The electric utility industry is sick. If regulators fail to grant higher revenues to meet future growth, many utilities face insolvency and deteriorating performance. The only options appear to be either government bail-outs, or the more promising avenue of deregulating the part of the system that generates the power.
After experiencing declining costs and financial stability for decades, the utilities first began showing symptoms of this disease in the early 1970s. New plants to exceed the costs of existing ones, as construction and interest costs rose and as environmental challenges stretched out construction schedules.
The Arab oil embargo, by quadrupling the price of oil and raising the price of electricity, dampened demand. But as demand flattened out, capacity kept growing to meet the higher comsumption forcesasts of earlier years. All of these factors -- higher costs for new investments, higher fuel costs and overcapacity -- raised consumers' electricity bills.
Reacting to public resistance to these higher bills, public utility commissions clamped down on utility profits and new plant construcion, even when the new plants were designed to reduce expensive oil use. Wall Street was alert to these unfortunate trends. By 1981, the value of utility stock compared with the purchase value of facilities (book value) was about 75 percent, and falling. Bond credit ratings also fell during the 1970s, particularly after the supply interruptions and oil price hikes.
Utility executives continued to hope that state public utility commissions would recognize their financial woes and grant higher returns and cash flow. But public utility comissions are unlikely to change their behavior much until citizens become more gracious about accepting higher electric bills -- an unlikely possibility.
Clearly, federal and utility efforts to reduce electricity demand are important. But even if these efforts are wildly successful, utilities in many regions of the country still face large capacity investments. Estimates of utility capital requirements range from $350 billion to $400 billion in constant dollars over this decade.
Even if this figure could be substantially cut, utilities still may have to invest more in the next decade than the value of all current generating facilities. Failure to make these investments could lead to reductions in reserve capacity, which, taken to an extreme, could result in brownouts and blackouts.
Assuming substantial financial relief is not in sight, only two options seem either feasible or likely to deal with this financial crisis. The government could rescue utilities through purchase and operation of facilities or through financial guarantees. The recently enacted Northwest Power Act or creation of the Power Authority of New York may be precursors of a more active government role.
The other option would be partial or full decontrol of electricity production. Since large coal and nuclear power plants are not always the cheapest way to meet electricity demand, the argument for public control over generating facilities is becoming increasingly tenuous.
If all new capacity additions were exempt from regulation, utilities would no longer need to dilute their stock and increase their capital costs through financing new capacity. Additional capacity could be added by new companies or utility subsidiaries, rather than by financially strapped utilities. They would employ the least costly options available to produce power, whether by coal or nuclear plants, congeneration, windmills or small hydroelectric facilities. Competition among generating options should lower costs and open up a wider range of technological alternatives. Capital costs could be reduced by relying on more debt financing, reducing the amount of equity required.
Deergulation of electricity production is no longer an idea relegated to theoretical economists. Current federal legislation -- the Public Utilities Regulatory Policy Act (PURPA) -- already exempts small power producers and cogenerators from state regulation. Extending this exemption to all new facilities not only would be a natural progression toward deregulation, but would allow it to be phased in with a minimum of disruption.
At a recent conference sponsored by the California State Unility Commission, the heads of the California and New York Commissions, John Bryson and Chuch Zielinski, both advocated decontrol as the best solution to the utility crisis. Zielinski, now in private law practice, recommended decontrolling not only new generating capacity, but all existing capacity as well.
The depth of the utility financial crisis requires bold action. As policy-makers at the state and federal levels and utility executives ponder the future, they should give serious thought to the deregulation option. While no single fix can solve a problem that has developed over a decade, decontrol could help immeasurably. It is the one option that would avoid greater centralized political control over our electricity-generating systems.