20 Years of Electricity Restructuring in Pennsylvania
Twenty years ago Pennsylvania opened its electricity sector to competition and the promise of cheaper and more reliable service. Two decades later, competitive markets have mostly delivered, but with notable caveats. Former Pennsylvania Secretary of Policy and Planning and DEP Head John Hanger, and the Kleinman Center Policy Director Christina Simeone examine the benefits and shortcomings of two decades of wholesale and retail electric competition. Their findings appear in their recently published report, “A Case Study of Electricity Competition Results in Pennsylvania”.
Andy Stone: Good day and welcome to the Energy Policy Now podcast from the Kleinman Center for Energy Policy at the University of Pennsylvania. I’m Andy Stone. In 1996 the Pennsylvania Electricity Generation and Competition Act introduced competition to Pennsylvania’s electricity industry. The law came as deregulation swept across parts of the United States, breaking up long standing monopolies that controlled power generation and, at the retail level, giving some customers the opportunity to choose their electricity provider. 20 years later, competition has provided many benefits but has come with challenges.
Today’s guests are two experts on Pennsylvania’s electricity sector. They recently published a report funded and published by the Kleinman Center, which looks at the results of electricity industry restructuring in Pennsylvania. Christina Simeone is Director of Policy and External Affairs at the Kleinman Center and former Director with the PennFuture Energy Center. Co-author John Hanger is the former Pennsylvania Secretary of Policy and Planning and former Secretary of the Pennsylvania Department of Environmental Protection. He’s now an energy consultant. Christina and John, welcome to the podcast.
Christina Simeone: Hi there, Andy.
John Hanger: Thank you.
Stone: Your report is titled “A Case study of Electricity Competition Results in Pennsylvania”. Christina and John, how did you come about writing the report now?
Simeone: After 20 years of the competition law being enacted, I thought it was a good idea to have a data driven look at what the results and the performance of the law was both on the retail and the wholesale side.
Hanger: Right, this is the 20th anniversary of the passage of the law. The law passed in 1996. I think it’s also important to specify that the law brought competition to the generation sector. It did not deregulate Pennsylvania’s electric industry. Frankly had it, quote-unquote deregulated the electric industry, we’d have a disaster on our hands. What it did was end a state sanction monopoly on generation, the building and operating of power plants. It allowed any individual or a company to build a power plants and compete for retail business. It maintained the monopoly on the distribution of power and that distribution is today still a state sanctioned, fully regulated business. It is also important to understand even within the generation sector where there was an ending of the monopoly and the start of competition, that there remain significant rules. These rules are now created and enforced typically by an organization called PJM, which is an independent authority that has the responsibility to make sure that electric grid is reliably operated and the wholesale market for power is competitive.
Stone: Can you tell us, I guess Christina, what exactly this electric competition refer to?
Simeone: Okay. Well first it’s important to have a basic understanding of the electricity system. In very simple terms, electricity is generated at power plants, and it’s delivered into customer’s homes and businesses through a system of poles and wires. In the past state regulators determined the rates that both power plants and pole and wire delivery companies would be paid based on analysis of their costs plus a profit margin. The users of electricity had to pay those rates and didn’t have any other options. Wholesale electricity competition forced power plants to now compete against one another to provide power to the grid. And the rates that they were compensated on was based on market outcomes rather than regulators.
Retail competition gave electricity users the option of choosing a supplier that they wanted to provide them with electricity supply. Competition did not affect the way that pole and wire companies were compensated, that continues to be regulated by state-based regulators like a public utility commission. And those rates are based on cost plus a profit margin. And this is really because it would be economically inefficient to have multiple companies competing to provide multiple lines of poles and wires into a person’s home. So the theory behind wholesale competition was that it would make power plants operate more efficiently and more cost effectively if there was competition and that would lower costs for consumers. And then the same thing was really true for retail competition by giving customers choices about who was their provider, it would promote more innovations, it would lower costs. And so that’s some of the things that we looked at with the report.
Stone: So what specifically were the benefits of competition supposed to be?
Hanger: I think to answer that question, you have turned to remember where we were 20 years ago. Pennsylvania had electric rates that were higher than the national average, and in some cases way higher. For example, the PECO service territory, which is Philadelphia and the suburbs, had residential rates that were typically in the top 20, sometimes in the top 10, highest rates of the country. The Pittsburgh area was serviced by a utility called Duquesne and it too had residential rates that were amongst the very highest in the entire country. Many power plants operated by burning coal in a very inefficient way. It converted coal to electricity very inefficiently. It was sort of like the equivalent of a car that got 10 miles to the gallon. And there was no pressure to change that because the utilities had a monopoly, they were in business, with a fixed, almost guaranteed return, whether they operated efficiently or not.
So we had an inefficient, a dirty, a high rate electric environment in Pennsylvania 20 years ago. So what the study looked at was where are prices today typical for consumers and we looked to of course by measuring those prices in constant dollars, because it’s a 20 year time period and with one or two very small exceptions, prices for all customers in all parts of the state are down, in many cases considerably in constant dollars. We looked at emissions, the pollution coming from the generation of electricity and that is down also very, very substantially across the board and we also looked at some of the products that are being offered and there you certainly see many more products than existed 20 years ago. For example, you see long term contracts, two, three, year contracts where you can lock in your price. That was impossible 20 years ago. You see renewable energy products of different kinds. Some are wind made in Pennsylvania some are, what are called national wind products. And that there are certain other innovations that have occurred. I think it’s fair to say that the innovation that we’ve seen so far is really the beginning as opposed to the end of the innovation cycle.
Stone: So you say that prices actually have improved, that they’re lower for consumers as well as the wholesale level, but to what extent have prices come down?
Simeone: Okay. So we can get into some of the performance and the retail and the wholesale competition that we observed through the report. So for wholesale markets, we found that average annual price of wholesale energy in 2015 was actually lower than the inflation adjusted prices in 2000 and that really competitive markets have quickly allowed low cost natural gas commodity prices to be passed on through to consumers in the form of lower wholesale electricity prices. The wholesale markets have been able to successfully attract new investment into newer electricity generation resources that tend to be more efficient, for example. And also older, less efficient resources have exited the market. We’ve seen a significant decrease in coal fire power plant output in the fuel mix and a significant increase in natural gas based power output.
Environmental emissions of carbon dioxide, nitrogen oxides, and sulfur dioxide felt 21%, 31% and 74% respectively between 2005 and 2014. And we also found that generation resources are generally becoming more reliable, so there’s a metric called the equivalent forced outage rate, which is basically a measure of the probability a generation resource is going to go offline or going to be unable to perform when it’s needed. That a metric has dropped from 11% in 1996 the year the law was passed to 6.9% in 2015. On the retail side, data quality was a little bit of an issue, but overall performance was positive for the commercial and industrial customers like commercial businesses or manufacturing plants, industrial manufacturing plants, they tended to save money when they shopped for competitive supplier and contracted with a competitive supplier. However, residential customers were more likely to save money by continuing to purchase electricity from the local utility.
This local utility service is called default service and we’ll talk about that a little bit later. But it was really for those residential customers who continued to take utility default service instead of the competitive product, it was unclear whether the higher prices from the competitive suppliers were driven by higher costs or greater value. For example, that greater value could have been provided by a renewable energy product or another innovative product that maybe gave them some sort of equipment giveaway or something that made it hard to compare to the standard utility product. And that’s an area that certainly needs further research. When we looked at residential electricity supply prices back from 1996, adjusted them for inflation and compared them to today’s prices, we found that almost every residential customer in this state would have saved money through competition, and specifically that utility default service product. We calculated those savings to be an excess of $800 million in 2016.
In addition to the non-monetary benefits to residential customers included these product innovations that John spoke of, such as the ability to maybe choose to lock in your price for multiple years, choose a product that gives you 100% renewable energy that was generated in Pennsylvania, or other products. We did observe though that some product offerings that were expected were not available. We also look at delivery rates, which again are not affected by competition. These are the rates that customers pay to the wires and poles companies to bring electricity into their homes. In general, commercial and industrial rates fell both on a nominal and inflation adjusted basis. While for the residential sector, those rates increased above the rate of inflation and are typically over 50% of the customer’s bills, which have some implications for electricity shopping, for example.
Stone: The rates came down for everybody, even the customers that stayed with their default provider, which would have been the provider before this whole process began. Does this is imply then that the default provider rates were also going down due to competition over this period?
Simeone: What we compared was the price of electricity service pre-competition or during, yeah, pre competition and compared it to the utilities default product. That default product is procured on the competitive wholesale market. So really a lot of those savings have to do with the performance of the wholesale market. Even though default service is a retail product and part of a customer is portfolio of choices that they can pick from. A lot of that savings was due to wholesale market performance.
Hanger: So language here is very important. I think there’s a couple of things that are critical in the language. There isn’t anything other than a competitive product being sold to any customer in Pennsylvania today. The old rate base rate of return monopoly products ended by law in 1996. The standard offer, or the default product, is a competitive product that must be procured competitively and it is provided by the, right now the local utility though under law, it could be provided by a different company. In other words, another company could petition the public utility commission to take the place of a utility and provide that competitive offer. But there is no such thing as a noncompetitive electric product being sold to any customer in Pennsylvania today. They’re all competitive products. That’s the first point.
The second point is that whether it’s a default product or a retail product provided by a what’s called a competitive supplier though by just about, for every customer, those products costs less today than what customers were paying 20 years ago, once you adjust for the fact that it’s 20 years later and there’s been inflation over that period of time. A couple of small exceptions to what I’ve just said, but basically whether a customer is buying the competitive default product or like, as I am, buying a competitive product from a retail supplier, the vast majority of customers have saved considerable amount of money. And I think that’s critically important to understand.
The next thing to understand is that the power plants that are connected to the grid are all on average operating much more efficiently than they were in two ways. One is they break down about half as often as they used to break down. And the under the old system, when the monopoly was in place, an owner of the power plant got paid whether the power plant ran or not, it was that investment was in a rate and unless the utility commission took that investment out of the rate, customers continue to pay for that investment. The utility commission basically never did that. That was one exception. Literally when metropolitan is and melted down the Three Mile Island nuclear reactor, that was a little too much for the regulator. And they actually decided, you know, why we better not have the customer pay for that anymore. But with that rather than notable exception, it just didn’t happen. So there was no incentive to run your, your power plants well, and if they broke down, so what? Now if they break down, you don’t get paid. There’s no dollars coming in. So, not too surprisingly, there’s a lot of attention to how well these plants run.
The second thing that is very important is that the power plants now care about how much fuel they burn to produce a unit of electricity. Under the old monopoly system, the owners of the power plants got paid for every single ton of coal they burnt, regardless of how well or badly they burnt that ton of coal, it was just recovered in rates. Now, if you are burning more coal than necessary to produce a unit of electricity, in other words, you’re using fuel inefficiently, you’re the equivalent of a gas guzzler. You are going to have higher costs and even run the risk of being unprofitable because the price that you’re getting paid is a market price. And it doesn’t necessarily cover your fuel costs. It might or it might not. So there’s huge pressure now to actually build power plants that are the equivalent of a very fuel efficient car. They’re more Priuses on the road, so to speak, in the power grid today, than Hummers. And in fact that the typical power plant now is converting gas at 40, 50, 60% efficiency rates when in the old days, meaning 20 years ago, it was a typical power plant converted fuel to electricity at about a 33% efficiency rate.
Those are huge gains. And it’s true those wholesale gains flow through to the retail products, whether it’s a default product or so-called competitive supply product, most of the gain is coming from the wholesale sector. That’s true. It’s not quite all of it because we’ve got things like demand response and some other things that are very frankly almost delivered completely by competitive suppliers. Not quite, but almost. So it’s not all of the gains that are coming out of the wholesale sector and being passed through retail competition. But it’s a lot of it. The last thing I would like to say is for those customers who like me, care about the environment. One of the things that really annoyed me 20 years ago was that my money always been taken out of my pocket, with no choice, and given to highly polluting companies. Now I actually am a customer of a company that is providing me electricity generated a hundred percent from wind farms in Pennsylvania. I’ve actually been able to contract with a company that not only is providing wind power but wind power generated right here in Pennsylvania. And for me that’s a huge value.
Stone: Are you paying a premium for that?
Hanger: I pay more than the lowest cost offers in the marketplace and I personally do it gladly and happily. So that’s part of the choices that are being offered. Today, actually, what I’m paying for 100% wind power product in Pennsylvania would be less than what I was paying for electricity if I were a PECO customer or Duquesne customer 20 years ago, considerably less. I’m actually in the Hershey area, so I’m not in those service territories, but were I in those service territories, I’d be actually paying less for my wind power than what I was paying 20 years ago for coal and everything else.
Stone: Today’s guests are Pennsylvania electricity market experts, Christina Simeone and John Hanger. They are discussing results of their new report on 20 years of electricity market competition in the state. The next question I’d like to go to is what policy choices lie ahead for retail and wholesale electricity?
Simeone: Yeah. Well, the report talked a little bit about these policy choices ahead. We didn’t take positions but more identified what we believe are going to be decision points. For Pennsylvania, the future of default service, certainly one thing that was identified. Competitive suppliers argue that residential retail markets would improve if utilities no longer offered default service and instead competitive suppliers could offer that service to customers. However, consumer advocates argue that utility providing default service is an important part of retail choice, is an important consumer protection mechanism, insulating customers from market volatility for example. You know, more is going to, more debate is going to have to inform that discussion, but we believe that’s something that lies ahead.
Hanger: The basic policy choices that are in front of the commission obviously fall into two buckets. One is wholesale and the other is retail. I personally think this most important choice is something that we haven’t really talked about and that’s the future of the distribution monopoly. Again, in 1996 that distribution monopoly was continued. And what we’re seeing now is that perhaps technology is moving rapidly enough to drive down prices of so-called distributed energy resources. These are things like solar panels on a home or maybe a biodigester on a farm. There’s a lot of different examples. So that families and businesses might be able to drop off the grid entirely. A combination of generating their own power, perhaps storing it onsite when they produce excess power for their needs, are creating a real policy debate or choice that has to be made about the future of the distribution grid. And to me, that’s going to be the most important policy choice I had.
One of the things we actually noticed in the report is the part of the electric bill that was continued to be a monopoly has increased in price at rates faster than the rates of inflation. So we see the part of the business which has been subjected to competition. We see prices below the rates of inflation. Some customers have saved 50% in real terms. Some of the savings are very, very large. But across the board, the distribution monopoly has continued and across the board, the prices for that distribution service has increased at a price or a level faster than the rate of inflation.
Stone: So, this deregulation has been around for a couple of decades now in different forms. Why is it so relevant to be talking about this today?
Simeone: Well, I think it’s the low price of natural gas. So the very quick transition to a large supply of low cost, natural gas has really changed competitive electricity markets where we’re seeing overall the pot of money available to all the suppliers in the market has drastically shrunk. We’ve seen more natural gas resources that are more efficient and cheaper and cleaner. More of those resources enter the market and a lot of older, dirtier, less efficient resources exit the market. And the market players that are left are saying, well, that the pot of money is smaller now and we’re having a hard time competing. And there have been discussions about, well, is competition working? Maybe it’s working for some people and not working for others. And when I mean people, I mean generators.
Hanger: Some of the generators.
Simeone: Some of the generators.
Hanger: Some of the generators are absolutely support these competitive results and others who have frankly nuclear assets in some cases old coal plants that are getting priced out of the market, want a subsidy. So the generation industry is split between those companies that believe in competition and want and are willing to take their chances with it versus those who are losing and want to be bailed out by the government.
Stone: You know along those lines, there has been a push for some reregulation of some parts of the industry. Can you give us a little bit more insight into exactly what’s going on there?
Hanger: Well, in Ohio you have incumbent electric utilities, First Energy and AEP, that were remained vertically integrated, meaning they owned power plants as well as distribution, and transmission lines. And they have seen their profit margins fall drastically. First Energy has been run in a way that they are having actually a hard time meeting their credit requirements and their debt requirements. They’re under real financial pressure. I personally don’t have any sympathy for them because they run power plants in a way that are inefficient. Other competitors are eating their lunch and by the fact that other competitors are eating their lunch, consumers are doing well and emissions are going down. So this is, in my mind, the worst kind of special pleading that we often see. Big economic interests have a lot of political friends, they give a lot of donations, they know their governors, they know their president, they know everything about the political system and when they lose in the marketplace, they don’t take that as the final result. They run right to the folks who can reach into my pocket, your pocket, and take money out of our pockets and put it in their management coffers and their shareholder’s coffers. I guess I don’t blame them for trying, but I do blame a political system for giving into that.
Stone: Well, you described yourself a few minutes ago as being very environmentally concerned. Now in New York, they’re trying to reregulate or provide incentives to the nuclear power plants ostensibly for environmental benefit.
Hanger: Yes. In New York, they have created something called a Zero Energy Carbon Credit. It’s already been challenged in federal court by a couple of the generation companies who don’t like the subsidy schemes. They are competitors that are not getting subsidized. They’re competing against a company that will get subsidized and they are not too surprised and saying that’s not fair. I personally believe that competition has driven down emissions and that’s actually a fact. It’s not a belief that the emissions are falling rapidly. I do take global warming very, very seriously. I do think that zero carbon assets should be properly compensated. Personally, I believe that ought to be done at the federal regional level through the tax system as opposed to market distorting mechanisms that have already been struck down by FERC in the case of Ohio. And we’ll see what the federal court does in New York.
Simeone: And I think as in simple terms, it’s important for the listeners to understand that when generation was regulated, it was regulated based on its average cost so that the plants average costs and that rate would compensate based on that analysis. In a market-based system, compensation is based on the marginal system price. So the last and most expensive unit that is needed for a supply that cost sets the clearing price that all the other generators are paid for. In this area, natural gas resources set that marginal price. So as natural gas prices are going down, the price that everybody gets paid in the market gets lower. That’s why I talk about the bucket of money keeps shrinking.
So for some generators, re-regulation, a return to rate based regulation, or subsidies look very attractive because they would rather be getting paid their average costs. That would be much better than what they’re getting now, which might not, they may not be meeting their costs to begin with. But I think it gets into a very tricky situation where, as John said, you’re making appeals to regulators based on a boom bust cycle that’s been seen historically with any kind of commodity-based system. So in boom times, companies are going to want market based systems in bust times, we’re going to want to reregulate. And do you allow something like that to happen? I mean that’s a broader theoretical question, but certainly one that can’t be ignored. On the other hand, some people say, hey, well if you continue to allow these dynamics to play out, then our system is going to be two natural gas dependent. And are we allowing ourselves or leaving ourselves exposed to some theoretical problem in the future? And these are some of the arguments
Stone: Your report was issued before the presidential election and President Elect Trump is generally seen to be pro markets, but as also signal to desire to help the coal industry. How do you predict the Trump administration will impact competitive markets?
Hanger: Well, I don’t agree that he’s pro markets. I think he’s pro himself. Beyond that rather important point, which I guess is debatable, I think the Trump policy in this area is like Trump policy in all areas, confused and ever changeable. It’s hard to take it seriously. I mean we’re going to have to. He’s the President Elect but you tell me what the policy was yesterday and I have a good chance of telling you it change today on just about anything. He clearly doesn’t understand the dynamics between coal and gas. Gas has, as well as technology, just more efficient mining techniques have caused job losses, the job losses in the mining industry where the steepest during the George W. Bush administration, they were steeper than they were in the Obama administration. Nobody accused George Bush of having a war on coal but long wall mining and other kinds of mining techniques, we’re putting a lot of miners out of work in that period of time.
In the Obama years, it’s been basically cheap natural gas that’s been putting a lot of miners out of work plus renewables. The renewables are much more competitive today and that’s the second place that he’s clearly confused and I’m being trying to be polite. He doesn’t understand that the cost today of solar and wind are vastly different than they were two years ago, let alone 10 years ago. In fact, wind in many parts of the United States is the cheapest way of generating electricity. When I say many though, those parts of the state like West Texas, those parts of the country like West Texas where the wind resources is very, very good. Solar prices have come crashing down. And certainly, in the Nevada and Arizona deserts, it’s cheaper to make power with solar than by burning coal, building a new coal plant and burning it today. So the economics have changed radically pretty quickly. And certainly, President Elect Trump is well behind the times on those economics.
Simeone: Yeah, I mean, apart from the, you know, greater message that I think he’s put out, kind of not as interested in climate change and low carbon technologies, more interested in fossil fuel production and protecting the coal industry. I would agree that a lot of his energy policy seemed very inconsistent and I’m really not sure how it plays out. For example, his kind of desire to increase energy production, coal, oil, natural gas production would really decimate the industries right now, which are already dealing with rock bottom prices and having trouble servicing debt and going through industry consolidation and bankruptcies. He has a trade platform that would make it harder for those commodities to reach international markets. So I’m not sure the strategy there. With respect to being kind of pro competition perhaps. He’s also pro coal and in the electricity markets it would be very hard for coal to compete given low natural gas prices unless they had some out of market supports. So there’s a lot of confusion and it doesn’t seem to be an integrated strategy at this point. So yeah, too early to tell.
Stone: We’ve been talking with the Kleinman Center’s, Christina Simeone and former Pennsylvania Secretary of Policy and Planning, John Hanger, about 20 years of electricity deregulation in Pennsylvania. Their report, “A Case Study of Electricity Competition Results in Pennsylvania”, is available on the Kleinman Center website. Christina and John, thank you very much for talking.
Simeone and Hanger: Thank you.
Stone: And thanks for listening to this episode of the Energy Policy Now podcast from the Kleinman Center for Energy Policy at the University of Pennsylvania. If today’s discussion helped clear the air on electricity deregulation, please recommend the podcast to friends and find out more about research and events from the Kleinman Center by visiting our website, www.kleinmanenergy.upenn.edu.
John Hanger
Christina Simeone
