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PO Box 1070, Frankfort, KY 40602  Phone 502.875.2428, Fax 502.875.2845

Electric Utility Deregulation 1997 & 2001  Posted: February 4, 2001
Electric Utility Deregulation

The failed California experiment in restructuring the delivery of electricity at the retail level (called "deregulation" or "unbundling") may leave you wanting more information about what is occurring nationwide and what the impacts of deregulation might be for Kentucky's consumers.

While the proponents of deregulation, the power marketers and utility
generation groups waged an aggressive campaign nationwide and in Kentucky to convince the public and the press that reregulation of electric utilities at the retail level was inevitable and universally advantageous, the failed California experiment and the reaction of other states to slow or stop efforts at introducing retail electric competition, reflects that it is neither inevitable nor in the best interests of the public generally, and Kentuckians in particular. Kentucky's General Assembly considered the issue of electric utility deregulation, and many legislators expressed a healthy skepticism as to whether consumers in this low-cost electricity state would
really benefit from deregulation.

At the heart of the deregulation concept is the elimination of monopoly service areas which were provided in return for the utility's agreement to a universal "obligation to serve" at a fair price, and the replacement of that "regulatory bargain" with a decoupling of the local distributors from the power generators and a market-based price. As in any competitive marketplace, there would be winners and losers, and the retail customers, particularly those on fixed incomes, the poor and rural Kentuckians, would be
the losers in a competitive electricity marketplace.

California's failed experiment resulted not from clean air standards but from the failure of the competitive marketplace to assess and to plan for meeting future generation need, and the artificial dampening of prices at the distribution level imposed in order to convince consumers that they would gain, rather than lose, under the new system. The failure was predicted by many observers and was predictable, although there is cold comfort in being
right at such a high social and economic cost.

I have attached the Council's 1997 testimony before the Special Subcommittee On Energy of the Kentucky General Assembly. I hope it will be helpful to you in understanding what deregulation would mean to Kentucky.

For the most current picture of electricity restructuring activity in each state and in Congress, you can subscribe to a free weekly summary prepared for the U.S. Department of Energy, by e-mailing Patrick Mara .
The summary is also available on the web
Here





Kentucky Resources Council, Inc.


Post Office Box 1070
Frankfort, Kentucky 40602
(502) 875-2428 phone
(502) 875-2845 fax
e-mail FitzKRC@aol.com


Written Statement of The Kentucky Resources Council, Inc. On Electric Utility Restructuring And Competition

Before the Special Subcommittee On Energy of the Kentucky General Assembly

Prepared by Tom FitzGerald, Director

October 17, 1997


Mr. Chairman, members of the Committee, I appreciate this opportunity to address the committee regarding electric utility
reregulation.

The effort to separate generation of electricity from transmission and distribution of electricity, and to promote retail competition in
electricity by allowing the transmitting and sale of electricity to a retail consumer in a utility's service area by someone other than the
utility, which I call "reregulation" of electric utilities, will have a potentially profound effect on our state. There is every reason for
Kentucky to move very slowly in this area, since we are in a unique position relative to other states in having the lowest combined
electric rates among classes of users in the nation, and a large rural and low or fixed income population who could be placed at risk by
radical reregulation efforts.

It is not an understatement to suggest that the potential impacts on Kentuckians from irresponsible policies concerning utility
reregulation, which could include higher utility costs for residential and small commercial customers, potential access problems for
low-income and rural Kentuckians, adverse economic development impacts, increased air pollution, and loss of demand side
management and conservation, are profound and must be addressed.

Despite the aggressive campaign being waged by power marketers, investor-owned-utilities, industrial customers in high-cost
states, and power brokers, to convince the public and the press that reregulation of electric utilities at the retail level is inevitable and
universally advantageous, retail electric competition is neither inevitable nor is it in the best interest of the public, and Kentuckians in
particular.

It is important to remember why government regulation of utilities was undertaken. Historically, after a period of decentralized utility
service, utilities consolidated and gained market power, leading in many cases to abuse of that power and a failure to provide fair and
adequate service. To avoid the municipalization of electric utilities, it was agreed that there would be a regulatory "bargain" - a
territorial monopoly, with guaranteed reasonable rate of return on prudent investment, in return for an obligation to serve at fair rates.
The reregulatory framework destroys that relationship, and allows that generating capacity of utilities, which Kentuckians have
invested in through the construction work in progress program, to be wheeled onto the open market to the highest bidder. The
inevitable result is that we will be competing for power with industrial customers in other states interested in avoiding the imbedded
costs; costs largely associated with questionable investments in nuclear power in those states.

Who is pushing rapid reregulation? It is not your residential or commercial constituents. It is the large industrial users in the high-cost
states, some industrial users here in Kentucky who are dissatisfied with the low-cost power now available to them and want even
lower rates, investor-owned-utilities in Kentucky who would love to wheel power at market rates to high-cost states, and
commodity traders and power marketers.

Why should Kentuckians be concerned?

Because electricity rates will probably rise, particularly for the elderly, the poor, those on fixed-incomes, and rural Kentuckians.

Because captive consumers could end up paying a disproportionate share of imbedded and fixed costs.

Because electric service will likely become less reliable and less safe.

Because environmental and conservation programs aimed at making energy use more efficient and lowering energy bills could be
abandoned.

Because research into burning coal more efficiently and cleanly, and other energy research, could be adversely affected.

There are many issues at stake for Kentuckians.

Will rates go up or down for all classes of consumers, particularly those most vulnerable? The average resident doesn't have a power
manager in their house who has the savvy to shop power. In a marketplace where generating capacity is spun off and power can be
brokered at market rather than return-on-investment rates, there is every reason to believe that large industrial consumers will gain
preference in rates and service, leaving higher cost supplies for residential and small commercial users whose demand is more
inelastic.

The effect on fixed-income populations is of particular concern, since those consumers could be "redlined" and left with less
attractive plans, or be left to be served by the "supplier of last resort" at higher prices. Electricity is not merely a commodity- it is an
essential service. 17.5% of older Americans income, on average, is spent on residential energy bills. While on average, a
median-income Kentucky family spend 3.8% of income on energy costs, a family receiving assistance (formerly AFDC) spends up to
30.5% of income on energy, and an SSI recipient spends 16.5% of income on energy. Any increases in energy costs for older persons,
and others on fixed-incomes, may mean a choice between cutting back on energy or other basic necessities.

The effect on new home construction has caused a legitimate concern on the part of the National Association of Home Builders, who
have indicated a fear that reregulation may result in increased utility hookup fees, elimination of many utility demand-side
management programs, and of low-income energy-efficiency programs, and unfair distribution of electric rate reductions favoring
large users at the expense of residential users.

When the choice is between the certainty of low rates and a high degree of reliability in the delivery of electricity to our homes and
businesses, as we currently enjoy in this state, and the uncertainty of competing against industrial consumers in New England and
other high-cost states for that same power, and losing the obligation to serve, what benefit is there for the public in Kentucky in
reregulation?

Do we want to be deluged with telemarketers trying to sell packages of services which cannot be meaningfully compared and which,
when analyzed through all of the new line-item costs, result in net increases in the cost of basic services? What will happen to the
person who changes suppliers? Who will be able to cut-off service, and will there be deposits for service?

What will this "brave new world" mean for the average consumer? Will electric power companies be obligated to serve? Even if
obligated to serve, will they be motivated to provide adequate and fair service to the rural, the fixed-income, the small residential user
whose transaction costs are high relative to the amount of electricity used? Or will cherry-picking and redlining occur?

What will the consumer pay to have the services that are now delivered in a "bundled" fashion rebundled in a "competitive"
marketplace? If the distribution, transmission and generation functions are no longer vertically integrated and separated, what will the
consumer really see in savings once the transaction costs are added up? The Wisconsin Federation of Cooperatives painted this
picture:

Thus, buying electricity from one company, having it transmitted
to your community by another and delivered to your home or
business by a third would presumably become the routine. Almost
as likely is that a fourth company would send someone to read
your meter and pass the information to a fifth, which would do the
arithmetic and send you a bill, unless it confines itself to bookkeeping and leaves the mailing to company number six.

For the frugal householder who sets out gamely upon the new
electrical wilderness buoyed by the hope of saving a penny or two
per kilowatt hour, calamity looms ahead. The elaborately choreographed
ballet of middlemen will pass his little purchase through successive
sets of hands, each claiming their cut, until it accumulates incidental costs like a third-world traffic ticket. Ironically, just as the consumer is beset by this proliferation of superfluous intermediaries, the number of actual suppliers competing for his business will have shrunk.

A major concern in the pricing of power under a reregulated, competitive model is the "segmentation" of the market, or the "inverse
elasticity rule," in which the rate charged is whatever the market will bear and includes charging less to those more responsive to
price and more to those who are captive and less responsive to price because of a lack of options.

Two examples of this phenomenon are the deregulation of airlines and the telephone industry. Airline ticket prices for vacationers fell,
because that class of consumers could drive; alter plans, or vacation elsewhere. The last-minute ticket prices typically used by
business travelers skyrocketed; increasing in airports dominated by one or two airlines, by up to 26%, according to the U.S. General
Accounting Office (Airline Deregulation, April 1996). Under a deregulated telephone industry, business long distance rates dropped
by 50% but local rates on local residential service increased 64%.

Predictions of what will occur to price under a deregulated environment because of inelasticity of residential customer demand were included in a December 1995 Massachusetts report A Prescription for Competition: The Restructuring of the Electric Utility Industry:

Customers with relatively high elastic demands are those who
have several options they can take relative to the acceptance of
utility service. In the long-run, these are mainly industrial
customers. . . .

On the other hand, over the long-run, residential and low use
customers generally have a highly inelastic demand for public
utility service; they have a dire need or reliance on the utility
service and therefore are less willing or able to reduce demand as
the price increases.

. . . Therefore, the electric utility will be able to increase revenues by charging a higher price where demand is inelastic and a lower price where demand is more elastic. The rates charged to customers with inelastic demands could be raised with little worry about greatly diminished consumption.

Who picks up the tab when the supplier fails to deliver, and the commercial or residential user is left without power? Will the cost of
non-performance and all of the damages resulting, be borne by the end-user or the supplier of last resort?

What will happen to the tax base, as local utilities no longer necessarily serve customers?

What will be the result of the restructuring of the electric industry on effective competition? True competition is not a
"winner-take-all" proposition, but is reflected in a marketplace where no one entity or groups of entities wields sufficient market
power to manipulate the marketplace. It is ironic indeed that while touting publicly the benefits of competition, the real utility response
to the advent of reregulation has been to merge into increasingly larger units, reducing effective competition. Ongoing consolidation of
electric utilities and energy industry companies creates the possibility of abuse of economic power and manipulation of energy
markets at the consumers' expense, particularly after the excess capacity that acts to dampen prices, is gone.

Will the system remain reliable during peak times and in catastrophic storm events, as electric power companies cut costs by cutting
staff, and as the migration of young talent from the regulated sector to the unregulated market continues? The silence of electrical
engineers who are afraid of losing their jobs, bespeaks a broad fear among those who are familiar with the US electrical network that
the transmission system is not capable of supporting an open electrical network.

System reliability is a key issue that is glossed over in most discussions about reregulation, but is a paramount concern. In the
telephone breakup, when the system fails or becomes overwhelmed, you get a busy signal. With utility reregulation, you don't get a
busy signal - you get potentially life-threatening problems. Electricity Week published a recent article captioned "All engineers give
two thumbs down" which discussed reliability issues. The statements of electrical engineers was sobering:

Power transactions are direct revenue producers, preventive
maintenance is not. Guess what gets cut." This comment by a
transmission planning engineer from a large northwestern
utility, reflects what every utility engineer has been thinking
ever since competition started heating up.

Virtually every utility engineers questioned by EW correspondents
predicts that reliability - the hallmark of electrical service - will
go down under competition.

* * *

A recently laid-off energy applications specialist with 45 years
of utility experience can be excused for some bitterness. But
few would argue with his assertion that, "Electric power is a
technical and complicated industry that is now being run by non-
technical bureaucrats, who know nothing about the product they
are selling. I can see the day when you could be without utility
power for a week. I bought an emergency generator with
voltage regulation for my home and would recommend that
everyone get one."

A substation foreman from Maryland, recently retired after 30
years, says "I expect that there will be many problems with
reliability all over the country, including here on the East Coast,
because of deregulation. There will be a lot less cooperation
between competing companies, smaller reserve margins,
poorer maintenance. You can't cut the workforce and expect the
same level of service."

A senior partner at BPA agrees that, "Line loadings are occur-
ring without the appropriate upfront study." This engineer points
out that the recent outages at BPA provide a "real-time
indication that reliability concerns need to be addressed now
rather than later."

The uncertainty of future generation need planning is a consideration given short shrift because of the current excess generation
capacity. The unbundling of generation, transmission and distribution sales could greatly complicate the planning processes needed to
assure that investment in future generation capacity is undertaken when and as needed and on a prudent basis. Unbundling would
make integrated resource planning, forecasting, and other traditional means of assuring needed generation, more problematic.

The future of conservation programs is also in doubt under a reregulated electric utility framework. The investment of electric utilities in demand-side management as a mechanism for moderating demand and making end-use of energy more efficient, may be
adversely affected where there is no guarantee that the customer in whom the utility has invested to lower end-use costs by
increasing efficiency at the point of use, will remain with that utility as a customer.

Renewable energy programs might be adversely affected as well under the "bottom-line" market-driven approach to delivery of
utility service, which will place greater emphasis on short-term profit over investment in technologies. The amount of research money
that the private industry has invested in alternative energy, and in technologies to burn coal more efficiently and cleanly, have already
suffered in anticipation of the reregulation and will likely continue to suffer under a reregulated framework. The restructured system,
in which short-term profitability would eclipse other values, would shift more generation to the lower-cost units, potentially
increasing air pollution at facilities lacking appropriate air pollution controls.

What impact will reregulation have on economic development in this state? I haven't looked but I'm willing to guess that our economic
development brochures for Kentucky use as a major selling point in this state has been the low-cost of power. If that power is
wheeled on the grid to other states, will the large industrial prospect move to Kentucky when it can shop another state which might be
better located in terms of workforce or markets, and still buy Kentucky's inexpensive power?

Before Kentucky considers reregulation, the advocates must demonstrate with supportable numerical forecasts, not merely the
short-term savings in generation and other costs that are claimed to be a result of restructuring, but also the proposed allocation of
those savings among Kentucky's population.

While the marketers and the other proponents of reregulation would have you believe that we must "be proactive" and adopt some
form of a reregulation for Kentucky, the truth is that there is no inevitability to reregulation. This is not a matter of the "natural order"
as one utility executive attempted to portray the case by comparing reregulation to "Jurassic Park." Instead, this is an attempt by the
investor-owned utilities, who have excess capacity in the short-term and have tired of a regulatory framework that has capped their
profits at a reasonable rate, to remove those caps and increase their profits. At the national level, as unions, home builders, retired
persons, low-income advocates, the Farm Bureau, and many others have begun to realize what reregulation means to the public, the
movement towards federal legislation has slowed considerably. We should move prudently and cautiously in Kentucky, assessing with
a critical eye the experiences of other states. Realistic and independent assessments commissioned by the legislature rather than
private parties, should be undertaken of the many facets, including the downsides, of reregulation.

Reregulation does not benefit the public unless and until it provides assurances over the short-and long-term, comparable to the
existing framework and adequate to satisfy the public need, of:

- Universal service at affordable rates;

- Equity among classes of consumers in the allocation of costs

in proportion to usage

- Responsible treatment of stranded investments which does not

saddle the public with costs of failed speculative investments;

- A reliable and safe electric system providing the same or better

degree of reliability as now experienced, and with severe sanctions

for failure to deliver power and for failure to maintain the system;

- Protections against market-power abuse;

- Strong consumer protection provisions

- Assurances of protection of the most vulnerable classes of consumers

including elderly, fixed-income, and rural residential and commercial

customers

- A guarantee that residential customers are not the last to benefit from

restructuring, but are instead the first.

- A systems benefit charge or other mechanism to fund research and

development into alternative energy and clean coal technology, and to

fund low-income programs and end-user energy efficiency programs;

- Net improvements in environmental protection through competition,

and disincentives for shifting generation to plants lacking BACT controls;

- Methods to insure meaningful customer access and aggregation, and

other mechanisms to overcome barriers to full participation;

- Full disclosure of each company's portfolio and environmental

protection record to allow for meaningful customer choice;

- Assurances that past monopoly status will not confer unfair advantag
on utilities or subsidiaries in the area of power sales or marketing, and in marketing other services to customers (such as appliance repair, telephone service, etc.) Cross-subsidization of unregulated utility activities and preferential relations in the use and access to resources and information between affiliates is a concern that is best addressed by demanding that complete divestiture and separation of all functions (generation, transmission and distribution) occur; and

- fair collection and billing practices.

This list is illustrative, but not exhaustive, of the significant issues that must be addressed in considering whether to allow retail
competition in electric power supply. The replacement of the regulatory framework with a reregulated environment shifts the risks
disproportionately to the consumers, and particularly residential and small commercial consumers, in a manner that must be
understood and evaluated in determining wherein lies the public interest. The Council does not support reregulation of the electric
utility industry, and believes that reregulation is not in the best interests of the average citizen of the Commonwealth, for these and
other reasons.

Thank you for your time and attention to these comments.

Kentucky's enviable position in large part reflects a lack of imprudent investment in nuclear generation. In order to avoid
post-reregulation rate increases for residential customers, California's legislature approved a $10 billion bond issue to finance a
short-term rate decrease - a bond issue that Californians must repay. To the extent that the high cost states wish to engage in bailing
out the utilities through bond issues and other sleight-of-hand approaches that artificially dampening rates in the short term and make
reregulation appear to be in the public interest, that is certainly their decision. We should not be asked to subsidize those poor
investments by raising our rates from investment-based rates to the speculative market levels.

Recognizing that segmentation of the market with higher costs for classes of consumers, proponents of reregulation argue that "choice
is its own virtue." Consumer choice of suppliers without real distinction or substance is no virtue. Proponents do not highlight the
darker side of "choice," which is that the suppliers can "choose" the consumers because of the cessation of the obligation to serve,
leaving classes of consumers with no real choice, but rather typically assigned involuntarily through a lottery or "risk pool" basis to a
supplier of last resort.

Wisconsin Federation of Cooperatives. Power Politics: The Disappearing Competitors; May 22, 1997.

Whether one accepts the utility argument that consolidation is a defense to acquisition, rather than an aggressive pursuit of greater
market power, the result is the same - progressively larger, less-regulated utilities dominating the landscape and reducing effective
competition.

An article by Robert Varela, editor of Public Power Weekly, reported economics writer Robert Kuttner's description of the economic
cycle of U.S. markets in this manner:

The first stage is characterized by excess capacity, the second by cutthroat competition, the third by corporate consolidation, and the fourth by resulting monopoly power. The electric industry of the 1920s and 1930s followed the pattern, and is in the process of reliving it in the 1990s.

Air pollution from older utility plants is a health concern in the Commonwealth. Restructuring may create unfair advantage for older,
dirtier coal-fired plants, absent measures to require a level playing field among power plants in emissions limits, because of their lower
costs relative to utilities that have installed pollution control equipment. The older plants would have an edge also because the price of
power needs to recover little capital cost, since ratepayers have paid those costs for decades.

Supporting materials are attached.

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