Evolution of Electricity Regulation: From Past to Present

1. Chapter 12Traditional Electricity Regulation:The Calm Before the StormPart A Peter Schwarz Professor of Economics, Belk College of Business and Associate, Energy Production and Infrastructure Center (EPIC) UNC Charlotte of 16

2. Outline • Introduction • A Brief Economic History • Overview of the Electric Industry • Regulating the Electric Industry • Alternative Forms of Regulation of 16

3. Introduction • Supreme Court case Munn v. Illinois (1877) • Government can regulate industries affected with the public interest • 1930s • Electricity regulation begins throughout the U.S. • Permitted a natural monopoly • Economies of scale (EOS) yields benefits from having a single producer • Regulation intended to pass benefits of EOS to consumers What would happen without regulation? of 16

4. Introduction: Prices • An electric utility will periodically appear before its public utility commission (PUC) to determine rates • PUCs allow for a normal rate of return • Inefficient? • P = AC • P≠MC • Averch-Johnson (1962) • Indicates that firms will use too much capital compared to other inputs such as labor • Stigler (1971) • “Regulatory Capture” • Regulators may face incentives to act on behalf of firms rather than consumers of 16

5. Brief History of Electricity and its Regulation • 1879 • Thomas Edison develops the incandescent bulb • Patented 1880 • 1882 • The first electric utility is founded (again, by Thomas Edison) • Pearl Street Station, New York City • Large scale electric lighting made possible for the first time of 16

6. History: “War of the Currents” • DC Current • Runs continually in the same direction • Ex. Battery or Fuel Cell • Difficult to increase or decrease voltage • Loses energy when transmitted over long distances • Developed and used by Thomas Edison • When confronted with difficulties, Edison hired Nikola Tesla to find solutions • Tesla proposed AC Current • Rotating magnet results in a current that switches directions • Voltage could be stepped up or down • Lower electricity losses • Edison found the idea “splendid,” but claimed it was impractical of 16

7. History: “War of the Currents” (cont.) • George Westinghouse • Hired Tesla from under Edison and purchased several of his patents • Started using AC current to serve markets not yet served by Edison • 1893 World’s Fair • AC triumphed when Westinghouse won the bid to supply electricity to the world’s first all-electric world’s fair • The bid was half that of the Edison Company What do we use today? Both! AC dominates grid. DC for solar systems, Electric vehicles, LED lighting. Require inverter to convert DC to AC. of 16

8. Early Days of Electricity • Expensive due to having large centralized generating facilities and extensive infrastructure requirements • Was more expensive than natural gas, the primary fuel for lighting at the time • Required additional demand to take advantage of economies of scale • At the time, electricity was only used at night to run lights • With the addition of a sizable daytime demand from industrial motors and rail transportation, electric lighting supplanted gas as the leading source of illumination in the 1930s of 16

9. Brief History: The Beginnings of Electric Utility Regulation • Lack of regulation in the early days resulted in high prices and redundant services • Early 1900s • States and municipalities began establishing public utilities commissions (PUCs) • Foundation for rate-of-return (normal return) regulation introduced by the PUC in Wisconsin • Federal Power Commission (FPC) • 1920: Established to oversee federal hydroelectric projects • 1935: Gained power over interstate transmission and wholesale prices • 1944: Supreme Court case FPC v Hope Natural Gas • Rate makers now had to balance the competing interest of stockholders and consumers of 16

10. Regulation: Continued • 1960s • Massive blackout in the northeast • Led to the establishment of the North American Electric Reliability Council (NERC) • Oversees the wholesale supply of electric power • 1970s • Saw dramatic price increases • Due to higher fuel prices used for generation • FPC replaced by the Federal Energy Regulatory Commission (FERC) • 1978: Public Utilities Regulatory Policy Act (PURPA) • Required electric utilities to buy electricity at avoided cost from qualifying facilities (QF) • Avoided Cost: cost of building new capacity to meet demand • Contributed to higher electricity prices • Acted as an impetus for states to consider deregulation and restructuring of 16

11. Overview of Today’s Electric Industry • Three Stages • Generation • Primary sources, such as fossil fuels, can be burned to produce electricity, a secondary source of energy • Different countries depend on a wide variety of fuel mixes • France: Nuclear • Norway: Hydro • Iceland: Hydro & Geothermal • U.S.: Coal and Natural Gas United States Generation Mix of 16

12. Overview: (cont.) • Transmission • Transformers “step up” voltage before the electricity passes through high-voltage transmission lines • Takes place over long distances • FERC regulates lines that cross between states as well as those that serve multiple utilities • Distribution • Electricity then passes through another set of transformers used to “step down” voltage • Smaller distribution lines are used to deliver electricity to end-use customers • Takes place over short distances • Can be either overhead or underground of 16

13. Three stages of the Electricity Industry: Source: http://marketrealist.com/2014/09/must-know-supply-chain-delivers-electricity/ of 16

14. Electricity: A Good Like No Other • Electricity cannot yet be stored economically in large quantities • Therefore, supply must equal demand at all times • Loss of Load Probability (LOLP) • Developed Countries: One day’s worth of outages in ten years • Developing Countries: Daily interruptions • Prices do not typically reflect real-time conditions • When demand threatens to exceed supply, customers do not receive price signals that would encourage them to cut back their use • Excess capacity is therefore required • Increases the average price of electricity of 16

15. Customer Sectors • Industrial • Manufacturing, mining, agriculture, and construction • Commercial • Office space, retail, educational facilities, etc. • Residential • Homes/Apartments • Transportation • Subways, Electric Vehicles, etc. of 16

16. Global Trends in Electricity Use • United States • Electricity use growth rate slowing • Declining industrial use • Disruptive technologies • Rooftop solar, electric vehicles, etc. • China • Increasing energy use • Enough to offset declines in the U.S. • Increases are leveling off after years of 10%+ growth • India • Increasing energy use • Increases expected to rise rapidly as the country continues to develop • EU • Flat or declining electricity use of 16