Fortnightly
The Monopoly Mindset
November 15, 1995By Audrie Krause
California regulators and the utilities they oversee have been talking a lot in recent years about competition. But just being able to "talk the talk" isn't enough \(em utility companies and the regulators who monitor them have got to "walk the walk." And on that score, they've just barely begun to crawl. Despite all the marketing hype, the monopoly mindset is still very apparent among industry officials and regulators.
Take California's energy industry, for example. With considerable fanfare and hoopla, the California Public Utilities Commission (CPUC) announced in March 1994 that the state's electric industry would soon be "restructured" into a competitive industry in which customer choice would lead to lower-cost service. The impetus for this proposed restructuring was widespread dissatisfaction with the high cost of electricity in California. With electric rates 50 percent higher than the national average, a broad-based coalition of consumer, business, industry, and agricultural customers had already asked the CPUC to reduce rates across the board by 25 percent over the next five years. The high rates stem in large part from earlier decisions by the CPUC that enabled Southern California Edison and Pacific Gas & Electric Co. to pass on to their customers virtually all the excessive costs they incurred building nuclear power plants. (Edison, along with San Diego Gas & Electric, owns the San Onofre nuclear generating station in San Clemente; PG&E owns the Diablo Canyon nuclear power plant in San Luis Obispo.)
The CPUC's announced intent to restructure the electric industry caused utility stock prices to plummet. When the CPUC later conducted public hearings throughout the state to listen to what consumers had to say about the proposed restructuring, hundreds of investors \(em most retirees \(em demanded that regulators continue to protect the value of their
investment. In other words, they wanted to continue to reap substantial profits off bad investments. The investors' presence at the hearings \(em which are normally poorly attended \(em followed a carefully orchestrated effort by PG&E, Edison, and SDG&E.
Rewarding Bad Investments
The utilities need not have bothered. When they announced the restructuring plan, California's regulators had signaled their intent to protect the utility companies against any losses stemming from "uneconomic" or "stranded" investments, which are regulatory euphemisms for overpriced nuclear power plants. California's regulators subsequently reiterated their promise to protect investors against such losses when, in May 1995, they released two alternative revised proposals for restructuring the electric industry.
The monopoly mindset leads regulators and investors to conclude they have a right to profit from bad investments. Competitive businesses are unable to pass on such costs because their customers would quickly take their business elsewhere if they did. In competitive industries, poorly managed companies don't survive.
For example, PG&E's blunders in building Diablo Canyon are now legendary. First, the company's geologists failed to identify a major earthquake fault under the plant site. Then, construction workers read the engineering blueprints backward and incorrectly installed seismic supports. The power plant literally was built and torn down twice before PG&E got it right on the third try. In a competitive industry, colossal blunders like these would probably have led to bankruptcy and ruin. Instead, regulators allowed PG&E to avoid what would have been an extremely embarrassing prudence review by adopting an "incentive" ratemaking arrangement for Diablo Canyon. After a one-time writedown, PG&E's profits soared because of Diablo Canyon, and California regulators have subsequently declined to correct their error. The lesson here is that in a monopoly environment, utilities can expect to profit from their mistakes.
Now that California regulators are seeking to restructure the electric industry, the time is ripe to write down the value of these overpriced nukes. After all, authorized utility profit levels are typically set with the understanding that stockholders may not fully recover their capital investment. But when that risk threatens to become reality, utilities and regulators balk at making shareholders pay the price for management's poor judgment in building nuclear plants. Instead, regulators make it clear they intend to pass those costs on to consumers through a "Competitive Transition Charge."
This same sort of thinking is apparent in the current effort by Edison, PG&E, SDG&E, and Southern California Gas to pass on to consumers the costs associated with promoting the development of electric and natural gas vehicles. This particular example may well be unique to California, where freeway gridlock is a way of life for millions of commuters, particularly in Southern California. Faced with the growing discontent of heavily taxed voters, California lawmakers lack the political will to increase taxes to fund public transit. Nor are they willing to take a hard look at the land use and transportation policies that lead to freeway gridlock and the resulting decline in air quality. Instead, lawmakers and regulators favor hiding the cost of these promotional efforts in the cost of utility service for consumers.
Without question, automobile emissions contribute significantly to California's air-quality problems. Without question, the introduction of low-emission vehicles (LEVs) will ultimately improve California's air quality. But why should the captive customers of monopoly utilities be forced to pay for these efforts through increases in gas and electric bills? Many entrepreneurs in California are already at work on the design, development, and distribution of LEVs. These individuals are risking their own capital on these efforts. If they succeed, they will profit; if they fail, they may lose their investments. This is how capitalism works.
Free Enterprise=Free Ride?
Ironically, the same regulators who favor such hidden taxes are ardent supporters of "free enterprise." But forcing poor and disadvantaged consumers to bear the risk of investments that could ultimately earn profits for utility shareholders is not free enterprise, it's corporate "welfare."
If California utilities are allowed to raise rates to fund programs that promote LEVs, they will essentially be making a risk-free investment. If those investments are successful, utility stockholders will reap the profits associated with increased sales of gas and electricity. If the programs are unsuccessful, investors will have lost nothing. It's a great deal for the utility companies and their investors, but a lousy one for consumers. It is also a prime example of the monopoly mindset at work. In competitive industries, risks are assumed by investors, and CEOs who make too many bad investment decisions wind up without a job.
It isn't only energy utilities that pay lip service to the advantages of competition and free enterprise.
Thanks to advances in technology, the telecommunications industry has experienced significant declines in recent years in the cost of providing local phone service. Primarily as a result of computerization, tens of thousands of telephone industry workers have lost their jobs in recent years, significantly reducing operating costs. Yet Pacific Bell (PacBell) sought, and California's regulators approved, a 35-percent increase in its basic service rate, in conjunction with the introduction of competition into the intraLATA toll market. For all but the largest users of local toll services, the increased cost of local phone service wiped out any potential savings from the reduction in intraLATA toll rates. Furthermore, regulators declined to even consider the issue of equal access for long-distance telephone companies, thereby assuring PacBell a competitive advantage in the intraLATA toll market.
California regulators also allowed Pacific Telesis (PacTel), PacBell's parent company, to spin off its wireless operations (subsequently renamed Airtouch) without compensating ratepayers for the millions that PacTel had collected from customers and spent in the 1980s to develop the cellular business. The result was that shareholders reaped the rewards of a risk-free investment that ratepayers had been forced to finance through higher rates.
Now PacBell is attempting to invest risk-free in competitive markets for interactive video and wireless communications. PacBell hopes to force captive customers to finance its venture into the world of video dialtone by claiming that most of the project's $16-billion price tag is needed to improve local phone service. While relatively few of PacBell's customers are likely to use the video services the company hopes to sell, all consumers may eventually be burdened with most of the estimated $1,000-per-household cost associated with the utility's entry into competition with the cable industry. In a competitive industry, these investments would be made by shareholders.
Adding insult to injury, service quality has declined significantly at PacBell for all but the biggest customers. This might be expected in a monopoly environment, but in competitive industries, quality service is just as important as competitive pricing.
To some extent, utility companies can't be faulted for wanting to have their cake and eat it, too. It's not easy to reverse 50-plus years of monopoly mindset, particularly for managers who never had to deal with competition. California regulators are another matter, however. In recent years, virtually all of the appointees to the CPUC have promoted the free market as the best way to lower utility costs and improve customer service. These individuals speak in glowing terms of the benefits to California's economy of a more competitive utility industry. But talking about the benefits of competition and establishing policies that promote competition are too different things. California's regulators \(em like the utilities they oversee \(em are far better at "talking the talk." And talk alone won't bring about true competition. Until regulators and utilities cast off their monopoly mindset, consumers won't benefit from competition. t
Audrie Krause is the former executive director of Toward Utility Rate Normalization (TURN), a California nonprofit consumer advocacy organization, and a former reporter for the Fresno Bee. She was recently appointed executive director of Computer Professionals for Social Responsibility (CPSR), a Palo Alto, CA-based national alliance of computer professionals, computer users, and computer science educators dedicated to educating others about the impact of computers on society.
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