billion cubic feet of natural gas a day there is, for example, the Neptune Project. Investors on both sides of the border are considering a network of underwater cables to carry Canadian electricity to major urban markets in New York, Boston and elsewhere. NB Power, desperate to sell surplus electricity, has said it would buy transmission capacity on such a project, and might become an investor.
Nova Scotia has said it encourages both Neptune’s promoters, and those of a smaller project, because the province wants to export electrons (electricity) as much as it wants to export molecules (natural gas). But it remains to be seen if the huge capital costs of such projects are truly economical. In a continental energy market, it will no longer be possible to pass off the costs of bad policy onto consumers, so governments must be cautious about getting involved. Energy companies should be given a lot of latitude to risk their own money where they see a market opportunity, but there is no reason for the taxpayer to subsidize that risk.
Even if Maritime consumers and governments preferred the quiet life and wanted to leave the electricity industry just the way it is, the costs of doing so would rapidly become insurmountable. It is not merely that we would be forgoing lower prices for retail and industrial consumers. We would also be giving up employment and investment opportunities. And if we don’t look outward, continental consolidation in the industry will soon come looking to buy assets and customers here.
The region has potential to grow as an energy supplier in a sea of consumers. But reciprocity is the rule. To exploit the opportunities US markets offer us, we have to bring the benefits of electricity competition and consumer choice home.