Electricity Deregulation, the Environment, and Buildings

Since the Energy Policy Act of 1992 mandated open access to electric transmission lines, deregulation of the electric utility industry has been like a freight train gathering steam. Although only a handful of states have enacted legislation or executive rules concerning deregulation, the changes are being felt all across the country. Electric utilities that have operated for over a century as regulated monopolies, with guaranteed profits to their shareholders, are suddenly faced with the specter of open competition for their customers. These changes affect the basic premise under which electricity has been sold since shortly after Thomas Edison first strung wires in Manhattan.

The primary driving force behind deregulation is the promise of lower electric rates, at least for large, industrial users of electricity. Lower rates sound like a good idea, but they may encourage more use of electricity from polluting sources, with severe environmental consequences. Deregulation also undermines some of the legal and financial principles that have spurred utilities to invest in energy conservation, including promotion of energy-efficient and environmentally friendly buildings.

It is also possible that deregulation may be the first step on the path to a cleaner energy future and widespread investments in better, more efficient buildings. Many utilities never committed themselves fully to the conservation programs they were mandated to run. The monopoly structure and political power of the utilities worked against real innovation and new approaches to supplying and selling electricity. Ultimately, the question depends on whether the American public becomes committed to lean and clean energy services or chooses to use lots of cheap power, regardless of the true costs. Deregulation has the potential to throw both of these doors wide open.

A complicated transition

In keeping with a global trend towards open markets and competition, the electric utility industry is following in the free market footsteps of the telecommunications and gas industries. Current trends are moving towards a mandated separation between electricity generation, transmission, and distribution services, which up to now have been operated by utility companies. Transmission and distribution services are likely to remain controlled monopolies, providing equal access to any electricity provider wanting to sell power through the system.

Much of the debate surrounding deregulation has concentrated on just how the transition will be handled.

These transitional issues mean a lot to the companies involved, but there is the risk that they will overshadow the long-term implications of today’s decisions. “Competition is not an end goal in itself, it is a means to an end,” asserts Karl Rabago of the Environmental Defense Fund. Rabago suggests that we should be paying more attention to what signals the industry will be given in terms of social values and priorities.

Stranded costs

One of the transitional issues that is generating the most public controversy is who will pay for the remaining debt on past investments by utility companies.

Over the past several decades, utility companies invested billions of dollars in new power plants and power-supply contracts, within a regulated system that allowed them to recoup those costs from ratepayers. In some cases the companies were even required to purchase power at above-market rates from independent power producers. Because some power plants, including certain nuclear facilities, cost many times more than their original estimates, there is a great deal of debt remaining to be repaid.

If companies lose their captive customers and electric rates do indeed go down, these costs could become “stranded,” leaving huge debts. Energy efficiency consultant David Gottfried reports that nationwide these potentially stranded costs total about $135 billion, of which $70 billion is for nuclear power plants and the rest for other investments and commitments made by utilities under regulatory authorities.

Ratepayer advocates argue that the general public should not be left footing the bill for what they see as poor decisions by management, and that the losses should be carried, or at least shared, by utility stock owners. So far, the states of California and Massachusetts have ignored this argument and made agreements that include provisions for utility companies to recover their stranded costs, but New Hampshire’s initial ruling provides for only 40 percent recovery. This ruling is being contested by Northeast Utilities, which owns Public Service of New Hampshire, so the State’s deregulation effort is now held up in federal court.

Good-bye to DSM

As regulated monopolies, utilities concentrated for over half a century on building power plants and transmission lines to meet increasing demands for electricity. Only after the 1973 oil embargo did regulators, and then utility companies, start paying attention to Amory Lovins and others, who were pointing out that the ratepaying public would be better served by cost-effective investments in efficiency and conservation instead of new generation. This insight led to the evolution of least-cost planning for electric utilities, whereby they were expected to consider all means of meeting electrical demand, including investments in reducing that demand—demand-side management (DSM).

While all utilities worked to reduce demand during peak periods (when they could make up the difference by increasing demand during off-peak hours), not all took easily to the idea of overall load reduction. And regulators in different states took varying positions on how much investment in conservation they would require. Some agreed the public’s interest in a cleaner environment justified investments that would reduce overall electricity use, even when those investments drove up the cost per kWh. Under this scenario, customers taking advantage of such programs ended up with lower bills due to their reduced consumption, while those who didn’t lost out by paying higher rates while using as much energy as before. Other regulators applied a “no-losers” test, requiring that all investments be money-savers for the company and hence for ratepayers.

Overall, the existing system has been serving to promote efficiency and conservation to some degree, but on a nationwide basis it has been inconsistent. Using one objective criterion—the nation’s commitment under agreements from the 1992 Rio Earth Summit to stabilize emissions of CO2—the existing approach has not worked well at all. In select areas, however, it was effective. Conservation advocate Paul Horowitz points out that over ten years Connecticut Light and Power reduced its overall load by 500 megawatts from projected levels—enough to avoid constructing a new power plant. But will the environment be better served by a deregulated industry?

The nightmare scenario

If the promises by deregulation advocates of dramatically lower rates are fulfilled, and no other mechanism is in place to constrain electrical consumption, there is a risk that pollution will spiral upwards.

Most of the country’s cheapest power plants burn coal, which is a high-polluting fuel, even with mandated technologies to remove sulfur from flue gases.

The rosy scenario

On the positive side, there is the possibility that freedom from monopolies with guaranteed shareholder profits may lead to dramatic innovations in the delivery of energy services, including those that reduce actual power consumption. It’s also likely that as more power becomes available from renewable sources, customers will have the option of choosing it over conventional, polluting electricity. All those surveys about how much consumers are willing to spend for green products may soon come to a real, nationwide test! And companies that use environmental protection as a selling point may find it worthwhile to invest in greener power as well.

The greatest benefits are only likely, however, if the political mood shifts towards making the polluters pay for their negative impacts on society. Societal costs of electricity generation are termed externalities in industry jargon, because they do not show up in the companies’ financial statements. If companies were forced to pay these costs, many clean, alternative sources of energy would become the cheaper option.

Movements to require power companies to internalize these societal costs have been hampered by the political power and inertia of the existing industry structure. According to industry analyst Leonard Hyman, however, a deregulated industry is likely to be more flexible and more easily influenced by political will. Hyman, who is on the board of the utility-funded Electric Power Research Institute, points out that the first step is to find a way to value the environment: “If you don’t put a price on environmental degradation, it won’t be accounted for.”

Support mechanisms

Two primary approaches are currently being considered to support conservation and renewable energy activities in a deregulated industry. One is a

line charge, or fee assessed on all electricity distributed to users, that would generate a fund to support these activities. The second option is a

portfolio system, which would require a company selling electricity to provide a specified percentage of its power from renewables or to purchase renewable energy credits from companies generating such power.

Line charges are also the primary strategy regulators are relying on to help utilities recoup their stranded costs and to subsidize electricity to low-income households. Funds collected under a proposed Massachusetts line charge, for example, are to be split between low-income subsidies, support for renewables energy projects, and energy efficiency activities. Some free-market-oriented industry observers, however, see the use of line charges to subsidize renewables and conservation as nothing more than a tax on electricity consumers to subsidize uneconomic power sources. Kennedy Maize, editor of

The Electricity Daily, reports that a proposal by Rich Cowart, chair of the Vermont Public Service Board, for a nationwide line charge is doomed politically. “People are running away from it like it was radioactive. He’s talking about a new tax,” Maize told

EBN.

Many proposals, including two bills before the U.S. Congress, contain some version of the portfolio plan. In all these plans, the required percentage of renewable energy would increase over time, though the schedules for these increases vary from plan to plan. They also differ in their definitions of what are acceptable renewable energy sources. The bill currently before the U.S. House of Representatives (H.R. 655) includes some sources of hydropower in its renewables portfolio plan, while a similar bill in the Senate (S. 237) does not include any.

Portfolio requirements are generally popular among environmentalists as a means of keeping renewable energy sources viable until they can become cost-competitive. It isn’t clear, however, that the percentages required in many of these portfolio plans would be greater than what would be generated from renewable sources anyway.

Effects on Energy Efficiency in Buildings

So what is the likely impact of all these changes on programs to promote energy-efficient and green buildings? Utilities competing on the open market may continue to support some conservation programs as a way of building customer loyalty, but these marketing-driven programs will be greatly scaled back from the heyday of DSM. The other primary role utilities are taking on is the profitable work of the Energy Service Companies (ESCOs), financing conservation measures and sharing in the savings. According to Gregory Kats of the U.S. Department of Energy, there is over $100 billion worth of available energy efficiency investments with internal rates of return of 20 to 25 percent.

Of the various types of DSM programs, the first to go in many cases are those that have funded energy efficiency retrofits. Architect Duncan Prahl, until recently the Energy Crafted Homes program manager at Northeast Utilities, notes that such programs have already captured the most dramatic savings opportunities and that it is harder to pay for a retrofit than for an incremental upgrade during new construction. For this reason, Prahl feels that new construction programs like Energy Crafted Homes, which pay relatively small incentives for improvements with long-term benefits, are somewhat better off. These programs can be expensive to run, however, so it’s not surprising that some utilities have pulled back from their participation. This is the case with the widely distributed Good Cents Program. Similarly, Bonneville Power Authority is no longer offering rebates for participation in its Super Good Cents program, so its member companies are limiting their participation.

A third type of DSM program is designed to provide broad market transformation, such as a nationwide investment in more efficient refrigerators and washing machines. When they’re successful, market-transformation programs are seen as an excellent investment of public resources, but in a deregulated setting the returns won’t come to the utilities. These programs have historically been undertaken in partnership with government agencies, and those agencies are likely to be playing more of a leadership role in a deregulated environment. “Whoever is doing these kinds of programs, whether it be the utility or some other entity in the deregulated environment, this sort of program will be an attractive program to achieve those energy goals,” says Andrew deLaski, manager of the Consortium for Energy Efficiency’s Clothes Washer Initiative (see page 6), a classic market transformation program.

In states and localities where the public and political will has supported strong conservation and renewables programs in the past, that support is leading to new forums for achieving those goals. The California plan calls for an independent agency to take over utility conservation programs, while in New England the distribution companies are likely to be ones implementing such programs.

Broader green building programs faring better

Among new construction programs, those that have a broader agenda than just energy conservation are best positioned to survive the tumultuous transition.

There are two reasons for this resilience. First, they have a potential funding base beyond electric utilities. The Austin Green Builder Program, for example, was funded entirely by Austin’s municipal electric utility until this year. It is now successfully diversifying its support, according to Roger Duncan, director of the city’s Planning, Environmental, and Conservation Services Department, which runs the program. This year, 25 percent of the program’s funding is coming from the city’s water utility and wastewater treatment program, and Duncan expects to see support in the future from the stormwater management program, aimed at preventing non-point-source water pollution.

Second, as creative staff at Portland General Electric discovered in the early ’90s, it is easier to sell the public on “Ecowatts” than on “negawatts.” Packaging energy conservation as part of a comprehensive environmental package increases its appeal.

Portland General Electric’s EarthSmart program, which promotes comprehensive environmental goals in both residential and commercial construction, appears to be on solid footing, even as the company faces a buyout from energy giant Enron, Inc.

Southern Electric International’s Good Cents Environmental Homes program entered the market at a bad time, just as competition was becoming a concern for utilities, so it hasn’t achieved widespread application. Now some participating utilities are cutting back on staffing for the program, but others are just signing on. Central and South West Corp., a holding company for four utilities in Texas and Oklahoma, is now actively promoting the Good Cents Environmental Homes program. Southern Electric’s Robert Duvall sees the integrated environmental package as an important benefit to increasingly image-conscious utilities. Of course, green builder programs that never depended on utility funding, such as the one sponsored by Home Builders Associations in Colorado (see

EBN

Vol. 4, No. 1), are rolling along, feeling no direct impact from the changes.

Transitions are tricky

For any program or initiative connected with electric utilities, the next decade will be tumultuous. Uncertainty about the shape of things to come has led many companies to drastically reduce their commitment to conservation and efficiency programs, and regulators in many states are no longer enforcing past agreements about such programs.

Even in states with a commitment to supporting efficiency and conservation programs during this transition there are some troubling obstacles. In California, for example, the plan is to shift these efforts from the utilities to a public agency. For the time being, existing programs are being continued, but the administrators know that they have no future. Builders and architects may be reluctant to sign on to a program that will be gone by the time their building is complete. And given how long it has taken in the past for such programs to gain name-recognition in the building industry, any new programs are not likely to make much impact initially. To make matters worse, the California law limits the total timeframe for funding of such transitional programs to five years. Programs in New England may not be similarly constrained. “If there’s a sunset involved, that’s going to doom many programs,” says consumer advocate Charlie Higley of Public Citizen.

Significant program innovation is possible

As with the broader environmental picture, the potential silver lining for building-related programs is in the world of new possibilities that deregulation offers. The possibilities for partnerships and packages offering combinations of energy efficiency services and supplying competitively priced power is just the first step. PGE’s Huston Eubank sees large commercial and industrial customers becoming very sophisticated in their understanding of these options, including the benefits of choosing buildings with superior environmental performance, even in an era of lower-cost power.

Public Citizen’s Higley worked on energy efficiency programs in Wisconsin before taking his current job in Washington, D.C. He feels that under the regulated monopoly system, conservation efforts were halfhearted and ineffective because “the only incentive for DSM was regulatory bullying.” “The move to competition could create new providers of energy efficiency services that will blow away anything the utilities have done,” Higley suggests. Others caution that profit-driven Energy Service Companies may skim off the most cost-effective measures, leaving behind the ones with longer paybacks, so there may still be a role for agencies acting in the public’s interest.

To allow the various opportunities to unfold, the new rules must not preclude innovation. For rooftop photovoltaics to succeed, for example, nothing should prevent net metering, whereby the homeowner can sell excess power back into the system. Seeking good public policy without constraining innovation is no easy task. A fine line must be walked between blind faith in free markets and stifling regulations. The trick, says Environmental Defense Fund’s Karl Rabago, is to “get the incentives right and then let the market function to maximize all the benefits.”

The general public has been notably absent from much of these debates, resulting in a risk that our common interest in a healthy planet will not be heard over the din of demands for lower prices. Builders and architects interested in making better buildings have two important tasks in this process: making their voices heard to affect policy decisions and continuing to prove that better buildings are not only possible but a wise choice.

– Nadav Malin