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Would Non-Profit Utilities Cure What Ails California Electricity?

Converting an investor-owned utility to a non-profit is no silver bullet.

Wildfires, possibly sparked by electrical lines, are still burning here in California, and there is no rain in the forecast. In policy circles and the media there are endless discussions of the right response, many of which confuse two crucial, but quite separate questions: What should be done in the next few months to get through the worst of our fire season? And what should be done in the next few years to address the sad state of some of the electricity infrastructure, the bankruptcy of the state’s largest utility (Pacific Gas & Electric), and the growing wildfire threat from climate change?

IOU-POU-CoopCounties

The discussion dominating Northern California politics and media in the last week has been whether PG&E – the bankrupt utility whose equipment has sparked the most devastating fires – should be converted, in whole or in part, to a non-profit customer-owned cooperative or publicly-owned utility (POU). There are some technical distinctions between public and customer ownership, but they are minor compared to the drastic change from for-profit investor ownership. We will get to the “in part” conversion proposals below, but first let’s talk about non-profit utilities more generally.

IOU-POU-CoopSharesWhy Should Electric Utilities Be Different From Other Businesses?

The U.S. economy has thrived with most goods and services produced by private, for-profit companies competing to sell their products. History has shown that the lure of profits generally leads firms to be more innovative and more effective at controlling costs.  Almost no political leaders in the country, even those on the most progressive end of the Democratic Party, argue that we should move very far from that model. Not even “Medicare for All” is a call for government ownership of drug companies or hospitals. So, why should electricity be any different?

Well, actually there are a couple of common arguments. The first, and I think less persuasive, is that electricity is too important to be left to for-profit companies that are not operating with the public good as their primary mission. While electricity is important, so are food, housing, drugs, gasoline, telecommunications and many other industries that are served by competitive privately-owned firms.

The more compelling argument is that a competitive market is simply not an option when it comes to providing electricity transmission and distribution services — two of the primary activities of electric utilities today. Either we have public ownership or we have local investor-owned utility (IOU) monopolies operating under stringent economic regulation. Deregulation has benefited the country in natural gas production, airlines, gasoline, trucking, and numerous other industries, including electricity generation. But transmission and distribution remain natural monopolies, for which there is no credible model of a competitive market.

So, the choice is government/coop ownership or government-regulated IOUs. Given the horrendous fires we’ve seen in the service territories of California’s IOUs, many people now see government ownership as a better choice. Yet, it isn’t hard to come up with examples of non-profits that have failed their customers. Puerto Rico’s public electric utility (PREPA) after hurricane Maria is the most horrendous example. Nor is it hard to come up with California government agencies that its residents love to hate, from the state’s Department of Motor Vehicles to local planning departments that review building permits.

Do Utility Profits Harm Safety and Reliability?

One of the most frequent arguments against IOU’s is that the need to earn profits discourages private utilities from spending money on safety and reliability. But that’s not clear at all if the regulator — the California Public Utilities Commission (CPUC) in this case — allows the utility to pass through prudent costs to ratepayers. Utilities are generally fine with spending the ratepayers’ money on safety and reliability, but it takes effective regulatory oversight to make sure the expenditures are actually delivering as promised.

To do that, however, the state has to fund the regulatory agency and pay its employees at a level that assures real oversight. From talking to CPUC personnel — and to my own students who have declined to apply to the CPUC or left after a couple years due to low salaries – it’s clear to me that California is failing to provide the resources for effective oversight.WildfireAroundTransTowers

In fact, many advocates for public or customer ownership are also the most outspoken critics of the CPUC. If they think that the CPUC, a state agency, is such a failure, why are they so confident that a government agency (or a non-profit coop) running the utility will be a success?

Do Profits Raise Costs?

Paying profits to shareholders is also held up as a problem because IOUs must earn higher revenues to make those payments. Well maybe, but non-profit utilities also face a cost of raising capital. They just do it all through selling bonds, and paying interest on them, rather than also selling equity and paying returns to shareholders.

Nonetheless, advocates of public power note that the interest rate on public utility bonds is typically lower, which is true. But why is that? One reason is the favorable tax treatment of local government bonds, which is, of course, not an efficiency, but just a subsidy from the federal government. There may be an argument for grabbing that subsidy, but let’s also recognize that paying for those subsidies means that either federal taxes have to rise or federal expenditures on other public services have to fall.

A second reason is that the local or state government backing the bonds of a POU is taking on risk that shareholders would bear under an IOU. Think about what happens when the power lines of a POU start a wildfire that damages property and takes lives. The liability would then be on the government entity, which would have to cover the cost to the victims and still make good on the bonds, or it would have to declare bankruptcy.

PGEServiceAreaandPopDensitySolving the Problem for All Customers

It’s not a coincidence that the first area to advocate for making their part of PG&E territory into a public entity has been the city of San Francisco, an urban area in which the power lines pose very little wildfire risk. It is possible that PG&E is too big, and the best solution is to break it up, but it is certain that carving off the low-fire-risk areas will leave the more wooded and rural — and, on average, poorer — parts of its service territory where the fire risk is highest. No one is going to want to be the public (or investor-owned) power provider for those areas unless someone else covers the wildfire liability. Without a holistic plan to provide power in all of PG&E’s service territory, cherry picking what are now the low-cost areas will just create massive wealth transfers and exacerbate inequality.

And, by the way, San Francisco gets nearly all of its electricity from other parts of the state. How do you think that power gets to the city?ElecCoopsMap

None of this is an argument that non-profit power would necessarily be worse (or better) than having an investor-owned utility running PG&E’s system. Some studies have suggested that public power agencies have lower retail prices, but it is very difficult to know how much of that is driven by service territory differences, state energy policies, tax advantages, access to cheap federal hydropower, or historical accident.  In any case, the last few years has made clear that there is a lot more to being a successful or unsuccessful utility than rates.

What’s clear to me is that converting PG&E to a public or cooperatively-owned utility would not be the silver bullet that creates a more efficient, reliable and safety-oriented electricity provider for Northern California. It would at best be just the beginning of a long road to re-invent the utility. And in the meantime we also need to figure out how to get from here to the next rainy season, which can’t come soon enough.

I am still tweeting interesting energy news articles, research papers and blogs (and occasionally my political views) @BorensteinS

Keep up with Energy Institute blogs, research, and events on Twitter @energyathaas.

Suggested citation: Borenstein, Severin. “Would Non-Profit Utilities Cure What Ails California Electricity?” Energy Institute Blog, UC Berkeley, November 12, 2019, https://energyathaas.wordpress.com/2019/11/12/would-non-profit-utilities-cure-what-ails-california-electricity/

 

Severin Borenstein View All

Severin Borenstein is E.T. Grether Professor of Business Administration and Public Policy at the Haas School of Business and Faculty Director of the Energy Institute at Haas. He has published extensively on the oil and gasoline industries, electricity markets and pricing greenhouse gases. His current research projects include the economics of renewable energy, economic policies for reducing greenhouse gases, and alternative models of retail electricity pricing. In 2012-13, he served on the Emissions Market Assessment Committee that advised the California Air Resources Board on the operation of California’s Cap and Trade market for greenhouse gases. He chaired the California Energy Commission's Petroleum Market Advisory Committee from 2015 until its completion in 2017. Currently, he is a member of the Bay Area Air Quality Management District's Advisory Council and a member of the Board of Governors of the California Independent System Operator.

26 thoughts on “Would Non-Profit Utilities Cure What Ails California Electricity? Leave a comment

  1. I think most people recognize that there are tradeoffs between having an investor-owned utility that is regulated or a government run municipality, and neither is ideal. Cooperatives probably do bear a strong resemblance to municipalities. In very broad terms, I would think a post like this one would be more constructive if it were to consider how the costs and benefits of each type of institutional arrangement has changed over the last ten or twenty years.

    Do we have any compelling evidence about:

    1) What circumstances appear to drive the decision about whether a utility is an IOU or municipality?

    2) The performance of IOU verses municipalities and cooperatives?

    3) How the tradeoffs between utilities and IOUs have changed over the recent years?

    My quick and casual reading of the academic literature does not impart clear answers to any of these questions. It is hard to find compelling natural experiments. And most studies are rather old, and may be a poor reflection of tradeoffs today. Other factors matter: it’s not just whether you have an IOU, but how and how well that IOU is regulated; it’s not just whether you have municipality, but who manages it, and the strength and quality of the broader political/economic institutions that surround that municipality.

    One interesting natural experiment: the conversion of Kauai (one county / island in the State of Hawaii) that was converted from an IOU to a cooperative in 2002. It would be interesting to conduct a difference-in-differences comparison between Kauai and the other Hawaii islands, owned and operated throughout by HECO, an IOU. The outcome would be interesting, but unlikely generalizable, since the broader political economic institutions surely factor into it.

    With regard to 3), in broad strokes, here are two key things that have changed in recent years: Interest rates and complexity.

    First, interest rates and the cost of capital have fallen far more for the public sector than have the rates of return afforded to IOUs. Moreover, while the rate gap has risen, very low prevailing and prospective interest rates greatly increase the cost of the excessive premium afforded to utilities. To see this, consider the present value of an excess dividend stream over 30-50 years into the future. That present value becomes considerably larger when discounted at a lower rate. With real interest rates around zero or negative in much of the developed world, allowed rates of return of 9-10 percent are extraordinarily costly. The tax issues mentioned are trivial in comparison. Note that it’s not just the direct cost of excessive rate of return, but the perverse incentives such excessive rates instill. These help to explain why, for example, coal-fired power plants owned by regulated IOUs currently operate even when prevailing prices are below fuel costs—to justify an ongoing rate of return on assets that ought to be rendered obsolete. They also discourage utilities from employing demand response and distributed resources to avoid grid upgrades from which they profit. Even under price or revenue caps, the game in the end tends to be about building rate base, and without a strong regulator policing every micro investment with its own optimization modeling, it’s hard to see how to leverage an IOUs profit motive for broader social benefit.

    Second, the nature of the grid is becoming far more complex, due to intermittent renewables, battery storage, automation and network connectivity that can potentially enhance demand-side balancing. The portfolio of options is extraordinary and difficult to optimize. The utilities will clearly favor solutions that involve their own capital instead of the optimal solutions, while the higher complexity exacerbates the asymmetric information problem and makes regulation more difficult. If needed capital investments were clear, as I think they were (at least relatively speaking) in the grid of the past, then regulating capital is not especially difficult and price and revenue caps probably work to incentivize a utility to keep operations and maintenance costs in check, but possibly at a cost of grid stability. California’s growing fire risk likely influences the balance here, even in the absence of other regulatory challenges.

    So, I think lower interest rates combined with the higher risk premium afforded to IOUs is a big change favoring public ownership, at least relative to the past. Greater complexity suggests the need for a markedly different regulatory model or a change in ownership. Some places, like Hawaii, New York, seem to be grasping around for ways to change incentives in the regulatory model. While a municipality may be more desirable today than in the past, I gather that there is little appetite to contemplate a drastic change like ownership during an already precarious transition. The initial years of such a transition are unlikely to be smooth.

  2. Isn’t the underlying issue here inverse condemnation? As the writer points out, without a new state law to upturn California’s interpretation of this precedent, a publicly-owned utility would still be liable for wildfire damages, thereby putting it at risk of bankruptcy, which would also negatively impact its ability to issue bonds.

    • California utilities have tried to brand the issue as inverse condemnation (or strict liability) as the core issue, but the real issue is about management negligence. Yes, liability is borne by the utility, but the real issue is who among utility stakeholders pays those costs–ratepayers or shareholders? If a utility is found liable then it pays damages, however, if there is no negligence then ratepayers pay those costs, not shareholders. The recent CPUC decision on the 2007 wildfire found SDG&E management negligent (for which it is still in denial) which means that shareholders must pay. The same may be true for PG&E in the 2017 and 2018 fires. Even WITHOUT inverse condemnation, those utilities’ shareholders would still have to pay those costs–changing the law would make no difference in whether PG&E remains solvent.

      The more relevant question on inverse condemnation is how should we split the responsibilities for those damages? If electrical equipment is causing the fires, should individuals have to bear those costs? Or do we want individuals to be incented to take prudent protective action and even to reconsider relocating to a safer area?

  3. It seems odd to be reminding such a knowledgeable person as Dr Borenstein of one of the most important issues in economic regulation in the post-War era but his discussion of the asymmetry of regulator and regulatee shows no recognition of the Averch-Johnson (AJ) critique and its aftermath. Unless it’s viewed is optimal to duplicate the resources available to both there is always more expertise on the side of the utility. Hence the regulator is in a poor position to second-guess expenditures on safety. This is at the center of the “gold plating” of assets that AJ critiqued. In some ways this may be viewed as a principal-agent problem. Under private ownership with regulation the principal is the regulator and the agent the utility. With public ownership the principal is the government, on behalf of the consumers, and the agent is the utility. My reading of the US experience of these two models, stretching back over 80 years (Puerto Rico notwithstanding) is that the overwhelming evidence is that the latter provides the same or better service at about 90% of the cost. I could say “you could look it up” but the EIA discontinued its series on public electricity about 20 years ago and the data is now held by the American Public Power Association. I also note that Historical Statistics of USA has been transferred to Harvard, whom you have to pay. However there are libraries with old printed copies that those who disbelieve me can search out, if interested.
    On a minor note, I would like to see Dr Borentein’s evidence that deregulation has benefited electricity generation. There are several studies to the contrary.

    • An important innovation from restructuring/deregulation–the widespread adoption of gas-fired combined cycle plants starting in the late 1990s that have pressured coal plants into retirement. The first CCGTs came on line in the late 1990s after the FERC order, and almost all of the plants built through the early 2000s were third-party or merchant plants. The technology was available in the mid 1980s but utilities didn’t build them. (The ARCO Carson refinery installed the basic technology in 1986 in it’s cogen plant). It took a much stronger incentive about risk and profits to induce that technological innovation. It’s also probably true that the wind and solar technologies took off for the same reason. The utilities want to protect their conventional technologies–these new ones threaten that investment.

      • Gas is threatened by renewables? Hardly. Until the sun shines all night and the wind blows constantly, renewables guarantee fossil fuel gas a primary role in electricity generation.

        In this heartwarming commercial, British Petroleum blows a kiss to its renewable besties for helping to keep fossil fuels relevant and profitable:

  4. “Either we have public ownership or we have local investor-owned utility (IOU) monopolies operating under stringent economic regulation.”

    Severin, re-regulation under a modified Public Utility Holding Company Act (PUHCA) is the only path to sensible and equitable electricity service for all. PUHCA, which required that all policies and investments of utility monopolies be “in the public interest”, was signed into law in 1935 specifically to end rampant exploitation of electricity customers during the 1920s. Federal oversight was handed to the fledgling Securities and Exchange Commission, which had the power of the Sherman Act and the resources to pursue and prosecute violators.

    One of the most egregious abuses was the self-dealing of holding companies owning both gas and electric holding companies. Electric subsidiaries bought fuel to generate electricity from their “sister” gas subsidiary, then billed customers at an artificially-inflated price of their choosing. After PUHCA was enacted SEC regulators went to work – and by 1949, combined electricity/gas holding companies ceased to exist.

    Since the 2005 repeal of PUHCA of 1935, and the removal of federal antitrust oversight, the CPUC has become a tool of California fossil fuel and renewable energy interests (in 2015, energy surpassed healthcare as the #1 source of influence in Sacramento). Now, self-dealing is back with a vengeance, closing California’s carbon-free nuclear plants only because Edison, Sempra, and PG&E are now able to pocket a hefty $1 billion each year in sales of natural gas.

    Federal oversight is the only answer – a lesson we’ve already learned, and one we may have to learn again the hard way.

    https://www.raponline.org/blog/when-utility-gas-affiliates-play-by-monopoly-rules-consumers-are-likely-to-lose/

    • California utilities’ problems long predate PUHCA repeal. See the link to my blog in my earlier response on PG&E’s missteps back to the 1960s. The problems are inherent in a monopoly utility, but now we have the technological ability to sidestep them, and we can finally acknowledge that risk sharing has been a myth so why should we bother paying a higher return to shareholders.

      • The only example of a 1960s “misstep” you quote is Rancho Seco, a first-generation nuclear plant which delivered 44.1 trillion watthours of carbon-free electricity to Californians for a remarkably low capital investment of $4.26/MW* (compare to Topaz Solar Farm, which provides unpredictable, intermittent solar electricity at a capital cost of $15.55/MW*.

        “…we have the technological ability to sidestep them [utilities]…”

        That statement raises a lot of questions:

        Have you gone off-grid?
        If not, what technology are you using to sidestep PG&E transmission?
        If you’re getting your electricity from a CCA’s “100% renewable” plan, your lights must go out when renewable electricity is unavailable. Do you find that kind of electricity service acceptable?
        Without any regulation, how do you know you’re getting what they say you’re getting…a handshake?

        Risk sharing has never been a “myth”. Sounds like you’re sharing it, and don’t even know it.

        *2018 dollars, capacity factor included

    • Based on my personal experience in litigation, FERC has been captured by transmission owners who hew close to the Commission’s pro-ISO policies, so I have little confidence in federal “oversight”.

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