Standing the electric industry on its head.

After years as a regulated monopoly, the electric industry is on unfamiliar competitive ground and so are the states that are letting it happen.

In June 1995 the New Hampshire legislature did something that would have been unthinkable a year before. It passed a law to let 17,000 New Hampshire residents choose their electric company. Frustrated with electric rates that were among the highest in the nation and believing that the state's monopoly utilities should face some real competition for their business, the legislature was the first in the nation to establish this kind of experimental program.

It was a harbinger of things to come around the country. Now a few states have passed far-reaching legislation to let all electric customers in the state choose where they want to buy their electricity. And almost every other state is considering the merits of taking the nation's most capital intensive industry from monopoly to competition. Known as "retail wheeling," this move to let customers choose their electric company, just as we all now choose our long distance phone company, is already putting the electric industry through some of its most fundamental changes in half a century.

The traditionally stodgy and predictable electric industry will look different five to 15 years from now, but no one knows just how it will look. Between now and the time that new industry emerges from today's confusion, it will have become very clear just how much the electric industry permeates every aspect of our lives. Legislators will have to make decisions that affect their states' economy, jobs, environment, tax revenue and the reliability of the electric system.

A GLIMPSE OF THE NEW INDUSTRY

Close to two years after the New Hampshire legislature passed HB 168, the state's experiment with retail wheeling has taken off and gives a glimpse of the shape of tomorrow's electric industry. "Only by trying it could we see how a competitive electric industry might work," says Representative Clifton Below. The pilot experiment took place at the same time legislators were working on much more comprehensive legislation to restructure the electric industry, Below says. "This gave us a chance to incorporate some of the lessons from the program into our legislation."

In New Hampshire, 31 different electricity suppliers wooed the pilot program's 17,000 customers with marketing ploys and incentives. Some offered electricity at extraordinarily low prices of less than 1.5 cents per kilowatt hour, others offered savings bonds or different prices for buying different amounts of electricity. One power supplier offered free bird-houses to those who signed up. A few companies tried to identify themselves as clean or "green" power providers, guaranteeing that they would supply power that was generated only from certain "clean" sources, although the definition of what was clean varied from one company to another.

What was new about this was associating a brand name and identity with electrons. Companies began to try to distinguish themselves from each other by becoming the "cheap" power company, the "green" power company or the power company that was a responsible corporate citizen. At no other time has anyone needed to or tried to associate electricity with brand identity. This change alone was a fundamental shift in the character of the previously staid industry.

It was not only the old power companies that were competing for customers. Working Assets, the company that made its name by offering a credit card associated with environmentalism, became one of the "power marketers" competing for customers. Working Assets signed long-term contracts to buy power that came from environmentally friendly sources rather than, for instance, big polluter plants. It then sold that power through traditional mass marketing techniques. Working Assets and the other power marketers selling in New Hampshire were typical of a new breed of company in the electric business; they own no utility plants and no power lines, but make money by buying power cheaply from an open market of electricity, and selling it for more.

Elsewhere across the country, hundreds of wholesale power marketers, some of them affiliates of the nation's old utilities, and some of them companies that have not before tried to sell electricity, are buying and selling power That is, they buy power on the open market and sell it to utilities. These power marketers claim that they can offer savings by selling directly to customers if states allow retail wheeling.

The new choices of services and companies were not necessarily what New Hampshire's customers wanted to see, and sometimes they engendered confusion. Some customers grew tired of having to think about their power company and the large array of options available to them. Others expected that their power rates would be lower than they actually were. Although the companies had advertised their electricity at rock-bottom prices, the final bill read an average of 10 cents per kilowatt hour - still a substantial reduction from what they had been paying, but much higher than what they had expected.

The difference between the 1.5 cents that was advertised and the 10 cents that most of the 17,000 New Hampshire customers ended up paying was partly made up of what has become known as "stranded costs." In New Hampshire's case, Public Service New Hampshire, one of New Hampshire's dominant electric companies, had built Seabrook, an expensive nuclear power plant, as well as a number of other power plants that produced power at rates higher than the market price for electricity. These power plants could become "stranded." That is, they might not be able to compete in a highly competitive power market. Saddled with the costs of these expensive power plants, Public Service New Hampshire could be in big financial trouble.

But Public Service New Hampshire pointed out that the state had approved the building of the power plants years ago, and that all these plants had been built as a result of a planning process in which the state had been heavily involved. Although some people still claim that these decisions to build expensive plants were simply bad business choices, the state elected to let the utilities recover most of the stranded costs that arose from the pilot program. These stranded costs, and the cost of sending the power over electric lines from power plants to customers, made up the difference between the low advertised cost of energy and the 10 cents per kilowatt hour or so that the customers were paying.

These stranded costs will not be limited to New Hampshire. Depending on who is doing the estimating, the nation's electric utilities could face a total of between $50 billion and $250 billion in stranded costs, mostly from expensive and noncompetitive power plants. In some cases, the stranded costs exceed the equity value of the utility that owns the stranded power plants. When these utilities make the transition from monopoly to competition, a few could go belly-up unless the states step in to help them. Yet the cost of helping some of these utilities through the transition could be enormous. Connecticut, with four problem-ridden nuclear power plants that will have lots of trouble producing power to compete with other cheap sources of electricity, is a prime example of a state in this dilemma.

An experimental program like New Hampshire's creates a model of how an electric industry would change and what obstacles might arise in the transition from monopoly to competition in a state with very high electric rates. Not every state has electric rates as high as New Hampshire's, and some states have far lower rates and a vastly different electric industry. Although it is instructive, not all of New Hampshire's experience is helpful to every other state. A few other states have begun pilot programs akin to New Hampshire's. Almost every other state is considering whether and how to make its electric energy business competitive and is facing issues that the pilot program did not address. Now legislation that several states have enacted and others are considering begins to deal with some of these other important issues, like taxation, the role of municipal utilities, rural electric cooperatives and other so-called "public power" firms in competitive markets, and the role of energy efficiency and renewable energy in competitive markets.

WHAT ABOUT TAXES?

"We are very nervous about going full tilt at retail wheeling without making sure the tax piece is taken care of," says Representative Carl Holmes of the Kansas task force committee on electric industry reform. "We could see some big tax revenue losses if we jump into utility reform without thinking hard about how to do it. I am also convinced that some tax policy will ultimately have a big effect on how competitive these markets really are."

In fact Representative Holmes' predictions about tax revenue are already ringing true in Wilmington, Vt. New England Power, one of New England's largest utilities, recently sent Wilmington's town manager a letter notifying her that it was about to sell all its power plants, including a plant located there. That power plant contributes more than $250,000 in property tax revenue to the town budget; if New England Power sells that plant, the town could see its property tax revenues decline by 50 percent or more because of revaluation. In another example, the Ohio school board association recently released a study that predicted property tax revenues could decline by as much as $275 million statewide if the state decides to open the doors to competition.

Property tax revenues are not the only revenue source that could decline. A recent study by Deloitte and Touche, sponsored jointly by the National Conference of State Legislatures and the National Association of Regulatory Utility Commissioners, noted that utilities are often taxed on the basis of their total revenues while power marketers and other companies competing with utilities are taxed on the basis of total revenues minus expenses. These latter taxes on income are lower and generate less revenue for state budgets as a result. Other states and localities may also have to change their franchise fee structure, or face the loss of franchise fee revenues. At this point, no state has passed legislation that tries to solve these tax problems, although Minnesota, Ohio, New Hampshire, Kansas, Oklahoma, Nevada and a few others have spent some time working on it.

PUBLIC POWER

Of the close to 3,200 utilities in the United States, only about 225 are investor-owned. The remainder are a mixture of small rural electric cooperatives, municipal utilities, state-run authorities and federal power agencies. But because these 225 investor-owned utilities generate 75 percent of the electricity in the nation, they tend to dominate the discussions in many parts of the country.

Particularly in the West, however, public power agencies have become an important part of the industry structure. But they have a different history, a different financial structure, a different set of regulations and customer base from many investor-owned utilities. Some of these small utilities feel threatened by competition, fearing that the well-heeled large competitors will pick off their best customers, leaving them to serve only the remaining small customers, without the financial resources to do so. In Colorado's 1996 legislative session a consortium of public power agencies blocked restructuring legislation before it even left committee.

California's AB 1890, enacted in the fall of 1996, required that all electric customers pay a fee of up to 0.3 cents per kWh through their electric bill to support renewable energy, energy efficiency and research and development programs. California is set to raise about $500 million over the four years for renewable energy (like wind, solar, hydro or biomass power) alone.

California devised this plan at the end of a lengthy set of negotiations because the Legislature became convinced that without outside funding, renewable energy, energy efficiency and research and development programs would wither and disappear when faced with competition from cheap fossil fuels. Because renewable energy sources are marginally more expensive than, for instance, a natural gas fired power plant, the competitive market would shut them out without a subsidy. This subsidy in California and other states may allow these programs to continue.

A HARBINGER OF THINGS TO COME?

Now that almost every state is looking at its electric business with an eye to using competition to lower costs, is it a sure thing that every state will follow in the footsteps of those few that have passed legislation? Legislators in New Hampshire, Rhode Island, California and Pennsylvania became convinced that retail wheeling would make their states more attractive to industry, bring efficiency to the industry and lower costs to everyone. Other states aren't so sure, but the 1997 legislative session is witnessing even more legislation than in the past two years.

State legislatures are forced to perform a balancing act as they try to replace monopoly and regulation with competition. "Without any experience with full-blown retail wheeling to draw on," says Senator Michael Sanchez of New Mexico, "we don't know for sure whether competition will result in lower rates, or simply more volatile rates. We don't know for certain if competition might do little more than bring the nation back to an age of unregulated monopolies that control electricity markets at the expense of true competition. And, we don't know whether the environment or the nation's diversity of fuel resources will suffer or improve as companies begin to base their business decisions more heavily on short-term economic considerations."

The transition to competition is a leap of faith, in hopes that competitive markets will be able to manage a complex, capital-intensive industry better than regulation. It will be years before we know if it has worked.

RELATED ARTICLE: ANOTHER FEDERAL "SOLUTION?"

Although the states have gotten a jump on the federal government in moving toward a plan that lets customers choose their electricity suppliers, the final word may come from Washington. Congress and federal regulators are seriously considering preemption of state authority over electric utilities. A "one size fits all" federal solution could be imposed that extends federal control to retail markets.

The federal role in electric utility regulation up to this point has been limited and largely focused on the wholesale market. The passage of the Public Utilities Regulatory Policy Act (PURPA) in 1978 set in motion the federal effort to increase competition. PURPA sought to encourage development of power sources that did not use fossil fuels as a way of mitigating U.S. dependence on foreign oil. The federal efforts to spur competition increased markedly with the adoption of the Energy Policy Act of 1992. The Federal Energy Regulatory Commission (FERC) established rules for the sale of wholesale electricity between utilities. The rules require utilities to allow other companies to send electricity over their power lines for a reasonable, non-discriminatory price.

Now Congress and federal regulators are considering more broadly based efforts to open the retail electricity market to consumer choice. During the 104th Congress, bills surfaced not only to reform PURPA, but also, in the case of a proposal by Congressman Dan Schaefer, to require states to allow competition in the retail electricity market. The Schaefer proposal would give FERC authority to impose retail wheeling on any states that did not enact legislation to allow the practice themselves.

Over the course of the 104th Congress, a dozen or so hearings on these proposals were held by both House and Senate committees and drew the attention of a variety of well-financed stakeholders who stepped up both their lobbying efforts and their contributions to candidates for Congress. They are expected to be influential in any action taken this session.

Former Senator Bennett Johnson of Louisiana will be a player representing a group of utilities seeking retail wheeling. Schaefer's efforts are likely to be bolstered by the Commerce Committee chair, Congressman Tom Bliley of Virginia, who has expressed sympathy for "breaking up monopolies of utilities."

Major power outages during the summer of 1996 pushed the Clinton administration to get involved. It established a multi-agency team to develop the president's legislative initiative on the issue. As a result, the U.S. Department of Energy has been drafting a comprehensive package of federal legislation that would let customers throughout the country choose their electricity supplier.

States have a lot to lose in the battle that is sure to take place in Washington this session as special interests jockey for market advantages. The issue is not simply whether the electric retail market is deregulated, but who does it.

RELATED ARTICLE: HOW TO DEAL WITH ENERGY EFFICIENCY

States are finding new ways to keep energy efficiency and renewable energy programs alive in competitive markets.

* Massachusetts has suggested that everyone pay 0.4 cents per kwh to fund energy efficiency and renewable energy programs.

* Rhode Island's law requires everyone to make a 0.23 cent per kwh contribution.

* California requires customers to pay up to 0.3 cents per kwh to create a $500 million fund over four years.

* Vermont is looking at a requirement that retail sellers of electricity include among their portfolio of generating resources some renewable energy such as wind or solar power. If a retailer doesn't happen to have any renewables in its portfolio, it could buy tradeable credits from a company that has such resources.

RELATED ARTICLE: PILOT PROGRAMS

Before launching statewide iniatives, eight states are running pilot programs to see how a competitive electric market might work. Most of these programs are just beginning. Watch what happens in these small-scale applications of a big idea in:

Idaho Illinois Massachusetts Michigan New Hampshire New York Pennsylvania Washington

Matthew H. Brown runs the NCSL Energy Project, which offers on-site assistance on utility restructuring to state legislatures, a national e-mail discussion group and an array of other resources. Call him to participate in the discussion group or to arrange technical assistance, [phone].