John Hanger

By John Hanger, Former Commissioner, Pennsylvania Public Utility Commission

Exploding fossil fuel prices are causing electricity prices in many parts of America to begin a sharp rise.

Utilities are burning ever more expensive coal, gas, and oil to make about 70 percent of the nation's power. Since 2000, gasoline and oil prices have increased by approximately 200 percent, natural gas prices by 300 percent and coal prices by 150 percent, and these fuel increases are beginning to show up in electricity bills in Wisconsin, Florida, Illinois, Tennessee Valley Authority, and soon Maryland and elsewhere.

As observers in Harrisburg watch prices spiral in other parts of the county, the following questions spring to mind:

· How long can Pennsylvania keep its electricity prices from jumping?

· Since the price caps - approved by the Public Utility Commission (PUC) as part of the restructuring settlements - expire no later than December 31, 2010, what will electricity prices be then?

· What should policymakers and consumers do now to keep electricity affordable?

To answer these questions, we must have a clear and accurate understanding of where we were, where we are now, and what likely lies ahead.

Following passage of the Federal Energy Policy Act of 1992 that moved wholesale power generation to competition, Pennsylvania passed the Energy Competition and Customer Choice Act in 1996. This law ended the monopoly on building and operating power plants but continued transmission and distribution (the delivery of electricity) as a fully regulated public utility.

As part of the transition to competitive power generation markets, consumers and utilities reached an agreement by which consumers promised during a long transition period to pay billions of dollars to utilities for their uneconomic investments (mainly hugely expensive nuclear plants) and for the costs of purchasing power from non- utility generators.

In return for consumers promising to pay for these "stranded costs," utilities promised to cap rates for both generation and combined transmission and distribution. Each utility had its own agreement and the amount of the stranded cost payments and the length of the rate caps varied by utility.

While rate caps ended a couple years ago in the Duquesne Light Service Territory (Pittsburgh) and some other smaller electricity service territories, rate caps continue in many parts of Pennsylvania until December 31, 2010.

The utilities that agreed to the rate caps did so, because they either had power plants that produced electricity at costs that were less than the rate caps or they could enter into long-term power purchase agreements for power at less than the rate cap.

From 1999 until 2004, power in the PJM Interconnection (PJM) competitive wholesale market typically traded in the 3.0 to 4.5 cent per kilowatt-hour range. Those power prices were absolute bargains by almost any measure.

For example, under monopoly regulation in 1996, a typical residential customer or small business customer was paying more than 8 cents per kilowatt-hour to Exelon or Duquesne just for generation (or 10 to 11 cents per kilowatt-hour in inflation adjusted numbers). In other service territories, most small customers were paying about 5 to 6 cents per kilowatt-hour just for generation (or 6.5 to 7.5 cents in inflation adjusted dollars).

With the option of meeting the rate caps by purchasing long-term power contracts or operating power plants that they owned, PPL, Exelon and Duquesne Light all have fully complied with their rate cap agreements, delivering electricity at an ever more reasonable price. In the cases of PPL and Exelon, doing well for their consumers has also meant doing well for their investors - both companies' stock prices increased dramatically since 1996, even though PPL's generation rates are capped until December 31, 2009 and Exelon's rates are capped until December 31, 2010.

Only FirstEnergy seems to be unable to keep its promises to its Pennsylvania consumers. The company has filed a petition with the PUC to break its generation rate cap four years earlier than it had promised and is seeking an approximately 50% rate increase by 2010. Not too surprisingly, FirstEnergy is not proposing to let consumers break their promise to pay stranded costs - through September 30, 2005, consumers have paid FirstEnergy $1 billion.

Like PPL and Exelon, FirstEnergy had the opportunity to buy power when wholesale prices were low, and the company still owns and operates nuclear and coal power plants that produce electricity at a cost of between 1.5 to 3.5 cents per kilowatt-hour, well below the rate caps in Pennsylvania.

FirstEnergy is not losing money when it supplies power to Pennsylvania customers, but it could be making more if it sold power into the current marketplace, where spot market prices have reached their highest point since the market's opening. The desire to maximize profits, as opposed to cutting real losses, is hardly an acceptable reason to break a rate cap promise.

Pennsylvania's successful mix of regulation and market forces has meant that electricity in the Commonwealth is the only energy bargain left in the marketplace, despite exploding fossil fuel prices. Total electricity consumer savings since 1996 exceed $6 billion dollars, and the last 10 years have been the best decade for power consumers in the last 40 years or more. The biggest winners have been the residential consumers of Duquesne Light, who saved between $200 and $400 per year from 2002 through 2004 and saw electricity prices drop to levels not seen since 1981.

But all consumers won. With the exception of 4,500 customers of a small utility in Pike County, Pennsylvania's electricity rates are less in inflation-adjusted dollars than they were in 1996, the year the state began to restructure its electricity industry.

While the price of electricity has been stable or declined, in the same time period white bread is up 31 percent, medical bills are up 42 percent, cable television rates are up 56 percent, college tuition costs are up 70 percent and some Pennsylvania utility water rates are up approximately 100 percent.

Pennsylvania's business climate and economy have also benefited from electricity restructuring. In 1996, electricity rates put Pennsylvania at a competitive disadvantage, with its average rate for electricity about 15 percent above the national average. As of December 2005, that competitive disadvantage had ended, since the price of electricity in Pennsylvania was just two percent above the national average and likely to be below the national average in 2006.

So while the last decade has been golden for consumers and investors of PPL and Exelon, what will be the price for electricity on January 1, 2011, the date by when rate caps end across Pennsylvania? Nobody knows the answer to that question, and the size of any rate increases will vary in different parts of the Commonwealth as a result of two factors: the level of current rates and the amount of stranded cost charges that will also be removed from rates when the rate caps expire.

For example, in the Exelon service territory rates are now comparatively high, and stranded cost charges are between 2 and 4 cents per kilowatt-hour for most of its consumers. The removal of stranded cost charges will help limit or even eliminate there any rate increase.

The price of electricity in 2010 will be a result of supply and demand and regulatory decisions that impact them. It will also be a function of the rates set for the delivery of electricity by the PUC. Right now, steps can be taken or not taken that will influence electricity's prices.

There are a number of specific policies to implement to help consumers prepare for losing the rate caps. Modern meters that record the usage at particular times of day must be installed in all businesses and homes. Using these meters, consumers could be paid market rates to voluntarily reduce electricity use during peak times.

Electricity conservation to reduce demand during all hours must be sharply increased. Renewable energy should be increased to reduce reliance on fossil fuels and to increase the supply of electricity. And funding for low-income customers who are unable to pay electricity bills must be increased.

To put downward pressure on prices, the key goals of policy should be to decrease peak demands and to increase the supply of renewable energy.

The Alternative Energy Portfolio Standards (AEPS) Act passed in 2004 by Pennsylvania and similar laws in New Jersey and Maryland will help increase the supply of alternative energy. But more needs to be done.

Pennsylvania must increase investment by another $50 million per year in alternative energy projects through the sustainable development funds, the Pennsylvania Energy Development Authority and the Energy Harvest Program. These funds can come from an appropriation in the state budget and/or small charges on transmission service.

Small changes in peak demand lead to large changes in prices - a one percent reduction in peak demand will cut peak prices by 10 percent within the PJM power pool. Reducing peak prices is vital to controlling electricity prices in 2010, since the 100 hours of the year when peak demand are the highest amount to a full 20 percent of the annual cost of serving a residential customer. Peak demand drives the price of serving customers.

Lastly, Pennsylvania has absolutely no energy conservation policy. An energy conservation policy at least would raise the energy standards for new construction, increase funding for existing programs like the Low Income Usage Reduction Program and provide tax and other financial incentives for buying energy efficient products. Time is running out to adopt and implement an aggressive energy conservation policy.

In four short years 2010 will be upon us, when we will begin our uncharted electricity odyssey, with no rate caps. State government can make our travels easier by enacting policies that will protect consumers, or our leaders can sit on their hands and see the price of electricity go the way of oil and gasoline.

John Hanger is a former Commissioner of the Pennsylvania Public Utility Commission and was instrumental in the passage of Pennsylvania’s Energy Competition and Customer Choice Act in 1996 and the Alternative Energy Portfolio Standards Act in 2004. He now serves as President & CEO of Citizens for Pennsylvania’s Future.

5/26/2006