Chapter 1 – A Brief History• We are transitioning from regulation to deregulation for many

of our telecommunication, natural gas, and electricity sectors• Vertical integration to horizontal• Examples in the U.S. include Illinois• Other examples include Australia, New Zealand, and Great Britain

Vertical Integration

Horizontal Integration

Chapter 1 – A Brief History• To understand this transition we must first examine traditional

regulation, it’s goals, and how it works.• Most of class – How we should regulate• Intertwined with – How we do regulate

• After deregulation some aspects will continue to be regulated• Transmission• Local distribution

When and why regulate?• Industry Y produces an unsafe product• Industry X has significant power over the economy of the

country.• Prices are too high• Prices are too low• Prices are too high for some and too low for others• Prices are unstable

Who to regulate?• Natural Monopoly• Capital intensive• Necessity• Non-storable (demand fluctuates)• Produced in favorable locations• Involve direct connection with consumer

How to regulate?• Estimate costs• Break costs into a price structure• Joint vs. common costs• Types of consumers• Time of use vs. peak-load pricing

• Make sure the firm covers costs• Make sure the firm operates• Charge customers

Regulatory Goals• Simplicity and public acceptance• Freedom from controversy• Revenue sufficiency• Revenue stability• Stability of rates• Fairness in apportionment of total costs• Avoidance of undue rate discrimination• Encouragement of efficiency

History of Electricity• 1879 – San Francisco built and operated first generating

station• NYC built generating stations for public lamps• Generating companies begin to grow and are not regulated• Each generating company supplied it’s own lines• 1886 – Westinghouse developed a system that uses

alternating current

NYC

History of Electricity• Firms grow, economies of scale production, greater

accessibility, mass consolidation of companies creation of “holding companies”, which can avoid state regulations and rate setting.

• 1935 – PUHCA (Pub. Util. Holding Co. Act)• Essentially kills holding companies• Creates Federal Power Commission (FPC) which regulates

interstate transactions and sales• Until 1973 (oil embargo) the electricity industry continues to

grow in an uneventful manner

History of Natural Gas• In early 1800s, they used manufactured gas to light the streets in

the US• By 1850, almost 300 separate gas companies• In the 1890s, pipelines from natural gas field in Texas and

Oklahoma were built to Chicago and other cities, and natural gas was used to supplement manufactured gas supplies, eventually completely displacing it.

• By 1900, almost 1,000 companies• Technology developments for electricity use - Incandescent lamp

system and AC transmission system, electricity was better for lighting.

• Gas companies began to sell furnaces, water heaters, ranges to compete with electricity

• Natural Gas industry consolidated

History of Natural Gas• 1920s – regulation of local nat. gas distribution• 1938 – Nat. Gas Act gave the FPC authority to regulate

interstate transmission and sales• After WWII, technology of pipeline transmission grew and

industry grew• 1954 – Court ruling that FPC should regulate the production

and gathering of nat. gas.• FPC had to now regulate thousands of producers• FPC froze well-head prices• Led to nat. gas supply crisis of the 1970s

Energy in the 70s• OPEC oil embargo – 1973 affected the electricity industry

because it still had a lot of oil-fired generators• Nat. gas industry price ceiling caused • Stagnation of exploratory drilling• Estimated reserves peaked in 1967 and declined• Shortages developed• Canadian imports replaced domestic supply• Canadian prices increased rapidly

Energy in the 70s• Addressing shortage concerns the US passed the following

National Energy Legislation• Public Utility Regulatory Policies Act (PURPA) – encourage

conservation & mandate the purchase of electricity from qualifying facilities

• Powerplant and Industrial Fuel Use Act – encourage use of coal instead of nat. gas by utilities and industry

• National Energy Conservation Policy Act – promote energy conservation, energy efficiency

• Energy Tax Act – tax incentives for energy conservation, renewable energy, and low-MPG automobiles

• Natural Gas Policy Act – addressed the impact of price controls and deregulated nat. gas prices

Natural Gas Deregulation• Federal Energy Regulatory Commission (FERC) implemented a

series of new regulations that re-shaped the industry.• Severed the connections in the producer field, interstate

pipelines that transmitted the gas, and distribution & retail companies

Vertical Integration

Horizontal Integration

Natural Gas Deregulation• Prices fully deregulated as of Jan. 1993• Still regulate transmission and distribution companies• FERC Orders• Made feasible for local distribution companies to switch nat. gas

suppliers• Implemented voluntary open access on U.S. pipeline companies• Unbundled transportation from marketing activities and made

pipeline-affiliated companies sell their nat. gas before entering into the transmission system

Electricity Industry – 80s & 90s• Regulators became advocates of efficiency and the

environment, rather than price setters• Electricity costs affected by • Utility building nuclear power• OPEC embargo• Had to purchase from qualifying facilities (co-generators and non-

fossil fuel sources)• Cost-effectiveness was goal, not cost/benefit• Rate-payers were locked into contracts that did not reflect the

actual cost of production

90s to the present• Energy Policy Act (EPACT) 1992• Created wholesale suppliers who generate and sell power to

utilities• Supply of electricity grew• Large industrial customers began looking for a way to bypass the

utility company• Electricity deregulation started in California in 94

• Electricity turned the nat. gas into a baseload generating source. As a result, demand for nat. gas increases, creating price volatility in both markets.

90s to the present• Regulators put a cap on prices to help utilities capture the

“stranded costs” of the investment in generating plants• Shields customers from true costs• Increases impacts when price cap is removed

• Deregulation among states has slowed• The process of deregulating nat. gas and electricity continues

to evolve• Because transmission and distribution are still regulated (and

probably will be for a long time), we still need to study and understand the concepts behind rate-regulation.

Next Time…• Chapter 2 – The Natural Monopoly• Definition• Theory