Corridors of Power

If you are over a "certain age," you probably grew up in a world in which you and your family had little or no choice of utility companies. Whether it was the local electric company, the local natural gas company or the local water utility, you simply paid your money and did not have a choice. It was a world that resembled Henry Ford’s famous comment about the Model T, that "The customer can have any color of car that he wants, as long as it is black."

Let’s recall the olden days of electric power, for example. Your local utility company probably ran the whole show by virtue of a government-granted license. In other words, the utility company was a monopoly, but it also had the obligation to serve every entity that required its services. (At the consumer and customer end of things, the final demand for power is called the "load.")

Under that arrangement, the local electric utility owned and operated the generating station just outside of town, or certainly within the region where you lived, and it owned and maintained the transmission towers that led from the powerhouses to the load. That utility company also owned the substations where the high-voltage power was stepped down into the street grid, of which it owned the poles and wires. And your friendly local electric utility company probably even owned the usage meter on the side of your house.

There was also a state regulatory agency, probably called the "Public Utilities Commission" or something similar. The PUC reviewed whatever documents the well-connected attorneys for the utility company placed before it, and almost always rubberstamped whatever the utility company requested.

Thus did the PUC set the rates you were charged, according to the revenue needs of the utility company. And really, when you think back, about the only part of the electric grid over which you had any individual say may have been the wiring inside your home (subject to the local electric code, of course) and the wattage of the light bulb in your bedroom.

Things Have Changed

Things are certainly different now, aren’t they? If you live in or near a major urban market area, you probably receive frequent notices in the mail containing offers from companies of which you have never heard offering to sell you utility services such as "renewable" electricity. If you have read your local newspaper business section over the years, you have probably noticed that the utility company has sold its generating stations to some third party, again a firm of which you have never heard. And you may have seen that the utility company has sold the transmission towers to some other entity whose name you cannot recognize. The local utility may still maintain the street grid, but then again, maybe not. Every month, you may still receive a bill from the old utility company. But your bill probably contains all sorts of charges broken out for fuel or basic generating costs, plus transmission, and perhaps a "delivery" charge payable to companies with strange names, as well as a myriad of taxes and local fees. What is going on?

Welcome to Deregulation and Competition

Welcome to the world of free market energy competition. This intellectual paradigm took root in U.S. public policy in a big way in the late 1970s. One of the leading lights of this movement was the economist Alfred Kahn of Cornell University, who earned his stripes as chairman of the New York Public Service Commission (New York’s PUC), and later as chairman of the federal Civil Aeronautics Board in 1977-1978 under President Jimmy Carter. It was Commissioner Kahn who set a national example with airline deregulation and increased competition with his efforts to deregulate airlines.

Deregulation is a political process in which the government removes or simplifies restrictions on businesses in order to encourage increased efficiency in the operation of market mechanisms. In other words, goes the rationale, deregulation means that fewer and simpler regulations will yield an increased level of competitiveness, with higher productivity, more efficiency and overall lower prices. Deregulation is not a uniquely American idea, by the way. During the past three decades, the concept has been applied, with varying degrees of success, in nations as diverse as Australia and Japan, the United Kingdom and Argentina, the European Union and even post-Soviet Russia.

Alfred Kahn’s initial focus on airline deregulation spread to other parts of the economy as well, particularly in the realm of transportation, such as railroads and motor freight trucking. The initial results were that under deregulation, literally hundreds of railroads and many thousands of trucking companies either went out of business or were forced by circumstances to combine with other firms via bankruptcy, asset sales and other forms of merger. And the results also included a large number of new entrants to the marketplace, to include companies like Federal Express (now FedEx), whose ubiquitous trucks would never have seen the light of day under the old, heavily regulated transportation system.

Living in a Different World

To make a long story short, by the 1990s, deregulation was occurring in the arenas of utility services, as well. This is when the old-time utility companies began to transform by selling off assets such as generating plants, transmission lines, wholesale distribution networks and even the "final mile" of distribution wires, if not the meter on the side of your house. If the name on your local utility bill looks like the familiar one with which you grew up, it may well be because some third party bought the right to use that name. From the standpoint of who owns what, you are now living in a different world.

I am using the story of deregulation in general, and what has happened to your old and faithful electric utility company in particular, to illustrate the point of how much and how dramatically things have changed on the other side of the light switch. I could tell a somewhat similar story about your natural gas utility, or the water utility company. Most people do not know or appreciate the scope of this change, and I want to use this discussion to lay some foundation that leads into the remainder of this article. This major transformation in the structure of the energy markets in the U.S., courtesy of the deregulation philosophy and the associated decoupling of different phases of generation, transmission and distribution to load, gives us at Outstanding Investments an opportunity that I will present later on.

Transmission and Transportation

In the energy delivery industry, and certainly in the electricity and natural gas sectors, the transmission system has become a critical market-enabling mechanism. That is, transmission functions in much the same way as the interstate highway system, if not as those oceangoing freighter ships that bring foreign-made goods to U.S. shores.

Think about that last analogy of the oceangoing ships. What makes a factory in China truly competitive with a factory in the U.S. that can make a similar product? Does a Chinese injection mold operator have a better education than an American injection mold operator? Maybe not, but then again, consider how much TV the American worker has probably watched over the years. Or is it those proverbial "Every Day Low" sweatshop wages that they pay in China? OK, we are getting closer to an answer. Or perhaps it is because the Chinese factory spews a toxic brew into the adjacent air and water, in such a manner that would get the U.S. factory padlocked and its managers frog walked by the bunny cops down to the local jailhouse. Yes, of course, this matters in the broad scheme of things.

These Chinese competitive advantages, and many more that you could recite, do matter to one degree or another. But my view is that what truly makes Chinese factories competitive is the ability to transport the goods so cheaply across the Pacific Ocean, in containers that are then rapidly unloaded and shipped, via "deregulated" rail and truck, almost to the point of sale. Cheap transport effectively puts the factory in China right next to the factory in the U.S.

Transmission and Corridors

It is the same thing with energy transmission as with oceangoing transportation. A well-managed transmission system is the key to enabling robust and competitive energy markets that offer customers choice, savings and related benefits.

Do you recall how we began this article? We looked back to the olden days when the utility company owned the power plant just outside of town. This is probably no longer the case where you live. So do you really know from where comes your electricity?

If you live in California, some of your electricity may come from New Mexico, if not British Columbia. If you live in Ohio, some of your electricity may come from Ontario, or even Quebec. If you live in New Jersey, some of your electricity may come from a plant in western Maryland. Or consider that one of the largest generators of wind-powered electricity in the U.S., for example, is Florida Power and Light, and many of its windmills are located in — are you ready? — North Dakota. Last time I looked, Florida is a long way from North Dakota.

What makes this all possible is the creation of long-distance transmission corridors, over which electric power is moved, or "wheeled," from one region to another. No, the North Dakota electricity does not go all the way to Florida. But the North Dakota electricity might go to Illinois, and electricity from Illinois might go to Alabama, and electricity from Alabama might power homes in Florida. How do you calculate the electricity rates for Florida consumers, and who should get paid how much at each step of the way along the transmission corridor? It gets complicated in a hurry.

And why is FPL building windmills in North Dakota? For starters, it is just too hard to build new power plants in Florida, both despite and because of the fast-growing population, which adds more load and demands more and more electricity each year. Think about it. What community in Florida wants a new large power plant with a tall stack and thousands of rail cars passing by, hauling coal to the facility? And what electricity consumers in Florida want to pay what it costs to run a natural gas-fired power turbine just to generate base load electricity? "Not in my backyard," goes the cry.

Or consider what happens to aging power plants, such as the pulverized coal units with the 600-foot-tall smokestacks of the old-fashioned utility company, when these industrial behemoths are ready for retirement. Can anyone, even the local electric utility company, consider replacing an older plant if it is located near an urban or near-suburban core? As a rule, many among the locals cannot wait to hear that some plant operator wants to decommission an old coal-burner near the city. "Goodbye and good riddance" is the typical sentiment. And nobody wants a new power plant to get built nearby, either, so the tendency is for power generators is to construct new generating facilities out in rural areas far from the urban NIMBYs and their lawsuits.

But developing energy facilities far from load centers requires construction of transmission lines over transmission corridors. Whether it is a new, higher-tech version of the old coal-burner or windmills out on the High Plains (or maybe even a new nuclear plant, one of these days), the problem of transmitting that power along a new transmission corridor from generation site to place of load is instantly presented. And just to add another layer of perplexity to the process, which comes first – building the generation or building the transmission? If you thought that building a new power plant in any one location was tough going, just try building a transmission line that crosses many jurisdictions, each filled with its local species of NIMBYs.

In the arena of renewable energy sources, one critical issue for wind farm construction is that installed capacity in some regions is outstripping producers’ ability to move the wind power from relatively remote areas to load centers in other areas. This affects market prices in a significant way, because the cost of installing and upgrading transmission lines to deliver the generation must be factored into the final consumer price.

Transmission constraints in West Texas, for example, have negatively impacted operations of numerous wind farms in that area. Thus, wind power generation in that region has been routinely curtailed to prevent overloading the local transmission system. This has resulted in losses of many millions of dollars per year of electric power sales. Texas generators and regulators are addressing the situation by upgrading existing facilities and constructing additional transmission facilities for high-voltage power.

Looking for Solutions

New Mexico has similar problems and has recently adopted its own solution. That state enacted legislation that will create the New Mexico Renewable Energy Transmission Authority, a quasi-governmental agency that will plan, finance, acquire and build power lines and energy storage projects. The Authority will have power to designate transmission corridors and to negotiate with other entities on the establishment of interstate corridors. It will be able to use eminent domain authority to help get projects built.

Another state, Wyoming, also has a transmission authority that likewise is intended to help transmit and export electricity produced by state’s energy resources.

The Role of Transmission

The points to keep in mind are that transmission is a critical link, and, in fact, may well be THE critical link, to enable competition between local and distant producers.

Now, can we make some money out of this? In the next article, we will apply some of these principles to growing our principal.

Until we meet again…
Byron W. King

April 13, 2007

The Daily Reckoning