Electric Shock: The End of the US Free Ride?

Are we facing the end of three decades of a free ride in electricity?

I’m going to posit that, since the U.S. decided to follow Thatcher’s Britain in the ideological belief that markets would always bring the lowest prices in the long term, we’ve been feeding off surpluses accumulated in the past – and lately, we’re eating the seed corn.

After a generation that didn’t think very much about where resources were coming from (surveys show we have high-schoolers who believe electricity comes from walls), we’re about to face empty storehouses, and the bill coming due to refill them will shock our still-fragile economy.

This issue affects more than electricity, but let’s focus there.

In the early 1980s, UK Prime Minister Margaret Thatcher’s government faced deep deficits, fed by depressed industry, long-term government social costs, and an oil-shocked economy. One way Thatcher’s Conservative Party saw to snag some additional income while promoting its free-market ideals was to get (somewhat) government out of businesses like energy and transportation.

UK taxpayers over decades had paid to build national electricity and gas systems. These were sold off, netting billions for the hard-pressed government. In electricity, the government kept control of the high-voltage transmission system, and thereby the wholesale power market. Electricity prices initially dropped, but rose again over time – a pattern subsequently repeated in European countries embarking on “liberalization” of power systems.

In effect, the UK took fully amortized generating facilities that had been paid for by ratepayers, sold them to private entities, and spent the receipts for other purposes. Not all the receipts, however – these sales required the intercession of a legion of attorneys, accountants, consultants and bankers. By some credible estimates, about a quarter of the value of these facilities was simply cashed out by market intermediaries.

It left the generating facilities with new mortgages, because of course buyers financed them. That meant ratepayers were charged all over again for facilities they had paid to build.

In 1990, as the Central Electricity Generating Board was phased out of existence, its last chairman, Lord (Walter) Marshall, told me the flaw he saw in the new privatized system: reliability. Under the old system, he said, the CEGB had a legal duty to keep the power flowing. Under the new system, no one did. No one had any obligation to plan ahead and build new generation. The new system assumed the market would incentivize someone when the price was high enough.

No one would notice this assumption, he said, until cheap North Sea gas ran out – Britain was then in the midst of a “dash for gas” in which new high-efficiency generating plants were being built. About 2015, he predicted, the UK would face diminished gas flows, aging generators, and the need for new generation with no cheap answers – and the flaw would become apparent.

He was overly optimistic.  The gas is already declining, the flaw is already evident, and the government is scrambling to figure how to meet ambitious carbon cutting goals and get new facilities built before old facilities, especially old nuclear ones, phase out.

A government panel is slated to issue reform recommendations in July, but there’s little doubt that more government spending will be part of the formula. Electric generators have no requirement to bank part of their profits to ensure the country has capacity for the future. No one does.

The U.S. is coming to a similar junction. From the Great Depression, electric utilities grew under a system of monopoly territories, granted on condition they service everyone on the same rate basis. Utilities had to string wires to all comers, and a homeowner on a distant ranch couldn’t be charged more per kilowatt-hour than a homeowner in town. To make that feasible, the utility was guaranteed a rate of return on its spending, with customer rates set by state regulators.

In the late 1970s and early 1980s, fuel prices soared and expensive nuclear plants began coming on line just as industries they were built to service collapsed across the Rust Belt and the economy hit recession. Consumer advocates sought ways to keep the lid on utility rates.

Social experiments, carried out by state regulators with fees added to electric bills, included two market phases: subsidizing independent power producers (IPPs), which didn’t lower prices, and then “privatization.”

State regulators, especially on the coasts, forced vertically integrated utilities to split up into still-regulated distribution companies that bring power to homes and businesses; independent generating companies that make the power; and high-voltage transmission grid operators who connect generators and distributors under a patchwork of state and federal regulations.

The theory: markets would bring competition among generators, and thereby low power prices. Returns were no longer guaranteed, and some rates were de-controlled. Pushing the theory, not least, were financial players who saw big bucks in all the power plant sales.

California showed the theory still needed some work, when out-of-state generators figured how to drive its market power prices through the ceiling. That experience stalled a lot of plans in the rest of the country to pursue markets, but “privatization” had already taken place in New England and the Mid-Atlantic. (Strangely, nominally liberal states rushed to embrace markets, while nominally conservative areas were the slowest.)

Now, public power companies – often small not-for-profit municipal systems dependent on large generators for power – are joining some state regulators in realizing that they’re in the UK bind – no one is responsible for reliability, markets aren’t getting new generation where it’s needed most, and power prices are rising from a host of causes, all beyond their control.

For the last few years, predictions have been accumulating about how much money is needed to build, and rebuild, our aging electric infrastructure, much of it pushed far beyond original plans. A 2008 study done for the Edison Electric Institute predicted $1.5 to $2 trillion would be needed for generation and transmission by 2030, and that was with no new federal edicts, for either pollution or renewables.

The grid was essentially full in 1980. Over the last 30 years, operators have been incentivized to get more mileage out of whatever exists, not to build new. Generators push plants to their limits with uprates, keep operating polluting plants grandfathered under environmental laws, and buy and sell power among themselves in markets – some of which have derivatives markets built on them and are trading profit centers. New facilities are built either with government subsidies and/or in still-regulated states.

As in the UK, privatized generators have no obligation to sock away profits to invest in costly new facilities based on projections of future need. To risk their capital, especially if a project takes more than Wall Street’s three-year rule of thumb, they insist on government “incentives.” And nobody has to build.

Now a series of long-delayed EPA air and water rules are coming down the pike, and they could force some of the oldest generating plants shut and even newer plants to make major retrofits. They will cost billions, and provoke a firestorm over whom to blame.

But let’s not delude ourselves: while we’ve been getting a free ride, we’ve come to think cheap energy is our birthright. We’ve had relatively cheap power because the industrial collapse that began in the late 1970s left us with a surplus of generation, mostly nuclear.  For a variety of reasons, demand grew slowly, even with an increasing population.

Regulators have operated our electricity system as a giant social lab – IPPs were going to save us, then power markets. Neither has wrought a miracle.

At some point, those old facilities just won’t keep going, and we won’t want them to. And then we’ll realize – without long term planning and paying – our current system is unsustainable. To keep our prices down now, we’ve eaten our seed corn. The free ride will be over.