Testimony before the Pennsylvania House Consumer Affairs Committee
June 10, 1996
My name is Irwin A. Popowsky, and I am the Consumer Advocate of Pennsylvania. I want to thank you for the opportunity to testify before this Committee regarding the subject of electric competition and specifically House Bills 2537 and 2075.
As you may recall, I testified previously before this Committee regarding House Bill 2075. That bill sets forth standards which must be applied by the Pennsylvania Public Utility Commission in determining whether or not to permit the hostile takeover of a Pennsylvania electric utility. I testified at that time that I fully supported the standards set forth in that bill, but I contended that the standards should be applied to all electric utility mergers, not simply to hostile takeovers. In my view, just because the management and board of directors of a utility support the takeover of their local utility, that does not mean such a takeover is in the consumers' or in the public interest. I would reiterate that view today and suggest that to the extent the General Assembly favors greater competition in the electric industry in Pennsylvania -- and I believe it should favor such a policy -- it is important that the potential benefits of competition not be eroded by any electric utility mergers which actually reduce competition and which are harmful to consumers and to the communities which our utilities currently serve.
Today, however, I would like to focus my comments on House Bill 2537, which directly addresses the question of retail electric competition in the Commonwealth.
I am pleased to state that I support each of the principles and most of the provisions of this extremely important and comprehensive legislation.
Let me start with Section 2, the Statement of Purpose behind this legislation, and particularly subsection (8). That provision states that:
[T]he General Assembly hereby finds that it is in the public interest to permit all retail electric customers to choose their supplier of electric generation services in a competitive market and to continue to regulate electric transmission and distribution and some aspects of generation in order to provide safe and reliable electricity at the lowest possible prices for consumers.
In my opinion, that sentence is exactly right, and that sentence states the exact policy on which our legislative and regulatory actions in Pennsylvania should be based. This provision does not say that all electric utility service should be deregulated. Rather this provision correctly distinguishes between the generation of electricity, which is not a natural monopoly and which therefore can be provided on a competitive basis, and the transmission and distribution of electricity, which are natural monopoly functions and which must continue to be carefully regulated in the public interest. This provision also makes it clear that competition is not a goal, or an end in itself; rather competition is a means to achieve the appropriate goal of providing "safe and reliable electricity at the lowest possible prices for consumers."
Section 2 of the Bill also correctly recognizes (in subsection 6) that wholesale generation competition alone will not be enough to reduce the high rates of some Pennsylvania utilities; nor will it eliminate the great disparity among Pennsylvania utility rates. Those are caused primarily by the high cost of some of the existing generation resources that are currently reflected in utility base rates. In 1960, the average residential rate per kilowatt hour charged by Philadelphia Electric Company (PECO) was one hundredth of one cent lower than the rate charged by West Penn Power Company. The entire spread among the residential rates for all seven major Pennsylvania electric utilities was less than one half a cent. In 1970, the entire range of residential rates was still less than one half of a cent per kilowatt hour, from a low of 2.07 cents to a high of 2.54 cents. By 1990, the spread among the residential rates for Pennsylvania utilities was more than seven and one half cents, with West Penn charging 5.04 cents per kilowatt hour, and PECO charging 12.58 cents. For a typical residential customer using 500 kilowatt hours per month, that was a whopping difference of $37.70 per month. What happened between 1970 and 1990? I don't think it's that Philadelphia suddenly became a big city, and Greensburg and Latrobe suddenly became smaller towns. Rather, I think that PECO embarked on one of the most ambitious and expensive nuclear construction programs in the entire United States. West Penn didn't.
My reason for raising this issue now is not to blame PECO for bad judgment or to praise West Penn Power for great foresight. For better or worse, the prudence of those decisions has already been decided. My point here is that the type of rate disparity that arose in that period could never have occurred in a competitive generation market. No one could sell PECO's nuclear power at its full exorbitant cost to anyone other than a captive monopoly consumer. Similarly, no one other than a captive monopoly consumer would voluntarily pay twice as much for electricity from Duquesne Light Company (which also had a horribly expensive nuclear construction program), when their neighbors literally across the street are paying half as much for the identical product from West Penn Power.
More importantly, however, there is no reason for this problem to recur in the future becasue, as House Bill 2537 correctly recognizes, the construction and operation of electric generation plants is not a natural monopoly. Competition in generation -- assuming it is full and fair competition -- will prevent that type of rate disparity from arising in the future.
That still leaves the question, however, of what to do now, when the question in Pennsylvania is not so much how to procure new generation, but rather how to pay off the cost of our existing high cost plants in a way which is fair to both ratepayers and utility investors. HB 2537 again, in my view, reaches the correct conclusion; that is, we should have a reasonable transition to a competitive electric generation market, in which the uneconomic costs exposed by competition -- the so-called stranded costs -- are shared among utility investors and ratepayers. I would note in this regard that Section 3 of HB 2537 incorrectly defines stranded investment to include "utility investments rendered uneconomic as a result of implementation of this act." I would submit that utility investments such as PECO's Limerick plant and Duquesne's Perry 1 and Beaver Valley 2 plants were "rendered uneconomic" years ago by technological and market forces. Indeed, those plants were uneconomic the day they came on line and have only become more so as new lower cost technologies have continued to emerge. The implementation of HB 2537 merely removes the regulatory protection which has enabled PECO and Duquesne to charge rates for those uneconomic plants which could not be achieved in a competitive market.
In my view, the law is clear in Pennsylvania that electric utilities do not have a constitutional or statutory right to demand 100% recovery of and return on uneconomic investments which can no longer be recovered due to competitive forces. Pennsylvania has long enforced the principle that utility investments must be used and useful (as well as prudent) in order to earn a full return from ratepayers. This basic tenet of Pennsylvania law was upheld in 1989 in a case which I had the honor to argue before the United States Supreme Court, Duquesne Light Company v. Barasch. In that case, the United States Supreme Court upheld the constitutionality of this General Assembly's enactment of Section 1315 of the Public Utility Code which, we argued, precluded Duquesne Light Company and Pennsylvania Power Company from charging ratepayers for the cost of four cancelled nuclear power plants. The Court, in an opinion written by Chief Justice Rehnquist, specifically rejected the argument of the Pennsylvania Electric Association that utilities have a constitutional right to recover all costs that are prudently incurred, even if they are not used and useful to ratepayers. As you know, the General Assembly also has enacted legislation that prevents utilities from charging ratepayers for the full costs of new baseload power plants that represent excess generating capacity.
I would urge this Committee to take the same approach here and to adopt the principle set forth in Section 7(h)(2) of HB 2537 that:
It is the policy of this Commonwealth to move towards a more efficient electric generation industry by distributing both the benefits of competitive prices and the burdens of stranded investments and transition costs widely and fairly among shareholders and customers.
Section 7(g) tries to accomplish this policy goal by establishing a sliding scale of stranded cost recovery -- between 100% and 65% -- depending on the length of the recovery period that the utility requires. If I could amend this legislation, I would suggest a more steeply declining recovery scale, such as one which goes from 90 percent in three years to 50 percent in seven years. Additionally, the legislation could be amended to make it clear that the percentages permitted under this provision are "ceilings" and that the Public Utility Commission could allow lesser amounts if it concluded that a lesser recovery was just and reasonable.
While I would obviously like to minimize the share that ratepayers will have to pay in any transition to a more competitive generation industry, I think it's most important at this time to recognize the principle that there must be some sharing of these costs. It is also essential that the General Assembly retain the provision in Section 7(e)(4) that, under no circumstances should the recovery of stranded costs be permitted to result in an increase in overall rates charged to any class of customers for any utility. It would be a cruel joke indeed if this General Assembly's effort to reduce rates through competition were to result in yet another rate increase for Pennsylvania consumers who already are paying rates which are well above the national average and well above anything that could be justified in a truly competitive market. It is also essential that, as set forth in Section 7(e)(1), any stranded cost recovery mechanisms must reflect efforts to mitigate such costs and must also reflect any offsetting increases in the value of generation assets whose market value is greater than its current depreciated cost.
I would also respectfully suggest that, if this General Assembly wishes to allow retail generation competition, then it must address the stranded cost issue, or run the substantial risk of having Pennsylvania policy on this fundamental issue be preempted by the Federal Energy Regulatory Commission (FERC). In a landmark order issued April 24, 1996, the FERC ruled that utilities which lose wholesale customers to competitors under certain circumstances have a right to recover 100% of their stranded costs. While I disagree with both the legal and policy rationale which authorized 100% stranded cost recovery in the wholesale market, I would certainly acknowledge that the FERC has the jurisdiction to decide this issue with respect to wholesale transactions. Of more importance here, however, is FERC's attempt in that Order to extend its faulty reasoning to stranded costs that arise as a result of retail competition. At page 558 of its Order FERC states that:
Should a situation arise in which a state regulatory authority concludes that it has no ability to address retail stranded costs, or the appropriate state courts ultimately determine that a state regulatory authority does not have authority to impose retail stranded costs, a utility may seek recovery here through its Commission-jurisdictional retail transmission rates of costs stranded as of the date of the customer's departure.
In other words, if a state Commission lacks authority to address a utility's retail stranded cost claims at the state level, then the utility can go to FERC and demand recovery of those costs from that federal agency.
The National Association of State Utility Consumer Advocates (NASUCA), of which I am Vice President, has filed a Petition for Rehearing on this issue, contending that FERC has no jurisdiction whatsoever to address retail stranded costs and that this is a matter which should be determined by each state as a matter of state law. Nevertheless, I would urge the Pennsylvania General Assembly to ensure that our Public Utility Commission has the authority and the clear legislative direction as to how this issue should be addressed. It appears to me that, in order to respond to the threat of preemption in FERC's flawed Order, the General Assembly should explicitly address the stranded cost issue through legislation. While I will continue to oppose any efforts by the FERC to exert jurisdiction over retail ratemaking issues, I believe it is advisable for the General Assembly to address this issue if it wishes to see any retail generation competition in Pennsylvania.
While my testimony has thus far focused on the efforts of this legislation to bring about competition in the generation function, I would suggest that the provisions regarding future regulation of the transmission and distribution functions are of at least equal importance. In my mind, careful regulation of these functions at both the state and federal level is necessary both to protect ratepayers against excessive monopoly prices and to promote competition in those portions of the industry where competition can benefit consumers. The Bill properly establishes the concept of an independent system operator to coordinate the utility system in a non-discriminatory and open manner. The Bill clearly retains the obligation of local distribution companies to connect all customers to the utility grid in their respective service areas and to provide generation service to those customers who do not choose alternative generation providers. The Bill also explicitly recognizes the need to promote universal electric service and the need to ensure that customer service levels do not decline. The Bill also requires the Commission to address issues of environmental quality, safety, reliability and market power and finally recognizes the need for significant Commission oversight over the financial and technical fitness of new entrants in the Pennsylvania electric generation and aggregation markets.
In short, HB 2537 addresses what I view to be the critical issues that must be resolved in the retail competition debate. Nevertheless, I do have some concerns and questions about some of the language in the Bill, on which I hope to be able to work with you as this Bill proceeds through the General Assembly.
For example, in Section 6(4)(iv) of the Bill, it is stated that the phase-in plan to retail competition adopted by the commission "shall permit all classes of customers an equal opportunity to enter into direct contracts" with alternative generators and that no more than 10%, 20%, and 30% of a utility's retail load can be provided through such direct contracts in 1998, 1999, and 2000-2002. I submit that residential customers need more than an "equal opportunity" to enter into direct contracts for generation supplies. They need actual mechanisms in place which will make it feasible for residential customers to enter into such contracts. Bill Clinton and I both had an equal opportunity to run for President in 1996, but the lack of a massive national campaign organization has crimped my ability to take advantage of that opportunity. Similarly, large industrial customers today are ready to hit the ground running and would almost certainly be the first to get the benefit of any low-cost direct contracts that are available in a newly competitive market. My fear is that we will quickly arrive at the same position in the electric industry that we have reached in the natural gas industry where nearly all of Pennsylvania's large industrial customers receive their gas supplies at competitive prices through gas transportation service, while nearly all of Pennsylvania's residential customers continue to receive retail sales service from their local distribution company. It is not a coincidence, I submit, that industrial gas prices in Pennsylvania have fallen over the last ten years while residential rates have increased. The Bill should be amended to ensure that the percentage of utility load which is served by direct contracts is proportionately spread among all customer classes, and is not subsumed totally by industrial customers.
Another provision with which I am concerned is the "reciprocity" provision in Section 8(7), which states that Pennsylvania consumers cannot purchase generation services from non-Pennsylvania utilities unless the states in which those utilities are located permit Pennsylvania utilities to provide generation service to consumers in those states. I can certainly understand the impetus behind this provision, but I would note that it reduces the options available to Pennsylvania consumers and limits the competitive pressure on Pennsylvania utilities. Certainly, it would be preferable if surrounding states offered Pennsylvania utilities the same opportunities to compete, but it will stifle competition and harm ratepayers if each state closes its borders to lower cost resources from other states.
In addition, while Section 13 of the Bill assures Commission jurisdiction over the entry of new generators and aggregators in the Pennsylvania electricity market based on technical and financial fitness, I think it is also important for the Commission to maintain certain customer service, reliability and safety standards with respect to these new entrants. Even if the prices charged by these entities are subject to competitive market forces, rather than regulation, it is important that Pennsylvania consumers be protected from inadequate service with respect to this uniquely vital commodity.
Finally, there are a number of provisions in the Bill which I would like to have further time to consider. For example, in Section 8(5), regarding independent system operators, the Bill states that the coordinated power system must operate "a day-ahead power pool by soliciting bids for anticipated needs." I frankly don't know whether a "day-ahead power pool" is the optimal method of operation, but I am concerned that placing that level of detail in the statute might preclude the development of more economical and reliable methods of accomplishing the goals of the Bill.
In that respect, I look forward to the upcoming release of the Public Utility Commission's report on electric power competition. I am hopeful that this report will provide all of us with practical assistance on technical issues such as this one.
I wish to thank you again for the opportunity to testify before this Committee and I would continue to offer any assistance that my Office can provide to you and other members of the General Assembly as this issue progresses.