Blackout casts light on power problem
Utility watchers say deregulation is at core of transmission troubles
By Erik Gunn, for SBT
The quest to find the cause of August’s blackout that plunged New York City and major portions of the Northeast into darkness for a day focuses on whether something went wrong in Ohio or in Canada.
But for some utility watchers, that misses the point.
The real culprit, they argue, is federal policy that seeks to hastily deregulate the wholesale distribution of electric power.
If that policy continues unchecked, critics warn, the cost is likely to be astronomical, and the blackout merely a harbinger of crises to come.
One who holds that opinion is Nino Amato – a former utility executive who now represents Wisconsin’s industrial energy users. Amato worries that in the aftermath of the August outage, business may learn the wrong lesson.
"Some people are using the blackout to drive energy policy saying more deregulation is needed," Amato said in a recent interview from his office in Madison, where he heads the Wisconsin Industrial Energy Users Group. "These are people who haven’t learned from California and people who haven’t learned from Enron. What’s needed now is for state governments to step in and for Congress to focus on reliability standards."
Time for reassessment
The controversy over the huge August blackout argues for a major reassessment of US and Wisconsin policy regarding electric power, some say.
It’s a reassessment that has been a long time coming. The state’s electric power industry is a far cry from the days when utilities were the dependable stocks that allowed widows to sleep peacefully at night because they held their value and paid a steady dividend. It’s also a long way from the days of cheap, consistently available electric power in Wisconsin.
"We’ve gone from a system that provided affordable electricity that was highly reliable to one that is more expensive and less reliable," said Steve Hiniker, executive director of the Wisconsin Citizens Utility Board, a lobbying group that advocates for consumers.
The culprit, Hiniker believes, is deregulation.
Deregulation was supposed to slash electric rates and reshape the power industry. Instead of huge, rigid monopolies lighting and heating our homes and powering our computers, washers, toasters and microwave ovens, we would see scores of small, nimble power suppliers, all competing with each other for our business and making electric power cheaper than ever.
It would be, we were told, not unlike what happened in the telephone and airline businesses, where competition really did bring down prices, albeit in the environment of a chaotic bazaar.
The bazaar never happened. Wisconsin only took baby steps toward deregulation, rather than embracing it outright – and then watched as the power revolution self-destructed in California’s market meltdown and Enron’s phoney energy trading.
Since 1997, Wisconsin’s electric rates have climbed dramatically, even though the Public Service Commission has imposed "freezes" on some major electric power providers.
How bad has it gotten? Wisconsin’s electricity rates – once a competitive selling point for the state – have increased at a higher pace than those of surrounding states and in the nation as a whole.
Nationally, residential electric rates have held steady from 1997 to 2002, while commercial rates have risen about 4% and industrial rates about 7%. Most Midwestern states show a similar pattern, with increases no higher than 6% over the five-year period.
In Wisconsin, though, residential, industrial and commercial rates have risen from 16% to 18% in the same five-year period. The only other double-digit increase in the Midwest was in Ohio. In Illinois, meanwhile, residential rates plunged nearly 19% over five years, and the state’s industrial and commercial rates rose about 6% and 5%, respectively — far less than Wisconsin’s.
Rates still favorable here
To be sure, Wisconsin’s rates today are comparable to and in some cases less than those of surrounding states; a PSC report expresses optimism that the state’s rates will remain favorable "barring unforeseen developments."
Others aren’t so sanguine. Utility projects on the horizon are projected to cost hundreds of millions of dollars. These include We Energies’ Power the Future plan to build new power plants in southeastern Wisconsin and the Arrowhead transmission line project, which has ballooned in projected cost to $445 million. "You’ve got all this tremendous upward pressure on rates," said Hiniker. "What are we going to do about it?"
Utility investors have had their share of shocks as well. While Madison Gas & Electric and Wisconsin Public Service have seen stock prices nearly double since 2000, Wisconsin Energy’s share price tumbled 20% in 1999 before rebounding. Madison-based Alliant Energy, after peaking at a little under $30 a share, fell to $15 last year and now trades at about $20 a share. And Xcel Energy, which provides power to the western third of the state, might have sent a few widows to an early grave: Peaking at more than $25 a share in early 2001, Xcel’s stock plunged to $6 a share a year ago and now trades at about $14 a share.
What went wrong?
The problems date to 1985, when Wisconsin allowed electric utilities to create holding companies that could invest in businesses not governed by the PSC. Although not deregulation itself, the law marked the first step in freeing utilities from state scrutiny.
The holding company law was proposed as Wisconsin struggled to emerge from the brutal recession of the early 1980s that devastated manufacturing in the southeastern part of the state. Holding companies were championed as an economic development tool.
"Utilities were flush with cash," said Amato, once an executive at Wisconsin Power & Light (Alliant’s predecessor). "They went to the Legislature and said, ‘If you give us holding company status, we will invest up to 25% of our assets and help build the Wisconsin economy.’"
The idea was that by creating holding companies, utilities – whose profit margins were dictated by the PSC – would have the chance to earn higher returns with some of their investments. In exchange, the state would get some much-needed economic development.
Wisconsin Power & Light became WPL Holdings, which invested in an environmental engineering firm (RT&E), a communications-transmission company (Norlight) and in affordable-housing construction. Milwaukee-based Wisconsin Electric Power Co. became Wisconsin Energy, which invested in industrial park property, mainly around its power plant in Kenosha.
The law allowing these new investments erected thick walls in the utilities’ balance sheets, so that investment losses in the non-utility lines of business would not be passed on to ratepayers. The system generally worked; both WPL and Wisconsin Energy’s outside investments were pointed to with pride.
Business culture change
Then things changed. Amato attributes it to a generational transfer of leadership. When the 1985 law first passed, WP&L was run by James Underkofler and Wisconsin Electric by Charles McNeer – men widely regarded not only as industrialists but as public-minded civic leaders. Both passed their companies on to more aggressive successors with grand dreams for the future.
Meanwhile, the country caught deregulation fever. Texas and California turned over the job of generating power to a group of unregulated power providers. Wisconsin never went that far, but the Badger State – worried by brownouts in the summer of 1997 — enacted legislation to open the way for new, independent power suppliers to build plants in Wisconsin without securing PSC approval.
"No one in the state had built new power plants at that point for 10 or 12 years," said Larry Salustro, general counsel for Wisconsin Energy and its We Energies natural gas and electric power subsidiary. "And the demand kept growing as the economy grew." Wisconsin had relied largely on imported electricity in the intervening years, buying from generators in Illinois and Minnesota.
The expectation was that the big utilities might leave the power generation business altogether. The new state law seemed aimed at encouraging that outcome, with a requirement that utilities needing power buy from the independent power producers, or IPPs.
The next turning point came two years later. Under a 1999 state law known as Reliability 2000, utilities spun off their high-voltage transmission lines into a separate, statewide company.
Traditionally, there are three parts to the power business. At one end is generation: making electricity. At the other end is distribution: delivering it to customers. In between is transmission: conveying power over longer distances, often to other power companies. While electric utilities historically owned all three parts, federal energy policy has put pressure on states to create regional transmission systems that send power over longer distances.
The easiest way for Wisconsin to join such a system was to convert its utility-owned transmission networks into a single statewide company, which would then join the Midwestern transmission network, known as the Midwest Independent System Operator.
Creation of the new state network, American Transmission Co., didn’t really represent deregulation itself, cautioned Dale Landgren, American’s vice president and chief strategic officer. As a monopoly, "we are as regulated or more regulated today as the transmission assets were when they were part of the utilities."
Still, an independent transmission network in Wisconsin furthered the federal dream of wholesale competition in making and selling electric power – in essence, a national marketplace in which various power producers compete.
To make it easier for utilities to buy and sell power from each other, both within the state and across the upper Midwest, Landgren sees the need for "better interconnectedness." To this end, "We’re looking at investing over $2 billion in the transmission grid over the next 10 years."
But, to put it mildly, things haven’t turned out as planned.
Take the 1985 law permitting outside investments. In 1998, WPL merged with two Iowa utilities — Interstate Power Co. and IES Industries — to form Alliant Energy. With the merger came a sharp shift in Alliant’s investment strategy. No longer was it focusing on in-state, economic development; instead there were far-flung ventures: McLeod USA, an Iowa upstart phone service, power facilities in Brazil and China, and other global projects.
When the foreign investments turned sour and McLeod’s stock tanked (the phone company wound up reorganizing in a Chapter 11 bankruptcy), Alliant’s earnings took a huge hit and some shareholders sued the company. Alliant cut its $2 dividend to $1 in 2002 and started selling off assets, some of them profitable.
At Alliant’s annual shareholders meeting in Madison in May, chief executive Errol Davis found himself defending the $2.6 billion company’s run of bad luck, blaming the California energy crisis and the scandalous collapse of the energy trader Enron, which destroyed confidence in a free-market model of energy delivery. He also minimized the role of outside investments in the company’s losses. Staying strictly a utility, he told angry stockholders, wouldn’t have preserved Alliant’s annual $2 dividend.
MGE sticks with power
One utility, though, has prospered by not diversifying. Madison Gas & Electric took a very different tack. "To this day, we believe we are a utility and our niche is being a local utility," said Jeff Newman, MGE’s vice president and treasurer.
The company did form a holding company, but that was to provide greater flexibility to raise money for a co-generation plant on the UW-Madison campus, a project moving through the approval stage. The holding company structure allows MGE to create a separate company to own the plant and lease it back to the utility — an arrangement that creates a predictable cash stream for investors and a predictable electrical rate for customers.
MGE never looked at the far-ranging sorts of ventures in which other utilities invested. "We’ve always stuck to our knitting," said Newman. "We did not believe getting outside that core interest was in the best interest of our customers." The proof, he said with satisfaction, is in the company’s relative stability today – not to mention its double-A bond rating.
To be sure, MGE is much smaller than either Alliant or Wisconsin Energy. In opting out of outside investments, is it merely making a virtue of necessity? Newman insists not. "It’s corporate philosophy. Size is not the deciding factor. You can always use your assets to invest in other things. MGE’s corporate philosophy has just been not to go in that direction."
Amato and Hiniker both argue that the holding company law should be revised to limit utility holding companies to in-state investments, especially since building up the state was how utilities sold the idea in the first place. Said Amato, "They should have been made to put it in writing."
Other flaws in the law
Critics cite other flaws in state law. Opening the state up to independent power producers, for instance, required utilities to give them preference when buying power. "That’s kind of like directing by statute someone to buy a car from someone else," said Hiniker. "The IPPs knew that they had a buyer who was required to buy from them. So they’re going to represent their interest as well as they can to get the biggest dollar they can. The consumer was put at disadvantage by the statute."
The independent power producers dispute this. "No one is forced to buy our power," said John Flumerfelt, director of government and public affairs for Calpine Corp., which has built or drawn up plans for a half-dozen Wisconsin plants, including ones in Cambridge and Beloit. He said the utilities that contract with Calpine for power have "aggressively negotiated contracts."
Calpine has suggested a gas-fired generation plant in Fond du Lac would offer a sound alternative to the We Energies plan for a new coal-fired generation plant in Oak Creek, and environmental critics of the coal plant are warming to the idea.
Alliant’s Davis said ways in which both federal and state laws favor non-utilities helped contribute to current power shortages. Looking back on the late 1990s, he said, "We certainly were in a position to build [new generating capacity] and probably could have moved into the future with a little less risk than now."
Independents fell out of favor with Wall Street
Reality has sharply curtailed the independents’ role, added Salustro of Wisconsin Energy. "In 1998, it was anticipated that independent power producers would be essentially taking over the power plant business," he said. But when California’s deregulated energy market imploded, Wall Street lost interest in the sector. Too risky. Add in the Enron collapse and the rising price of natural gas (which IPPs use because the plants can be built faster for less money), and the nascent industry seemed dead on arrival.
"It’s important that they stay around," said Salustro. "But if the idea of the ’98 law is that they would build all the future power plants, that just did not work."
Hiniker sees other problems. The law provided no review of the new power plants’ impact on rates, and it eliminated a requirement that utilities formally report on how they will meet future energy demands. Such planning is important, he said, because it allows the public to offer alternative suggestions that may save money in the long run.
In short, Hiniker argued: "All of the provisions of the ’98 act made the problem of electrical reliability in Wisconsin worse, and not better."
For defenders of electricity deregulation, the problem isn’t that it has failed, but that it hasn’t been tried adequately. The first lesson of California’s failed deregulation effort, said David Weimer of the UW-Madison’s La Follette Institute, is to make sure there are an adequate number of power suppliers to create real competition.
"California went into its deregulation during a period when demand increased and supply didn’t," said Weimer. This tilted the market to the power producers, who jacked up their prices. Weimer also said consumers need to understand that power costs vary according to time of use. Business already pays differently based on whether they use power at peak times or off-peak times; under a truly deregulated environment, he said, consumers would too — just as they do for telephone calls.
This is already technically possible, said Weimer. What’s missing is the rate structure and, for now, the will to pay "the political costs of getting an agreement to move to such a system."
Indeed, the conventional wisdom now is to build up that grid as quickly as possible, and to push ahead with deregulation on a big scale in the meantime.
Both Hiniker and Amato, however, say that’s wrongheaded and will ultimately hurt business and consumers.
Wholesale trading may come, Amato said — but only after a better network is built to improve existing transmission. In the interim, though, deregulation now will merely lead to market manipulation that benefits only a few power suppliers.
Unlike other commodities, where suppliers can build up inventories, storing electrical power isn’t practical, said Amato. "You’ll end up having California over and over again. You’ll have a small handful of winners, and the ratepayers are going to lose."
American Transmission’s Sept. 10 announcement that it would seek to build $2.8 billion worth of new high voltage lines hints at what’s to come. Amato said that certainly some of those lines would be needed. But he noted that 30 years ago, the PSC reined in plans to build too many nuclear power plants — and likely avoided a disaster that would have sent rates skyrocketing again.
Now the agency again needs to independently gauge what the state’s real needs in generation and transmission are, Amato argued. "If not, we’re going to see rate shock that will absolutely hurt high energy users in the state."
Both Amato and Hiniker question federal policymakers pushing for national deregulation. "Transmission was originally set up as an emergency connection between investor-owned utilities," said Hiniker. Now the lines are more like interstate highways, transmitting power bought and sold in a national marketplace.
Yet the New York blackout suggests, Hiniker said, that the "interstate highways" are really still old well-worn streets that aren’t ready for the traffic they’re being forced to carry. "It’s kind of like driving a car at 70 miles an hour through the middle of the city. Our transmission grid was not designed for the bulk transmissions of power that we’re trying to shove across the system."
Eastern Wisconsin in isolated position
Wisconsin, especially the state’s eastern half, is a virtual island apart from the national grid. The state would "have to pay a very high price" to be able to play competitively in the centralized, national model that federal policy envisions, warns Hiniker.
He’d rather see the state opt out and revert back to the days when power remained a local commodity. "Utilities that keep their focus on that core mission have done better than those that have looked afar," he said. And for power companies, "there’s plenty of profit to be made in the old system."
A few years ago, Hiniker notes, an ice storm in Quebec required the city to rewire its system. Authorities there considered, and ultimately rejected, the option of more tightly integrating themselves with the larger regional grid, opting instead to stick with the model of operating as its own service territory only loosely connected with the rest of the world. Then came the August blackout. "While Montreal went out," Hiniker said, "in Quebec lights stayed on."
Oct. 3, 2003 Small Business Times, Milwaukee