Chapter Six - DEREGULATION AND RESTRUCTURING

6.0 INTRODUCTION

Each of the preceding chapters has described background and key elements of Nebraska’s consumer-owned electric systems as they currently exist. This chapter examines the current status of electric industry deregulation at the national and regional levels to place emerging issues for Nebraska’s electric systems in context.

Deregulation of most major service industries such as telecommunications, airlines, banking and natural gas has taken place during the last two decades.1 The electric industry is viewed as the last major service industry to be deregulated. The magnitude of the changes involved in creation of competitive markets and restructuring of electric companies dwarfs all other deregulation. No other industry approaches the complexity of issues and the mount of capital in transition.

Deregulation of the electric industry began with the passage of the Public Utility Regulatory Policies Act in 1978.2 This established the basis for independent, competitive companies to enter the power generation business. During the 1980s, federal regulatory efforts sought to enhance access to transmission lines for these new generators and to help establish competitive wholesale markets. In 1992, passage of the Energy Policy Act mandated broad open access to transmission lines and encouraged greater competition in generation.3 The prospect of competition at the wholesale level was then expanded by large power consumers, independent producers, power marketers and others into proposals to establish competition at the retail level as well. The competitive market would theoretically provide every individual customer with a choice of power supplier. The market would also theoretically lower the retail price for each customer. However, it is possible that not all customers would share equally in savings and some customers could witness cost increases.

As currently envisioned, a system involving competition at the wholesale and retail levels requires deregulation of generation, establishment of regulated open access transmission operations and access to customers at the distribution level. It also requires restructuring of the electric industry from its current vertical structure which often combines generation, transmission and distribution in a single company into a structure with separate functional entities. It also requires extensive changes in law and regulation, as well as utility operations and financing.

At present, the federal government has left it to the states to determine the timing and form competition will take. Nearly all states have undertaken study or some form of action on this issue. However, there is a growing debate over whether or not electric industry deregulation and restructuring will bring benefits to consumers and how those benefits might be assured. As of late 1997, nine states have passed legislation with variant proposals to create competitive retail markets for electricity. A few states have determined that such competition will bring no apparent benefits to their consumers at the present time. Other states are taking a cautious approach to examine proposals for retail competition.

Policy deliberations in Nebraska may be shaped in part by the current conditions in the state, by possible federal mandates and by the decisions of other states in the region with whom the transmission grid is interconnected. The purpose of this chapter is to review past and current legislative efforts, federal regulatory actions and decisions, restructuring activities in other states and issues and activities associated with stranded cost, benefits and obligations. The chapter concludes with a listing of issues for review in Phase II of the L.R. 455 study which will examine the implications of competitive electricity markets for Nebraska. These issues are derived from Chapters 1 through 6 of this Phase I Report.

6.1 FEDERAL LEGISLATIVE AND REGULATORY ACTIONS

As noted above, federal legislative and regulatory actions have prompted activity at the state level. Generally, federal actions set the context for states to undertake legislation and regulation that addresses their own particular conditions. With states moving forward on varying schedules and with variant proposals for competition, there is some pressure at the federal level to establish national requirements for all states and date-certain timelines. This section briefly highlights actions being undertaken at the federal level.

6.1.1 Public Utility Holding Company Act of 1935 (PUHCA)

As noted in Chapter 1, passage of the Public Utility Holding Company Act in 1935 mandated the breakup of the major holding companies dominating electric generation and supply nationally.4 The passage of the act restructured the electric utility industry into its current form. It allowed continued holding company operation only under strict terms and conditions. For Nebraska, this broke the political influence of these companies and set the stage for purchase of their operations by Consumers Public Power District and the Omaha Public Power District.

Since the passage of the act in 1935, private electric companies have mounted periodic efforts to amend or repeal PUHCA. Repeal of the act is part of restructuring legislation being proposed. This is especially significant in view of amendments that have been made to the act in recent years and the wave of utility mergers and formation of new electric holding companies currently underway. Critics of the act believe it to be outdated and an obstacle to competition. Those opposing repeal believe that premature removal of restrictions contained in the act could undermine fledgling competitive markets by allowing a few large dominant companies to gain market power. Repeal opponents urge that amendment of PUHCA be viewed as part of comprehensive legislation on industry deregulation and restructuring and not as independent legislation.

6.1.2 Public Utilities Regulatory Policy Act (PURPA)

As noted above, PURPA was passed in 1978 as part of the National Energy Act. The principal policy objectives of PURPA involved energy conservation, the development of equitable electricity rates and the development of new, small capacity generation consisting of co-generation and renewable power producers. PURPA established several standards which could he adopted, modified or rejected by the appropriate state regulatory body. Its provisions allowing competitive power generation by Qualifying Facilities (QFs) help to set the stage for further deregulation in wholesale markets.

Under PURPA, Nebraska’s consumer-owned systems were free to set their own price for buying power from QF’s and those that set a price did so based on avoided fuel costs which are low in Nebraska. In some states, regulators required the avoided cost of future generation to be included as benchmark price. Due in part to low purchase rates, Nebraska currently has few QF’s. State’s such as California, for which state regulators set high rates through an administrative process, ended up with a significant number of contracts with above market rates which became a driving force for deregulation and also efforts to repeal PURPA Section 210.

There are strong pressures for repeal of Section 210 of PURPA that requires utilities to purchase the output of QF’s and instead allow the market to determine what the price should be for the output. Although the issue has relatively little current impact in Nebraska, it has strong impacts on states such as California where there is substantial QF power being produced. Those proposing repeal of Section 210 argue that it is anti-competitive and the goals of PURPA have already been achieved. They assert that renewable energy sources now have a foothold in the electricity supply marketplace and that further promotion is unnecessary. Those opposing repeal believe that the foothold renewable energy sources currently have could be rapidly eroded in a competitive market and that incentives are still needed to conserve energy and utilize alternative fuels. Opponents to repeal of the law argue that PURPA should also be part of comprehensive restructuring and deregulation legislation and not an independent legislative effort.

6.1.3 The Energy Policy Act of 1992 (EPACT)

Federal Energy Regulatory Commission (FERC) efforts to open transmission access on a case-by-case basis in the 1980s led to the need for expanded authority to order transmission access outlined in the Energy Policy Act of 1992. The Energy Policy Act of 1992 contained a total of 30 sections. Title VII - Electricity has led to new regulatory orders by the Federal Energy Regulatory Commission (Orders 888 and 889 described below) and provided the driving force for industry deregulation and restructuring. It is important to note that the scope of EPAct is far broader than Title VII and may lead to future legislation and regulation in areas beyond restructuring of the electric utility industry.

The primary purposes of EPAct’s Electricity Title was to open and expand the wholesale transmission market and encourage the development of new competitive generating companies. It did not mandate retail competition. The FERC is specifically prevented from ordering retail wheeling in Section 722 of Title VII Subtitle B.5 FERC has used its authority to urge states to move in this direction. In debates during the past few years between the FERC and state regulators and others, FERC commissioners have asserted that they already have regulatory authority over the rates, terms and conditions of unbundled retail access under a rationale that all electricity transactions have interstate implications. State regulators and others question FERC’s authority over retail issues. Retail competition has taken on a national debate of its own and FERC authority may be modified and expanded to extend to jurisdiction over the rates, terms and conditions of unbundled retail wheeling service in the states which mandate retail competition or in federally mandated retail competition. Further proposals for federal legislation, whether individual or comprehensive bills, require monitoring,

6.1.4 Selected Bills (U.S. House and Senate) Introduced Since 1995

There have been numerous bills introduced in the U.S. House and Senate since 1995 and several of the bills have similar or overlapping features. Relevant bills introduced to date are listed below, including the pending DOE/Administration bill which is currently circulating for agency review. In a broad generalization, most bills introduced are intended to remove what are perceived as statutory impediments to industry restructuring such as PUHCA and PURPA restrictions; address retail competition and individual consumer choice of a power supplier; offer implementation dates; provide for state jurisdiction and market power issues; and offer protections for consumers and the environment. Some bills are narrowly focused on a single issue.

Full analysis and summary of possible impacts of these bills and additional federal legislation on Nebraska will be undertaken in Phase II of the L.R. 455 Study.

6.2 FERC RULEMAKING AND DECISIONS

While new federal legislation is pending, states are attempting to address federal regulatory rules and orders that have followed the passage of the Energy Policy Act of 1992. The forms in which these rules are enacted will shape some of the primary operational and functional realities of deregulation and restructuring; setting a regional context in which states may have to act.

6.2.1 FERC Orders 888 and 889

FERC Orders 888 and 889, issued in April 1996 to implement the requirements of the Energy Policy Act of 1992, require all jurisdictional transmission owners to provide nondiscriminatory open access to transmission to all current and potential users. It is important to note that FERC orders apply to "public utilities" that are generally defined as private investor-owned companies under FERC’s jurisdiction. Public power and rural cooperative systems in Nebraska are not currently subject to FERC jurisdiction. However, because public power and rural cooperative systems own transmission lines that are interconnected with jurisdictional utilities and because they are members of regional power pools (such as MAPP) they are impacted by the FERC orders.

FERC Order 888 addressed the twin issues of open access and stranded costs. Fundamental to the current industry restructuring activities is the requirement for functional separation, or "restructuring," of transmission and generation in order to create open unbiased access of generators to transmission services. Order 888 required that all jurisdictional utilities: 1) separate transmission from generating, marketing and communications functions; 2) file nondiscriminatory open access tariffs containing minimum terms and conditions for use of transmission lines; 3) take transmission service (including ancillary service) for wholesale sales under the tariffs.

Order 889 addressed the development of a same-time information system that would give existing and potential users of the transmission lines the same access to information that the jurisdictional utility enjoys. This became known as the Open Access Same-Time Information System (OASIS) and Standards of Conduct Rule.

The legal and policy focus of these rides is to set the conditions for competition and remedy undue discrimination in access to the monopoly-owned transmission wires. A second critical aspect of the rules is to address recovery of the transition costs of moving from a monopoly-regulated regime to one in which all sellers can compete on a fair basis and in which electricity is more competitively priced. FERC’s goal is to eliminate the remaining patchwork of closed and open jurisdictional transmission systems and ensure that all these systems, including those that already provide some form of open access, cannot use monopoly power over transmission to unduly discriminate against others.

While paving the way for new generating and marketing entities in wholesale operations, the FERC Orders have created additional pressure at the state level. Several of Nebraska’s public power utilities, for example, are members of MAPP which has recently restructured its organization and is currently considering measures to provide appropriate non-discriminatory transmission tariffs and access through development of one or more Independent System Operators for the MAPP region. This activity has brought in a host of new players who intend to use the MAPP system or will be affected by its rules, such as the public utilities commissions in the MAPP region states. These activities are significant to Nebraska because the evolution of open access transmission for wholesale energy marketing may have significant direct and indirect impact on the retail service of public power utilities in the state.

6.2.2 Implications of FERC Orders 888 and 889 for Nebraska

Nebraska did not face the same problems as utilities in other states over transmission access in the 1980s. The state has had open access above 34.5kV for wholesale transactions for three decades.6 Nebraska’s pre-existing open transmission system, its geographical and electrical position on the regional transmission grid and the low generating costs of the state limited the state’s reliance on imported power (except for WAPA preference power purchases). FERC’s efforts in the 1980s had little impact on the state. FERC’s new authority, however, coupled with deregulation and restructuring in neighboring states and MAPP’s regional policies could have significant impact on Nebraska’s transmission operations.

For example: FERC requires that a transmission owner construct additional transmission if needed by parties requesting access. Non-jurisdictional systems in Nebraska would apparently not need to follow this requirement, although it may be mandated by MAPP policies required by FERC. Further, non-jurisdictional consumer-owned utilities are currently not required to file open access transmission tariffs that contain minimum terms and conditions of non-discriminatory service. However, three of Nebraska’s transmission owning systems have developed transmission rate schedules and one (OPPD) has voluntarily filed a Pro Forma Open Access Tariff with the FERC. MAPP might require further full filing of tariffs. But even if these transmission problems are resolved by MAPP, there is an additional question as to whether FERC has any reach into retail or distribution level policies of the state where MAPP could not reach.

Pressure on Nebraska systems could rise with further rulemaking in case-by-case actions at the FERC involving MAPP and utilities and utility groups such as power pools in their efforts to comply with FERC orders. The proposals in MAPP states, such as Wisconsin and other neighboring states for formation of Regional Transmission Groups and Independent System Operators to oversee transmission for the region require close monitoring and analysis. Nebraska electric utilities and companies that are members of the MAPP RTG include NPPD, OPPD, MEAN, LES, Hastings Utilities and Tenaska (a private power marketer). Membership in the MAPP RTG will allow access to the MAPP transmission network and tariffs. As of late 1997, Nebraska utilities have not joined an ISO, although a MAPP ISO is under development. Phase II of the study might examine a Nebraska Independent System Operator along with regional and subregional alternatives to identify relative advantages and disadvantages.

6.2.3 Mergers and Market Power

In addition to rising pressures in regulatory issues related to transmission, there are also significant implications in the merger activity underway in neighboring states. Mergers of major utility companies in Iowa, Kansas and Wisconsin may hold far-reaching impacts on competition in the region. Conditions placed upon mergers by affected state public utility commissions and FERC may include participation in an ISO organization to ensure that the possibility of utilizing transmission by the merged company to achieve market power is reduced by not having control of the operation of the transmission network owned by the merged entities. FERC is currently reviewing its merger standards to determine what, if any, additional safeguards are needed to protect consumers.

6.3 INDUSTRY RESTRUCTURING AND DEREGULATION IN OTHER STATES

Five of Nebraska’s neighboring states (Iowa, Missouri, Kansas, Colorado and Wyoming) have undertaken study of the issue, but have taken no other action to date. Among other states, restructuring legislation had been adopted by late 1997 in California, Maine, New Hampshire, Pennsylvania, Rhode Island, Oklahoma, Nevada, Montana and Massachusetts to implement customer choice or retail competition.

In addition to the states that have enacted legislation, a few states such as Idaho have deferred proposals for retail competition as not being in the being in the best interest of their consumers at the present time. Such action may indicate deferral of significant determination for the present, or it may mark a more firm regulatory commission or legislative committee stance opposed to opening of the retail systems.

6.4 STRANDED ASSETS, STRANDED BENEFITS, AND STRANDED OBLIGATIONS

The establishment of competitive markets at the retail and wholesale levels can result in loss of customers and displacement of high-priced uncompetitive contracts or facilities and a range of other costs, assets, payments and programs. These fall into the general categories of "stranded assets," "stranded benefits" and "stranded obligations." While FERC has asserted authority over stranded assets at the wholesale level, states have jurisdiction over a more substantial portion of the potential claims from claims at the retail level. However, the issue of recovery of stranded costs by Nebraska utilities is problematic. FERC has ruled in Order 888 that it will not grant deference to NPPD and other nonjurisdictional utilities. Without a state regulatory commission providing oversight for electric utilities to which FERC would grant recognition, deference and authority on matters of recovering stranded costs resulting from retail competition, it is questionable whether public power entities in Nebraska can legally act to enforce their own recovery and have that recovery recognized by FERC. Resolution of this issue through litigation or legislation is important.

6.4.1 Stranded Assets

The possible range of total stranded assets for U.S. investor owned utility companies has been placed at $50 billion to $300 billion, with the most likely scenario estimated to be a total of $135 billion.7 The greatest dollar concentration is noted to be in the Northeast and Western United States. These two regions could account for more than 40 percent of the total industry stranded costs. The U.S. Department of Energy has placed its estimate of stranded assets at $88 billion. The amount for the West North Central states (North Dakota, South Dakota, Minnesota, Iowa, Missouri, Kansas and Nebraska), according to DOE, is $2.7 billion or 8 percent of the current rate base using present values as stranded costs.8 These amounts are subjective, dependent upon actions taken prior to retail competition to mitigate the stranded costs and the length of the transition period to competition for which the costs would be amortized.

Some states have proposed that private utility companies be allowed to collect 100 percent of mitigated stranded costs. Other states are considering a 50/50 or 60/40 percent split between consumers and stockholders. Because Nebraska consumers are also the owners of the public power and rural cooperative systems and have backed the financing for the systems, they are both the stockholders and the customers and would absorb the full costs. Those amounts will vary by system. Stranded cost payments of 100 percent can dilute savings anticipated through competitive power supply purchases.

6.4.2 Stranded Benefits

Because of competitive pressures, energy efficiency and conservation programs, low income assistance programs, environmental protection and other related efforts could be eliminated or face reduced funding. The magnitude of stranded benefits depends upon the programs in place in the state and their relative cost. Most states are considering measures to protect these programs.

6.4.3 Stranded Obligations

Stranded obligations - payments made to local and state governments in the forms or property and income taxes, franchise payments, gross receipts taxes and other taxes and fees - have been estimated at $15 billion annually nationwide.9 Rigorous analysis of this issue may push the estimate much higher. Nebraska’s consumer-owned systems would include the $51.2 million in revenue transfers noted in Chapter 5, in addition to sales and use tax payments.

Potential Stranded Assets, Stranded Benefits and Stranded Obligations for Nebraska have not yet been estimated. Analysis of the amounts, types and methods of mitigation will be undertaken in Phase II of the L.R. 455 study, if appropriate.

6.5 BUNDLED OR MULTI-SERVICE DELIVERY

As discussion on competition in the electric industry has proceeded. A growing interest has surfaced in the provision of "bundled" or multi-service delivery to consumers. Such services commonly include both "wires" and energy services: cable television, telecommunications, natural gas, electricity as well as other services such as home security. The interest of suppliers extends in some eases to appliance and lawn care services. These services would be packaged and offered by a single supplier that may be part of a merged conglomerate, partnership or alliance. Many service providers consider this "bundled" or multi-service approach to be the leading arena in which electricity will be competitively bundled and sold.

In Nebraska, bundled or multi-service sales are in fact already taking place. Energy America is offering both natural gas and electric supply on a wholesale level. Panhandle Rural Electric Membership Association is offering Internet communication services along with retail electric supply. Basin Electric is providing both telephone and Internet services with wholesale electric supply. KN Energy, based in Lakewood, Colorado, is building on its retail natural gas market to offer a range of services in Nebraska including Internet, telephone, "infotainment" and appliance repair service. KN is co-marketing these services with DISH Network, a satellite entertainment company; Metricom, an Internet service provider; MaxServ, a home products repair service; Frontier, a long-distance telephone service; and DQE, an energy efficiency company for natural gas services.

As noted in Chapter 3, some types of consumer-owned systems are restricted by statute in the types of consumer services they might offer. During the 1997 legislative session, L.B. 506 was introduced to allow provision of natural gas and telecommunications services, along with electric supply by public power districts. However, the bill was indefinitely postponed by the Transportation Committee. It is also significant that a statutory prohibition on electric utilities operating as common carriers was repealed by the legislature in 1997.

The multi-service sales by private companies and consumer-owned systems, and proposals for broader participation in multi-service sales, indicate that competition in natural gas, cable television and telecommunications could increase the pressure for competition in retail electric service within the state.

6.6 TRANSITION FROM A REGULATED ENVIRONMENT
Summary of Emerging Issues

As may be noted in this summary discussion, a transition from the current industry market in Nebraska to a competitive market system would require some degree of change in the industry’s structure, its governance, its regulation, its operations and its tax and finance programs. The extent of change will depend upon the option or options chosen for Nebraska. The questions below summarize issues drawn from the foregoing assessment of the industry to be addressed in examination of options in Phase II of this study. They include both transitional and long term concerns.

(1) History and Public Policy issues

• What policy options and competitive market models would be available to the state?
• How would the basic principles of quality of service, reliability and low cost be affected by any given market option or model for generation, transmission and distribution?
• How would transitional issues under any given option affect the long-term structure being established?
• How would economic and noneconomic benefits for consumers be assured? How would reliability be assured? Would costs shift from large to small consumers? Would competition have varying impacts for urban and rural consumers?
• What role would consumers play in determinations about a competitive market system? What role would cities and towns play in determinations? What role would the legislature play? What role would the electric systems play?
• Would the legislature take a segmented or comprehensive approach to competition in retail electricity and other "wires" or energy services?

(2) Structure and Governance issues

• What would be the impact of any given market option or model for generation, transmission or distribution on the structure and governance of the Nebraska systems?
• What would be the impacts of any given option on the contracts, cooperative relationships and coordination of the individual systems?
• Would these competitive market system options assure lower rates and price stability for the long term?
• Would these options allow for continued opportunities for citizens to participate in policy making and rate setting at the local level?

(3) Statutory, regulatory and jurisdictional issues

• To what extent would alteration in structure require changes in the statutory and regulatory framework? For generation? For transmission? For distribution?
• To what extent will MAPP policies and practices alter the operations and options of the Nebraska systems?
• To what extent will FERC policies and decisions alter the operations and options of Nebraska systems?
• What would be the roles and jurisdictional authorities of the legislature and gate regulatory and planning bodies, such as the Power Review Board?
• What would be the extent of state or local jurisdiction over out-of-state power suppliers and marketers?
• Who would have responsibility for fundamental requirements for universal service, obligation to serve all consumers, and protection of low-income consumers who may not be desirable to competitive power marketers?

(4) Planning and Operations issues

• What would the impact of any given option be on the electric facilities within the state?
• Who will plan, construct and operate generating plants?
• What will the effects be on hydro production and irrigation?
• How will adequacy of capacity be assured in a competitive rather than cooperative planning framework?
• Will there be a consumer-owned pool or sub-pool?
• Will there be both wholesale and retail competition?
• Who will plan, construct and operate transmission facilities?
• Who will monitor and document reliability and set and oversee reliability standards?
• What impact will MAPP policies and requirements have on Nebraska transmission?
• Who will operate and maintain distribution facilities?
• Who will be responsible for line extensions and at what cost to consumers?
• What part of distribution functions will be competitive, if any?
• How will record-keeping and documentation be conducted?
• Who will be the provider of last resort?
• What will be the extent of joint planning to assure efficient operations and delivery of service?
• In the absence of forecasting, how will power supply be assured and at what cost?
• How will efficiency measures and DSM be advanced?
• How will environmental protection be maintained and advanced?
• How will renewable energy development be advanced?
• How will technology development be advanced?
• What will be the impacts on the work force and safety?
• What will be the impacts on effectiveness of service delivery and cost to consumers?

(5) Finance and Tax issues

• Without a guaranteed customer base and revenue stream, how would public power systems utilize revenue bonds to finance future debt? Or will all future financing come from taxable debt or internal funds? How would this affect operational capability and rates?
• Given the variance in the financial positions of the diverse systems, what would be the range of impacts, or significant individual impacts of a competitive retail market?
• How will the IRS resolve the private-use restrictions on tax exempt debt financed generation and transmission?
• How will consumer-owned systems comply with FERC open access requirements for transmission service, especially in light of private-use restrictions that may apply to transmission facilities?
• How will private-use restrictions impact consumer-owned system participation in ISOs containing investor, consumer and privately owned utilities and organizations?
• What would be the impacts of consumer-owned systems using taxable debt for participation in competitive, non-traditional energy services, telecommunications and other business growth areas within and outside currently assigned service areas?
• What would be the most beneficial process for stranded-cost recovery treatment for consumer-owned utility assets and debt in the transition to a retail competition environment, if retail competition is to be implemented?
• What would be the impact on revenue transfers of expanded FERC jurisdiction into traditional state jurisdictional areas in regards to rate setting and taxation?
• What would be the state and local tax implications as part of stranded obligations and what mitigation processes might be used?

(6) Deregulation and Restructuring issues:

• Given the progress of retail competition legislation in other states, should Nebraska consider retail competition, and how, and on what schedule would such a process would be implemented in view of the consumer-owned utility structure, operations and finance in existence?
• What are the primary transitional issues related to any given competitive market option?
• What is the extent of FERC jurisdiction over Nebraska’s consumer-owned utilities and the impact current and future FERC orders will have on Nebraska’s transmission operations?
• What would be the measure and methods of mitigation and recovery for stranded costs, stranded obligations and stranded benefits? What would FERC’s role be in this recovery?
• What are the implications of consumer-owned system participation in the MAPP ISO?
• What institutional mechanisms and regulatory measures would the state need to establish resolve and protect against market power problem?
• Given the recent trend in mergers between investor owned utilities for purposes of cost reduction and efficiency, would consumer-owned utilities benefit from increased mergers, alliances and other related cooperative efforts?
• What are the competitive pressures arising at the federal, regional and intrastate levels?

Chapter One - HISTORY
Chapter Two - STRUCTURE AND GOVERNANCE
Chapter Three - STATUTORY AND REGULATORY OVERSIGHT
Chapter Four - PLANNING AND OPERATIONS
Chapter Five - FINANCE AND TAX
Chapter Notes
Glossary