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Robert Nelson

Robert Nelson

Allow Electric Competition to Work for All Customers

November 11, 2011

If you are a residential customer of Detroit Edison, you may not know that you pay about 65 percent more for electricity per kilowatt-hour than a residential customer of the Lansing Board of Water & Light. In fact, since 2008, residential and industrial rates for Consumers Energy and Detroit Edison, the largest electric utilities in Michigan, have risen around 30 percent (compared to around 10 percent for the Lansing utility). These increases occurred during a period when the national inflation rate averaged less than 3 percent and national wholesale rates for electricity dropped as a result of decreased demand.

There is absolutely no rationale for a system of regulation that allows a state-regulated utility to charge 65 percent more for electricity than a municipally owned utility in the same state, and for retail electric rates to precipitously rise during a period of low inflation and declining wholesale rates. Because these increases threaten Michigan’s economic recovery, I believe it is necessary to scrap the 100-year-old system of rate base regulation for electric utilities and replace it with a process that, although marked by less scrutiny of each dollar that a utility spends, controls the overall rate of increase experienced by customers.

What I propose is for the state to discard the current rate case process and replace it with a system that requires a utility’s distribution rates — a major part of the customer’s overall electric bill — to be held within the rate of inflation.

With respect to distribution rates, what we are talking about is the part of the network that takes electricity from the transmission system — which takes power from the sources that generate the electricity and moves it along the grid — and delivers it to customers. Because the electric distribution business remains a monopoly, some form of regulation substitutes for the market.

The current rate case procedures for regulated electric utilities in Michigan, although grounded in century-old traditions, have changed dramatically in the last three years. The rate case system, as amended by Public Act 286 of 2008, now operates as an ATM for electric and gas utilities. But unlike the ATMs you and I use, there is no limit on the amount utilities can withdraw from them.

There’s no limit, essentially, because of two changes in the law. First, Act 286 permits utilities to “use projected costs and revenues” in their rate case filings. Second, utilities can request whatever they believe is needed in a future year and the Michigan Public Service Commission, absent a showing of good cause, must allow them to “self-implement” that amount.

Even if a utility overestimates what it needs, the Commission has concluded that “the requirement to refund overcollected rates does not sufficiently protect the interests of the state and the utility’s customers.” Moreover, by the time a utility has issued a refund, it has already filed a new case and can self-implement another rate increase, based on projected costs and revenues.

Ratepayers who oppose a requested rate increase are like Sisyphus, continually pushing a boulder up a hill. But unlike Sisyphus, they are faced with an endless supply of boulders, because the rate increases just keep on coming, year after year.

I propose that instead, the legislature enact a “revenue cap” system for setting an electric utility’s rates. Under such a system, the MPSC would adjust rates for all customers based on changes in the utility’s distribution revenues and how well the utility performs vis-à-vis other utilities.

Under this new system, it would be inconceivable, for example, that a utility would be able to increase rates by 30 percent in a three-year period or for a utility’s distribution rates to be more than 50 percent above a comparable utility’s rates. The system could be developed to provide incentives for efficiency savings so that a utility would be rewarded for good performance.

Why do I limit this proposal to distribution? Because the other components of a utility’s rates — transmission and generation — are already subject to other constraints.

The rates for transmission, which the electric utilities divested after Act 141 of 2000, are established by a federal agency, the Federal Energy Regulatory Commission. And the rates for generation are now, for the most part, determined by the market.

As for generation, in 2005 the regional, federally empowered Midwest Independent System Operator began making the decisions as to which generation should be used at a given point in time throughout most of Michigan as well as other parts of the Midwest. These decisions are no longer made by the utilities, and it makes little sense to pay for attorneys to debate the finer points of whether a utility should have purchased electricity from Generator X as opposed to Generator Y. That decision has been and will be made for it by MISO.

What’s more, the major electric utilities have already recovered from their ratepayers the cost of making their existing generation competitive with other generation in the market, so there is no need for further cost recovery to run these plants. And yet, the cost of fuel and purchased power is reviewed annually by the Commission in a kabuki dance called a cost recovery process that costs ratepayers in this state more than $1million a year to fund public interest intervention.

If a revenue cap system is adopted for Michigan electric utilities, we can eliminate the costly and ineffective process for setting rates, both as it relates to generation and distribution. If this is to be accomplished, the legislature must do two other things.

First, it should authorize the separation of these two segments of the utility business, as it sought to do in 2008 when it ordered the Commission to undertake a study of the feasibility of such a separation. In 2010 the Commission issued its report and concluded that new laws should not be enacted “to require further separation of electric distribution and generation.”

One of the primary bases for the Commission’s recommendation was that “those states that restructured generation and distribution experienced electric retail prices that increased at a higher rate than the U.S. average.” What the report failed to mention was the impact of the new ratemaking provisions of Act 286 on Michigan’s retail rates. The chart included in the report ended in 2009 and indicated that Michigan’s rates were below the national average.

But Michigan’s retail electric rates for industrial and residential customers are now considerably above the national average, and the rate of increase since 2008 far exceeds the rate of increase of nearly every one of the states that separated generation from distribution in that period.

The second thing the legislature should do is to remove the arbitrary 10 percent cap on the portion of the utility’s load subject to competition. All customers should be able to choose an alternative supplier of electricity. This was what the legislature enacted in 2000 and it is what virtually every state that has adopted a competitive model has allowed.

Such a requirement would not undermine the renewable portfolio standard adopted by the legislature in 2008, because alternative electric suppliers are required, under that Act, to meet the 10 percent standard. The utilities demanded a 10 percent cap on competition in 2008 because they asserted that they couldn’t finance a new power plant with the uncertainty surrounding how much load they would serve. Since that time, the utilities have cancelled or delayed plans to build new plants and have continued to ask for significant rate increases notwithstanding.

The uncertainty faced by utilities, real or otherwise, can be addressed by imposing a revenue cap on the utility’s distribution revenues and by maintaining the provision enacted in 2008 requiring MPSC certification of new power plants. If a utility proposes to build a new plant that will not be able to compete with other available resources, the Commission should reject it. If the Commission approves a new plant, the plant should be able to compete with all other generation in the MISO (regional) market.

Although a revenue cap would represent a major departure from electric utility regulation in this country, the concept has been adopted for several utilities in the United Kingdom. In addition, the Federal Communications Commission has employed a similar “price cap” system for large telecommunications carriers since 1990, and the MPSC adopted a price cap system for operating and maintenance expenditures by certain utilities in the 1970s.

What these previous efforts reveal is that significant cost savings can occur, including the substantial reduction in the cost of processing rate cases. A price or revenue cap system would eliminate the costly and time-consuming review of stacks and stacks of testimony and briefs that are discarded as soon as the next rate case is filed.

As it does today with the telecommunications carriers whose rates are no longer meaningfully regulated, the Commission would still have its hands full and could concentrate on other forms of important regulation. It would still regulate the transactions between the generation and distribution businesses of a utility to prevent undue discrimination, oversee an integrated resource process including the certificate of need review of new power plants, and protect low-income customers from being shut off and all customers from safety violations and the abuses of a distribution monopoly.

In summary, Michigan residential and industrial customers have been burdened by electric rate increases in the last three years that have been well above the national average. The current rate case process, under Public Act 286, has not and cannot control future increases. If allowed to continue, these increases, well above the inflation rate, will make Michigan industry more uncompetitive, saddle the middle class with more debt and force low-income customers to choose between heating and eating.

After more than 10 years of unfulfilled promises, it is time to allow competition to work for all customers. To do so, Michigan must abandon an issue-by-issue form of regulation, put a cap on the revenues a utility derives from its distribution system, separate that system from its generation system, and allow 100 percent of customers to choose the most cost-effective generation option.

Robert Nelson is an attorney, formerly of counsel to the Fraser Trebilcock law firm in Lansing, and a former member of the Michigan Public Service Commission and staff member of the Federal Communications Commission.

November 10, 2011 · Filed under Nelson

16 responses so far ↓

  • 1 Samuel Insull // Nov 11, 2011 at 5:13 pm

    Interesting article but leaves major issues unresolved and provides an oversimplified position.

    First, article implies all customers would get the market price. It seems that in a real market (rather than a utopia) poor risk customers ought to be paying a higher price than low risk customers.

    Who would take care of those customers who are poor credit risks? If you dump all high risk customers on a utility and let marketers cherry pick better customers, utilities would always be uncompetitive. This doesn’t seem very fair. It’s just a prescription to punish utilities for being… utilities.

    Second, when new generation needs to be constructed, who will build it? Under this scheme utility generation will be spun off into an affilliate and thereby deregulated. Thus a certificate of need won’t even be needed or wanted by utilities.

    Saying the market will naturally supply new generation is unrealistic. Generation shortages will mean higher prices and higher profits. In a competitive market generators will have incentive to withold, not build new generation.

    Plus merchant plant developers have already tried simply building to meet the marketplace. The result was many gas plants built whose owners soon became bankrupt. In fact Dynergy, one of our largest merchant generators just filed for bankruptcy this past week. The author seems to be counting on investors being fools a second time.

    The author’s model will work so long as there is ample existing generation, but would fail once construction is needed.

    To prevent failure the marketplace would soon have to be altered by new regulations to provide incentives to build new generation.

    In the end we’d have to construct an energy paradigm much like the one we already have. To me it seems like a lot of work for very little.

  • 2 Robert Nelson // Nov 12, 2011 at 7:51 am

    The separation of the generation and distribution segments of the industry has already occurred in other states and the shortages Mr. Insull describes did not occur. No new incentives were needed because the regional markets (Texas being its own regional market) responded. Keep in mind, the major Michigan utilities have recovered “stranded costs” from ratepayers to make them competitive with other market participants. The fact that a few generators went under when we had a significant and sudden increase in the cost of gas ignores the reality of today’s gas market. By allowing 100% of customers to choose, new independent power producers will come to Michigan and supply more than enough power, and at much lower rates.

  • 3 David Waymire // Nov 14, 2011 at 5:52 pm

    I like the attack on “merchant plant developers” as if they were unique. Let’s not forget that Consumers Energy and Detroit Edison were effectively bailed out by the MPSC for their poor management of the last two plants they built (Consumers with the Midland Nuke/Gas, DTE with Fermi). Too big to fail, they were. So rather than consigning them to bankruptcy, which was the obvious choice, customers got stuck with giant bailout bills, while the management teams picked up bonuses. Time to let the free market do its thing — we’ve proven that regulators can’t do it. I’m tired of socializing the risks and privatizing the profits. For more, visit http://www.customerchoicecoalition.com

  • 4 Michael Fox // Nov 16, 2011 at 9:06 pm

    Robert Nelson, thank you for the good article.
    I can point out energy supply solution model made by Marine County in SF Bay area. County tired dealing with PG&E price monopoly and manipulation + poor service and they sign independent PPA (power purchase agreement) with Shell Energy as IPP. You can find PPA on line it is a public. PG&E was furious. They spend ~$80 million trying to stop this from happening again and fail.
    Great story.

  • 5 Samuel Insull // Nov 18, 2011 at 9:15 am

    Mr Nelson how can you say no incentives were created in states where generation and distribution were separated? PJM created a capacity auction specifically to create a transparent flow of dollars for developers to use to develop new generation.

    And what has been the result where the separation of generation and distribution has occurred – really high prices and embittered customers. Not to mention some of those states (New Jersey and Maryland) that have passed additional legislation to create even more incentives to build new generation,

  • 6 George Leroy Tirebiter // Nov 18, 2011 at 3:07 pm

    The success of new unregulated internet and wireless telecommunications technology resulted in lower costs and more options for consumers. Not the reform measures of regulators and the phony competition of resellers. Perhaps something comparable will happen in electricity some day when developers come up with low cost and effective alternatives to the current grid. Otherwise, the costs keep rising in part because government is often acting to increase generation costs with mandates for high cost renewable energy, government directed efficiency programs, environmental improvements, implementation of retail electric choice (that only benefits a few), various rate subsidies and all the rest. There is a need for frequent rate increases to pay for all this, so don’t expect deregulation any time soon.

  • 7 Bob Nelson // Nov 20, 2011 at 10:47 am

    One needs only to look at the EIA data for Aug. 2010- Aug. 2011 to see that competitive electric markets have reflected the national decrease in demand: residential rates went down in CT, MA, MD, NJ, IL, RI, NH but went up in MI, WI and IN, the latter three fully or 90% regulated states. But if the one who defends these increases wants to hide behind the name of the greatest Ponzi schemers in the electric industry, what can one expect.

  • 8 Samuel Insull // Nov 25, 2011 at 4:34 pm

    Mr. Nelson I admit that rates in deregulated states went down with the collapse of electricity demand and the rush of new natural gas supplies. However when I look at say industrial rates in long time fully deregulated states they are usually higher in those states than in Michigan, Wisconsin and Indiana. That’s a small fact that is often omitted by cap busters.

    Also please refresh your memory. I was exonerated in court.

  • 9 Bob Nelson // Nov 28, 2011 at 10:16 am

    The policemen who beat up Rodney King were exonerated in court too. The fact that Mr. Insull was exonerated does not excuse the abuses of the system he created which wiped out the life savings of hundreds of thousands of shareholders. Also, the industrial rates in Wisconsin and Indiana were consistently lower than the rest of the region BEFORE deregulation. Michigan’s rates were above the national average before it restructured, went below the national average after it restructured and are now above the national average after it capped competition at 10%.

  • 10 Samuel Insull // Dec 2, 2011 at 10:12 am

    As long as you are wanting to look at statistics why not compare the average price of power in Michigan to the average price in deregulated states. That would seem to be most relevent here.

    On the EIA webpage under state summaries for the year 2010:

    Michigan’s average bundled price per kwh is

    12.4 residential

    9.95 commercial

    7.07 industrial

    The U.S. average price for deregulated states is:

    15.30 residential

    12.21 commercial

    8.56 industrial

    I’ll rest on these statitistics and not bother with name calling.

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