How to Free South Carolina’s Energy Market
YOUR ELECTRICITY RATES ARE HIGH, AND GOING HIGHER. HERE’S THE REASON.
In South Carolina – as in most other states – regulation has almost completely divorced the energy sector from the free market. Private energy providers must register with the state as public utilities in order to provide services. Once registered, the state helps enforce a monopoly territory where only one utility may provide power. Regulators determine the prices energy providers can charge. All of this regulation, we’re told, is in the best interest of all parties: supposedly it keeps prices down, prevents rapacious monopolies, and forestalls ruinous competition.
The only problem is that it doesn’t do any of these things.
Indeed, the regulators – namely the Public Service Commission – have failed to achieve these goals. The reason for the failure is that the flaws arising from regulation have been presented to the public as problems arising from the free market. Regulators haven’t prevented monopoly; they’ve guaranteed it with governmental power. Nor have regulators kept down prices. It is the natural tendency of goods and services provided by the free market to become both cheaper and higher quality over time. This is not the case in the regulated energy sector. The Nerve recently reported that over the last nine years two of South Carolina’s largest utilities, SCE&G and Duke Energy Carolinas, had their prices raised with PSC blessing 21 and 14 times, respectively. Over this period the average monthly bill for each of these utilities rose by more than 20 percent over inflation.
Nor is it clear that competition would ruin the energy market. Competition is both a boon to the consumer and the bane of the inefficient business. Competition forces businesses to innovate new ways to best serve the consumer or else shut their doors. As such, a privately owned monopoly with government backing is one of the best arrangements for a business – and one of the worst for consumers. In South Carolina, this arrangement has manifested itself in a practice known as advance cost recovery. Under advance cost recovery law, utilities can make risky investments without fear of losses. The utility simply presents the plans for its investments to the PSC, which then approves a rate hike on consumers to cover the cost of these investments. Consumers who are forced to accept the service of a regional monopoly have no choice but to take the new higher price.
In addition to approved price hikes, regulators protect utilities in other ways as well. A recent bill would have legalized solar leasing in South Carolina, a process by which solar companies lease solar panels to residents and install the panels to residents’ homes, free of charge; in exchange residents pay the company for the power they use generated by the panels. It appeared that the proposal actually had the political support needed to pass.
In response, the utility lobby crafted a new 19 page bill that would allow solar leasing (by licensed entities and with an overall cap on the amount of energy generated by solar leasing) and allow existing utilities to apply for cost recovery for investments made in the renewable energy sector. Naturally, legislators and regulators (often literally the same people) are happier to go along with the new plan, which simultaneously limits the competition that solar leasing firms can offer utilities, and opens up a new avenue for more utility price hikes. Some out of state solar groups see the new bill for what it is, and they’re decrying it for benefiting powerful vested interests over smaller solar producers. In-state solar interests have gone along with the proposal, but this may be due to the fact that they want solar leasing to become legal in any form while they can still take advantage of federal and state solar tax credits that expire December 31, 2016.
The theory of natural monopoly and the history of electric utilities
So how did we get here? The outcome of regulation is far from ideal, so how is it being justified? The genesis of energy regulation and the very idea of a public utility can be traced back to the early twentieth century and an idea known as natural monopoly theory. Natural monopoly theory asserts that in certain industries, fixed costs are high enough that they cause long-run average total costs to fall as output increases. In other words: an established producer who has already acquired a large capital stock (production goods) will be more efficient and able to out-compete rivals. Because of the high start-up costs and vast economies of scale in these industries, one producer will be more competitive than any two others, and as a result these industries tend to be naturally dominated by a single firm, a “natural monopoly.” Energy transmission and distribution has long been considered by many to be an industry prone to natural monopoly.
Thus if monopoly is inevitable, the thinking goes, consumers will be better off with a government regulated monopoly than one accountable only to the market. The problem with this theory and its conclusion is that it simply doesn’t hold up in the real world. Competition and even the threat of competition is effective at lowering prices and improving services in the energy market, just as it is in other industries, and regulation has done little to curtail abuses of monopoly power.
Prior to the wave of “public utility” regulation, competition was common in the energy industry. Economist Burton N. Behling has pointed out that “Six electric light companies were organized in the one year of 1887 in New York City. Forty-five electric light enterprises had the legal right to operate in Chicago in 1907. Prior to 1895, Duluth, Minnesota, was served by five electric lighting companies, and Scranton, Pennsylvania, had four in 1906.” Indeed, monopoly did not become the norm in the industry until government began granting monopoly rights to certain businesses. One of the examples often cited in natural monopoly theory is the gas industry in Baltimore in the nineteenth century. There was, however, continuous competition in Baltimore’s gas industry throughout most of the nineteenth century until the government intervened. The Maryland legislature introduced a bill in 1890 that gave the consolidated gas company monopoly rights in exchange for regular payments to the city.
Even in historical cases where one energy provider rose to prominence without government help, there is little evidence of a non-government backed monopoly charging monopoly prices. This is because in a free market high profits induce new competitors to enter into an industry. Whenever a non-government supported monopolist attempts to gouge consumers with monopoly prices new competitors will arise offering lowering prices than the monopolist. Thus, if a monopolist wishes to maintain his position, he must continue to act as if he has competition by keeping service efficient and prices competitive. While some would argue that high capital entry costs are an insurmountable barrier to potential competitors in the energy field, history has shown otherwise. Whether they were ultimately successful or not, firms haven’t been shy about competing in the energy sector, as examples above show. This threat of competition is all that’s needed to keep a monopolist honest, unless that monopolist has government support and competitors are legally prohibited from entering the market.
Once we know this, it is little surprise to learn that it was large energy providers themselves who pushed for regulation of their industry. In the early twentieth century Samuel Insull, head of Chicago’s Commonwealth Edison as well as another holding company, was one of the chief proponents of government regulation of electric utilities. Electric utility interests may have advocated for regulation on multiple grounds. Some may have wished to have competition legally barred and thus be able to profit from unthreatened monopoly status. Others may have simply seen regulation as inevitable and thought that if they asked for regulation they could receive it on more favorable terms. Either way, regulation and legal monopoly have not been in consumers’ best interest. Time has proven that.
Why does regulation fail?
It’s clear by this point that regulators have failed to keep down prices for consumers. Consumers of electricity from South Carolina’s largest investor-owned utilities have experienced this failing, seeing their average bills increase by more than 20 percent over inflation over the last nine years.
There are two principle reasons for the inability of regulation to provide consumers with the best prices and service. First, as pointed out by economist Richard Posner, public regulators simply do not have all the information (on industry structure, on the desirability of certain investments, etc.) that they need to correct any inefficiencies in the unregulated energy market, and the cost of acquiring this information is enormous, perhaps infinite. Second, in the real world it’s near impossible for regulators to maintain the perfect impartiality necessary to perform their function well. Regulated industries often manage to influence regulators to craft regulation in such a way that it benefits the regulated. This is known as regulatory capture. Evidence of capture and bias in South Carolina can be seen in both the review process for PSC members and the constant approved rate hikes for large utilities. Job performance reviews for PSC members are based in part on surveys of “persons appearing before the commission,” a group that includes the utilities they regulate. On top of this partial evaluation by utilities, the PSC rarely met a rate hike request it didn’t like as evidenced by large rate increases in recent years.
The above evidence is anecdotal, but more comprehensive research has validated the theoretical problems with electric utility regulation. After decades of study economist Walter J. Primeaux authored a book released in 1986 titled Direct Utility Competition: The Natural Monopoly Myth. In his book, Primeaux documents the results of his study of localities served by one electric utility (government backed by this point) and localities that continued to have competing electric utilities into the twentieth century. Primeaux found (as summarized by economist Thomas Dilorenzo):
- Direct rivalry between two competing firms has existed for very long periods of time – for over 80 years in some cities.
- The rival electric utilities compete vigorously through prices and services.
- Customers have gained substantial benefits from the competition, compared to cities where there are electric utility monopolies.
- Contrary to natural-monopoly theory, costs are actually lower where there are two firms operating.
- Contrary to natural-monopoly theory, there is no more excess capacity under competition than under monopoly in the electric utility industry.
Economist J.E. Kwoka, Jr. confirmed Primeaux’s results in his 1996 book Power Structure: Ownership Integration and Competition in the U.S. Electricity Industry.
It’s also worth noting that as technology continues to improve and technologies such as solar panels continue to become more viable, the case for regulated electric monopolies will only grow weaker.
What should the state do?
Put simply, the state should completely deregulate the energy industry. This is distinct from what is often termed “deregulation” in California, which involved market-distorting price caps that led to shortages – as price caps always do. Full deregulation means the abolishment of the Public Service Commission, the end of legally enforced regional monopolies, and legally permitted competition from all energy providers including solar leasing companies. Cost recovery should be abolished along with the PSC. Utilities intending to make capital investments should have to determine on their own whether the investments are worth the risk, rather than financing investments though price hikes on legally captured customers. A deregulated market would benefit South Carolina consumers by forcing electric utilities to compete on both price and quality of service.
In addition to deregulation, all publicly owned utilities should be dissolved and their capital goods/infrastructure should be sold to the highest bidder. Bidding should also be used whenever utilities have to use public lands to run power lines or other instruments of electricity transmission or distribution. In the latter case bids would not be made with dollars but rather through promises of the lowest prices for consumers. Public land use contracts for utilities could be maintained for limited periods for reevaluation purposes, and utilities that win the right to use public lands could have that right taken away if they fail to deliver on their promises.
While state lawmakers can do little about federal energy law, the legislature can still use deregulation to give South Carolina the freest electricity market in the nation. Regulation has had a chance to prove its superiority, and it has failed. It’s time to return the supply of electricity to the market.