Economic Consequences of Electricity Deregulation: A Case Study of San Diego Gas & Electric in a Deregulated Electricity Market

California Western Law Review Volume 36 Number 2 UCSD Civic Collaborative--Law, Legacies and Public Policy Article Economic Consequences of Electricity Deregulation: A Case Study of San Diego Gas
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California Western Law Review Volume 36 Number 2 UCSD Civic Collaborative--Law, Legacies and Public Policy Article Economic Consequences of Electricity Deregulation: A Case Study of San Diego Gas & Electric in a Deregulated Electricity Market Colin Drukker Follow this and additional works at: Recommended Citation Drukker, Colin (2000) Economic Consequences of Electricity Deregulation: A Case Study of San Diego Gas & Electric in a Deregulated Electricity Market, California Western Law Review: Vol. 36: No. 2, Article 5. Available at: This Article is brought to you for free and open access by CWSL Scholarly Commons. It has been accepted for inclusion in California Western Law Review by an authorized administrator of CWSL Scholarly Commons. For more information, please contact Drukker: Economic Consequences of Electricity Deregulation: A Case Study o ECONOMIC CONSEQUENCES OF ELECTRICITY DEREGULATION: A CASE STUDY OF SAN DIEGO GAS & ELECTRIC IN A DEREGULATED ELECTRICITY MARKET COLIN DRUKKER INTRODUCTION Since the late 1970s, government regulation of the economy has been relaxed to foster competition. Certainly, not every sector of the public utility industry has undergone the same degree of reform. In the airline and trucking industries, for example, where few barriers to competition existed, price and entry regulations have been eliminated. Changes in industry and regulatory structures for electricity, however, are more complex, and hence the pace of change has been slower.' Electricity is the largest industry in the world, running everything from our houses to our businesses to our hospitals. Any changes to the electricity industry will therefore be felt by billions of customers and consumers. In September 1996, AB 1890 deregulated the monopolized electricity generation market in San Diego by introducing competition into the market. This change has the potential to affect not only the San Diego residents who purchase their electricity from San Diego Gas & Electric (SDG&E) but also every economic transaction that occurs with a San Diego electricity consumer. 2 If one also considers the potential effects on the safety and reliability of electricity service, it becomes apparent that the effects of AB 1890 must * Colin Drukker, Master's Candidate in Urban & Regional Planning at the University of California, Irvine. B.A. in Urban Studies & Planning at the University of California, San Diego. I would like to thank Keith Pezzoli, Michael Schudson, and Scott Bollens for their helpful comments and suggestions and particularly their candor. Any errors made are mine and mine alone. 1. See Lewis J. Perl, Regulatory Restructuring in the United States, 6 UTIL. POL'Y 21, (1997). 2. For example, if AB 1890 produces higher electricity costs for the San Diego Shoe Company (a fictional company), the shoe company will pass that cost on to its customers, who will, in turn, have less capital to save or spend on other goods or services. Conversely, if AB 1890 produces lower electricity costs, customers and consumers will have more capital to save or spend on goods and services. Published by CWSL Scholarly Commons, California Western Law Review, Vol. 36 [1999], No. 2, Art. 5 CALIFORNIA WESTERN LAW REVIEW [Vol. 36 be heavily scrutinized to ensure that San Diego operates under the safest, cheapest, and most reliable electricity service possible. Deregulation is affecting many industries worldwide, such as telecommunications, airlines, trucking, and electricity. The electricity industry is by far the largest of the markets, and deregulation of this industry has been heavily studied. Electricity deregulation, however, has been primarily studied at global, national, or state levels. This article focuses on the regional reaction to deregulation. Although simple in theory, deregulation policies are often misunderstood. Researchers categorize deregulation as one of three methods by which the government structures and controls public utilities; the other two methods are antitrust legislation and public enterprising. 3 When competition was deemed feasible but would not work due to aggressive firms or conspiratorial agreements, the government enforced antitrust legislation.' If there existed a lack of incentives to induce the private sector to provide services, the government created public enterprises, 5 such as the Tennessee Valley Authority. 6 In the case of natural monopolies, the government has regulated prices to protect consumers and promote the efficient operation of utilities. Conversely, when these monopolistic enterprises grew inefficient or when changes occurred enabling competition, the government has deregulated these same markets. While these categories may make the decision to deregulate an industry appear simple and uncontroversial, the reality is that the appropriateness of deregulation is hotly contested in political, academic, and economic arenas. The issue most often debated is whether deregulation leads to greater efficiency and lower prices. Those who support deregulation contend that it creates diversification and competition, which can only enhance efficiency Critics warn, however, of collusive behavior and stress the need for cooperation and stability in utility markets See JOEL DARMSTADTER, ENERGY TODAY & TOMORRow (1983). Darmstadter considers deregulation to be a part of the regulatory method. See id. 4. See id. at 150. For example, in 1982, AT&T was forced to relinquish its 22 Bell System companies, as well as the Bell name, as a result of an antitrust suit. See Hal Hellman, Telephone, in 19 ACADEMIC AMERICAN ENCYCLOPEDIA 80 (1983). These companies were then reorganized into seven regional companies to provide local telephone service. See id. While AT&T was allowed to keep its long-distance telephone business, it is now faced with a large amount of competition from companies such as MCI and Sprint. See id. 5. See JAMES C. WILLIAMS, ENERGY & THE MAKING OF MODERN CALIFORNIA (1997). 6. Created in 1933 by Franklin D. Roosevelt, the Tennessee Valley Authority (TVA) helped to promote flood control, navigation, and the sale of electric power. See Lee S. Grene, Tennessee Valley Authority, in 19 ACADEMIC AMERICAN ENCYCLOPEDIA (1983). Although private power companies opposed the TVA, the production and sale of hydroelectric power was considered a legal by-product of flood-control and navigation dams. See id. 7. See MICHAEL A. CREW ED., DEREGULATION & DIVERSIFICATION OF UTILrrIES (1989). 8. See id. at Drukker: Economic Consequences of Electricity Deregulation: A Case Study o 2000] ECONOMIC CONSEQUENCES OF ELECTRICITY DEREGULATION 293 Looking at California's past energy policies, 9 there is a strong propensity toward restrictive or heavily regulated energy policies developed to protect the consumer. 0 These policies, however, have ignored the preservation of energy resources and thereby contributed to the degradation of the natural environment. Moreover, these policies were subject to the same kind of collusive behavior feared in a deregulated market. Although government involvement in energy management is recognized as a necessity, a deregulated market is drawing increasing support as the better method of managing energy's future use. Some argue that we must achieve greater energy efficiency in the future or risk draining the environment of all its resources. Others argue for the same increased efficiency for economic reasons. Both agree, however, that present energy technologies are not being maximized, and new energy policies are necessary to raise energy standards. 2 As the world's consumption of energy rises sharply over the next thirty-to-fifty years, our supply of fossil fuels will not satisfy this demand without seriously compromising the world's resources. 3 To avoid future environmental damage, current energy policies must be restructured to take into account the overall impact of energy use on society.' In addition to environmental concerns, policy makers must also consider the role of a utility as an essential service 5 when altering public utility policy. Utilities are essential services used by every stratum of the social and economic community. A change in utility policy, therefore, can directly affect every user and beneficiary of that utility. For example, deregulation policies can eliminate entire sectors of the government while also instigating an increase in new businesses and foreign investment.' 6 These changes may 9. For a more detailed history of Califomia's regulatory past, see WILLIAMS, supra note 5, at Some examples include the Forest Management Act of 1897, the Water Power Act of 1920, and the Central Valley Project Act of See id. at 238, , Very few regulations existed at the turn of the 2 0 century. See generally id. As electricity supply and demand grew, however, the United States and the state of California saw the need to regulate the use of land and the control of energy by private parties. See generally id. This trend continued into the 1960s when confidence in government regulatory agencies peaked due largely to a strong economy and plentiful energy supplies. See generally id. 11. Examples of private sector collusive agreements are price and supply fixing. When these agreements are performed by the public sector, they are called controls. Many, such as California Senator Peace or consumer advocate groups such as the Utility Reform Network (TURN), blame these controls for the above-average prices Californians have been paying for electricity. See The Utility Reform Network, TURN=Consumer Power (visited Feb. 14, 2000) http://www.turn.orglturn/tumarticles/home.htm . 12. See DANiELT. SPRENG, NET ENERGY ANALYSIS 3 (1988). 13. For a discussion on the stocks, flows, and impacts of the Earth's energy resources, see ROBERT HILL ET AL., THE FUTURE OF ENERGY USE (1995). 14. See id. at For purposes of this article, an essential service is one that is necessary to complete the fundamental tasks of everyday life, based on the present standard of living in California. 16. See PETER VAN BERGEuK & ROBERT HAFFNE, PRIVATIZATION, DEREGULATION, & Published by CWSL Scholarly Commons, California Western Law Review, Vol. 36 [1999], No. 2, Art. 5 CALIFORNIA WESTERN LAW REVIEW [Vol. 36 alter the job market, which may in turn alter the distribution of income within the area. Examining the results of macro-level deregulation should allow one to see larger trends and patterns. Overall, however, the consensus is that the impacts of deregulation are as varied as the number of countries who have implemented these policies. The strategy for creating the best policy depends upon factors such as the strength of the private sector, the distribution of income, and the system of government. 7 In addition, policy reforms in one market are interdependent upon the success of other markets. 8 This complexity demonstrates that there is no one size fits all conclusion on the effects of deregulation on electric companies and consumers. Deregulation must be examined on a case-by-case basis. This article adds to the body of literature on deregulation by examining the experience of regional deregulation and the effects of deregulation on an investor-owned company. 9 Because the majority of electricity deregulation takes place in countries where the governments own the electricity companies, current deregulation literature focuses on large-scale issues and lacks regional case studies involving private companies. This article focuses on the economic effects of deregulation on the San Diego region and the privately owned electricity provider, SDG&E. 2 Part I of this article examines why California deregulated the electricity industry and how AB 1890 was designed to achieve deregulation. Part II focuses on the economic effects of a deregulated electricity generation market on SDG&E in three specific areas: the modification of SDG&E's role as an electric utility, the reconfiguration of SDG&E's financial strategy, and the reactions of SDG&E customers. THE MACROECONOMY 35 (1996). 17. See id. at For more discussion on the interdependence of reform in markets, see id. at For purposes of this article, an investor-owned company is one owned by private citizens as opposed to governments. 20. See INTERNATIONAL ENERGY AGENCY, ELECTRICITY SUPPLY INDUSTRY: STRUCTURE, OWNERSHIP AND REGULATION IN OECD CoUNTRIEs 33 (1994). 21. This article has been compiled using relevant documents, news accounts, and formal interviews with SDG&E employees. A historical analysis of SDG&E's electricity rates and investment decisions was used to determine the effects of deregulation. Using electricity rates, investment decisions, and descriptions of the customer base, I compared the rates and investments on an annual basis to determine the degree of fluctuation since the first day of deregulation on March 31, A simple numerical study of the number of consumers leaving SDG&E was used to determine how electricity consumers are reacting to deregulation and SDG&E. Electricity rates and investment decisions of SDG&E were compared from 1993 to 1998 while consumer reaction was compared from October, 1997 to September, A conclusive causal relationship between changes in SDG&E and market deregulation will not, however, be evident for many years. This article is simply a first appraisal of an ongoing process, uncovering the beginning trends of structural change, energy investment, and consumer behavior in San Diego's deregulated electricity market. 4 Drukker: Economic Consequences of Electricity Deregulation: A Case Study o 2000] ECONOMIC CONSEQUENCES OF ELECTRICITY DEREGULATION 295 I. WHY DID DEREGULATION HAPPEN AND WHAT IS AB 1890? In 1974, the oil crisis caused by the Organization of Petroleum Exporting Countries began to wreak havoc on United States oil prices. Oil prices increased from $2.53 per barrel in 1970 to $15.76 in To counteract the increase in the cost of foreign oil, the federal government created the Public Utilities Regulatory Policy Act in This Act required utilities to buy power from unregulated generators to encourage the use of alternative fuel sources such as wind, solar, water, and waste, thereby reducing America's reliance on foreign fuel. In 1992, the National Energy Policy Act allowed additional types of unregulated companies to generate and sell electricity to public utilities.' California's electricity market, however, remained under the control of three government-sanctioned, investor-owned electrical companies. 4 The state, through the California Public Utilities Commission, regulated how much these utilities charged and what services they offered. In 1995, California legislators found that the three regulated companies charged citizens as much as fifty percent more than the national average charged by providers of utilities.' In an effort to drive prices down, legislators passed AB 1890 in September 1996 and deregulated California's electricity generation industry. 26 The Bill passed without opposition, carrying the support of Republicans, Democrats, utilities, labor, environmentalists, farmers, consumers, and small businesses. 27 Through AB 1890, California created a new electricity market structure, ending the utility monopoly on generation and opening the market to competition so that customers could choose among alternative electric energy suppliers. 28 The transmission and distribution of electric energy, however, con- 22. During the 1960s, the Organization of Petroleum Exporting Countries (OPEC) worked to prevent any decrease in the price of oil. See Lynn Turgeon, Organization of Petroleum Exporting Countries, in ACADEMIC AMERICAN ENCYCLOPEDIA 441 (1983). In the following decade, however, OPEC strove to increase oil prices, as shown by the 622% increase in Libyan oil. See id. In addition, the Arab members of OPEC imposed an oil embargo on countries supporting Israel during the Arab-Israeli War of See id. 23. See California Public Utilities Commission, Plug in, California! (visited Apr. 25, 2000) http://www.cpuc.ca.gov/divisions/csdielectric/plainenglish htm . 24. Pacific Gas & Electric (PG&E), Southern California Edison (SCE), and SDG&E served as geographic monopolies. PG&E services most of northern California and parts of central California; SCE services parts of central and southern California; and SDG&E serviced San Diego County. 25. See James P. Sweeney, Electric Deregulation Sparks Some Doubts, SAN DIEGO UNION TRIB., Aug. 10, 1997, at B AB 1890 was signed into law on September 23, 1996 as chapter 854. See California Legislature, Bill Number: AB 1890 (visited Feb. 13, 2000) http://www.leginfo.ca.gov/ pub/95-96/bill/asm/ab_ /ab_1890_bili_960924schaptered.html . 27. See John Herrington, On the Right Path with Electricity Deregulation, SAN DIEGO UNION TRIB., Feb. 12, 1998, at B See California Legislature, Bill Number: AB 1890 (visited Feb. 13, 2000) http:llwww.leginfo.ca.gov/pub/95-96fbill/asmiab /ab_1890_bill_960924chaptered. html . Published by CWSL Scholarly Commons, 296 California Western Law Review, Vol. 36 [1999], No. 2, Art. 5 CALIFORNIA WESTERN LAW REVIEW [Vol. 36 tinued to be regulated as monopoly services. One of the most important components of AB 1890 is the Competition Transition Charge (CTC)-a charge billed to all customers of California's investor-owned utilities to recover the cost of past capital investments, including power plants and other generating assets, which were poor investments in light of the shift to a competitive market. 29 Another important component of AB 1890 is the deregulation of the electricity generation market and the introduction of competition by means of a four-year transition period that began on March 31, 1998. This transition period will allow the utilities to charge a Competition Transition Charge. At the end of the four-year period, the market will be completely deregulated. II. EFFECTS OF DEREGULATION A. The Modification of SDG&E's Role as an Electricity Utility Growth in market size and technological changes have ended scale economies and made competition more feasible in the electricity industry. As more competitors enter the electricity generation market, both the possibility and necessity of deregulation increases. 3 ' In 1996, California senators felt that deregulation was not only possible but absolutely necessary. Senators Steve Peace and James Brulte authored California's deregulation legislation, AB AB 1890 forces SDG&E to compete with other electricity generators, and significantly alters the basic structure of electricity consumption in San Diego. In addition, the Federal Energy Regulatory Commission (FERC) created the Power Exchange (PX) 32 and the Independent System Operator (ISO) 3 to work in conjunction with AB 1890, thereby further re-structuring San Diego's electricity market (see Figure 1). 29. Doug Kline & Ed Van Herik, SDG&E Cuts Base Rates in Move Expected to Spur Competitive Electric Market, SDG&E PRESS RELEASE, Feb. 18, 1999, http:llwww. sdge.com/aboutus/newsroomlsdgenews.html . 30. Although the initial date was set as January 1, 1998, computer glitches forced a three month delay. 31. See Perl, supra note 1, at The PX is a system run by the Federal Energy Regulatory Commission that institutes a competitive spot market for electric power through the auction of generation and demand bids. See California Public Utilities Commission, Glossary, (visited Feb. 14, 2000) http:llwww.cpuc.ca.gov/electric-restructuringlesp-yegistrationlglossary.htm . All electricity generators must sell their electricity through the PX. See id. 33. A system run by the Federal Energy Regulatory Commission that is responsible for the operation and control of the statewide transmission grid, formerly the responsibility of PG&E. SCE, and SDG&E. Id. 6 Drukker: Economic Consequences of Electricity Deregulation: A Case Study o 2000] ECONOMIC CONSEQUENCES OF ELECTRICITY DEREGULATION 297 FIGURE 1 -
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