Why separate utilities? distribution functions from their generation and
energy service functions in a competitive retail electricity market?
One of the most basic requirements for a competitive retail market for
electricity is participants? access to the wires, transmission and
distribution, that move electricity from generating plants to consumers.
Physical connection to the wires is not enough -- the terms and conditions
of access cannot discriminate between competitors if full and open
competition is to develop. Some of the more difficult issues that have been
raised in debates about restructuring the industry have been questions about
how best to assure nondiscriminatory access to the wires.
One such issue has been the notion that it is important to separate, at
least in a functional sense, the distribution part of the utility -- the
wires and equipment that connect the utility to its retail customers -- from
the generation and energy services parts of the utility. In general,
distribution is expected to remain a monopoly function because it would be
impractical and wasteful to have several sets of wires delivering
electricity to the same areas. Because it is likely to remain a monopoly, it
will probably continue to be regulated.
In contrast, generation and energy services -- the businesses of
producing, acquiring and selling the electricity commodity -- are the parts
of the utility business that are becoming competitive. It is no
longer impractical for different generators or marketers to compete to
provide the electricity itself to retail customers. Generators are already
competing in the wholesale market. The provision of energy services (which
include the consolidation of customers into groups, packaging of energy with
various levels of reliability and other services) is expected to
develop into a competitive activity as competition is allowed at the retail
level.
The case of generation and transmission
Transmission can be defined as the wire and equipment that is used to
move electricity between utilities and over long distances. Transmission is
similar to distribution in that it is likely to remain a monopoly function.
Transmission owners are now required to provide transmission access to other
generators, but simple access is not sufficient to ensure effective
competition among generators. As competition has developed in the wholesale
market for power, it has been widely appreciated that transmission needs to
be separated from generation to prevent "self-dealing". For example, if a
company is allowed to mix its generation and transmission costs, it can
raise the price of transmission to cover some of its generation costs. This
enables the company to charge less than its full cost to generate the
electricity commodity.
The practice has four effects: First, transmission is overpriced, so the
transmission system may be underutilized. Second, generation is underpriced,
leading to greater use of the company?s generators than is economically
efficient. Third, competition is stifled by allowing the company to compete
unfairly against generators who must cover all their generation costs from
their generation revenues. Fourth, there may be temptations for the utility
to cut its transmission system maintenance costs to the bone to compensate
for higher generation costs. This can result in reduced reliability of the
power system.
The Federal Energy Regulatory Commission recognized the importance of
separating the costs of transmission and generation. To encourage a
competitive wholesale generation market, the Commission established
regulations that require such separation. How these functions might
ultimately be separated has not been determined. One alternative would be
divestiture into separate companies. Utilities in the Northwest and
elsewhere are exploring another arrangement in which control of transmission
equipment is turned over to an independent grid operator (IndeGO is the
Northwest example).
The case of energy services and distribution
While the desirability of separating generation and transmission has been
widely discussed, the similar relationship between energy services and
distribution wires has received less attention. Mixing these two activities?
costs in a single company would create the same opportunity for price
distortions and unfair competition as described for generation and
transmission above. The company could charge expenses incurred in the energy
services activity to customers of the distribution wires, with the result
that energy services are underpriced, distribution is overpriced, and
competition with other energy services businesses is unfair. In a world
moving toward retail competition, the pressure to subsidize the competitive
activity with revenue from the monopoly activity becomes more intense.
Separation of the two activities removes the pressure and prevents the
potential unfair and inefficient results.
There are other concerns about retail competition?s potential impact on
retail customers. One is a concern about quality of service. For example,
suppose customers select an energy service provider other than their current
utility. If there is a power outage, would the utility that controls their
distribution wires -- the utility they left for the new provider -- place
the same priority on restoring their power as for customers whose energy
services are still provided by the distribution utility? A similar concern
is whether, under competitive pressures in its competitive activities, a
utility would sacrifice the maintenance of the distribution system and thus
affect system reliability. These are valid concerns if the distribution
system is run by the same company that is selling the energy services.
Separation of the distribution and energy services activities solves this
problem.
Forms of separation ? functional vs. divestiture
Separation can be accomplished in a variety of ways, but the
possibilities generally fall into two categories: functional separation or
divestiture. Functional separation ordinarily requires separate accounting
and employee organization for the separated activities, but allows ownership
of both activities by the same owner(s). Divestiture requires that ownership
be separated.
Functional separation has the advantage of being relatively easy to
accomplish -- the utility can set up separate divisions within the company,
with the activities under separate management, with costs and revenues kept
in separated activity accounts. The main disadvantage of functional
separation is that even with regulatory scrutiny it is difficult or
impossible to be certain that costs are not being mixed, or that the
monopoly activity is not being managed to advantage the competitive activity
in some way. As long as ownership is common to both activities, there will
be incentive to manage the monopoly activity to favor the competitive
activity.
Divestiture has the advantage of a complete separation of activities.
With separate ownership, incentive for the monopoly business to favor the
competitive business is gone. The main disadvantage of divestiture is the
difficulty and complication of carrying it out. There may be tax
consequences for investor owned utilities. Regulatory concerns will arise in
assigning the assets and liabilities of the current company to the separated
businesses, especially if collection of stranded costs is an issue. If one
of the businesses is to be sold, there will be concern about whether the
pool of interested buyers is large enough to ensure a reasonable price for
the business.
Since each approach has its advantages and disadvantages, utilities and
regulators have been slow to settle on a preferred alternative. The general
approach has been to attempt functional separation while monitoring results
to see whether functionally separated companies can participate in
competitive markets on equal terms. If not, full divestiture is likely to be
necessary for fair and efficient competition in the deregulated activities.
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