Welcome to High-Cost


September 2006

by Timothy Capps


The Maryland Public Service Commission (PSC) was instituted in 1910 with the mission of regulating the electric utilities of the day as well as certain types of transportation systems. It has continued to function in that role for nearly a century, although its focus is now on state utility operations, transportation regulation having shifted over the years to other agencies at the state and federal levels.

During the nine-plus decades since the PSC was created, much has changed in the utility and energy world. Population growth has expanded the demand for electrical and gas services exponentially, and the shape of the industry that supplies power to residential and business consumers has changed dramatically. That industry is now dominated by very large companies that, until recently, enjoyed virtual monopoly status in return for operating in a regulated environment that effectively controlled their pricing policies while making certain that they faced minimal – if any – competition.

Bye-bye, ‘Bad Hair Days’
Here in Maryland, as else- where in America, it was a neat quid pro quo that assured consumers of a ready supply of
something essential to everyday living and the conduct of business: energy to keep the lights on, the air conditioning running, the heat pumping, the water running. For better or worse, our society has become extremely energy dependent, with the basic necessities of life built around having a reliable flow of electricity in one’s home, office, or other place of business or recreation. Sure, our great-great grandparents lived without
electricity, or gas operated vehicles for that matter, but every day was a bad hair day for them and their neighbors.

The public utilities industry grew as the nation grew, building generating plants and the connective capacity to deliver
electricity and/or natural gas into homes and businesses. This was typically done under the umbrella of a regulatory agency
that oversaw rates, approved permits for new generating or distribution capacity, and determined rates of return for these
monopolistic businesses so that they could earn a profit for their shareholders without unduly charging their customers for what was an increasingly necessary product.

Things of course got more complicated as
America sprawled. There were increasing demands for utility services from remote rural areas to megalopolises and the
country became more pollution conscious, which influenced the building of generating capacity and the types of fuels used to run those plants. We went through a nuclear phase in the 1950s and
‘60s, when the clean-burning aspects of nuclear power were paramount in deciding how to supply generation needs. Then came Three Mile Island, and
suddenly, there was no more appetite for permitting new nuclear facilities. In fact, two major East Coast utilities ended up in
bankruptcy because of their inability to get approval to operate completed nuclear power plants (whose construction costs still had to be paid).

Then, with nuclear energy placed on a remote back burner and rising concerns
over the pollution coming from coal-fired
generating plants, came the enormous rise in oil-based petroleum products as major oil-producing nations in the Middle
East and elsewhere starting controlling the output and pricing of crude oil. The era of cheap energy was over, noted by consumers in both the price of gasoline and their monthly utility bills. At the same time, demand for power has continued to rise in both the United States and world- wide – especially in countries like India and China, whose vast populations and economic evolutions into high volume
industrial production has made them increasingly energy-intensive and dependent upon foreign produced oil.

All these factors meant that the day when economies could be built and sustained by seemingly limitless supplies of cheap,
fossil-based fuels was a pleasant memory.

Enter ‘De-Reg’
Deregulation of public service industries in the United States was arguably energized by the conclusion of the anti-trust case that led to the break-up of American Telephone and Telegraph Corporation (AT&T). In that case, there was a shake-out period in which consumers got very confused by the competing claims of people who wanted their long distance business and maybe their local business, then started offering cellular service, and now internet connections and voice internet and interactive video, etc., etc.

It isn’t clear whether we’re paying more or less for phone service these days, but we certainly have far more communications options available than ever before and there has been a faster evolution in communications technology since the
AT&T break-up than in all of human history.

Next came the deregulation of the cable television industry, with results that, thus far, have been almost the opposite of what occurred in the telecommunications business. The much-anticipated competition in the cable market has not really materialized, since the logical competitors for cable service – such as the telephone companies and internet service providers – have been slow to venture into that world. The cost of entry into that business is still steep and the technology is still evolving, so we are just now beginning to see major telecomm
operators like Verizon and Cingular edging into cable competition against the Comcasts and Cox Communications of
the world. From the consumers’ standpoint, deregulation of cable rates has only meant steadily increasing bills with no signs of improved service or more entertainment options to offset those higher charges.

In this atmosphere – with deregulation the “next new thing” – a number of utility operators began to think about the pos-
sibilities of a deregulated marketplace for suppliers of power services. Buffeted by what they regarded as an antiquated regulatory environment, not to mention environmental demands, unpredictable fuel supplies, and volatile demand cycles, many concluded that they would be
better off crafting some form of deregulation that would allow them to compete in markets beyond their traditional service areas.

To accomplish this, they would need to convince regulators and, more importantly, elected officials, that deregulation would lead to greater com-
petition and therefore more options for customers and, theoretically, price flexibility. In various states, “de-reg” became the latest and greatest effort to shift a historically regulated industry into a market-driven mode. The utility providers
were tired of being perceived as stodgy, conservatively run companies dependent upon the political whims of their jurisdictions for their sustenance. They wanted the opportunity to spread their wings and fly, to become growth stocks instead of “carriage trade” investments.

Seven-Year Sleep
“De-reg” came to Maryland in 1999, when, after a couple of years of considering how to craft a business and regulatory model that would work for both the utilities and consumers, the legislature passed a bill to deregulate the state’s utility services.

The legislation was certainly not universally popular, and it was widely recognized that Maryland was about to tread uncharted waters. As a failsafe of sorts, the legislation, which was supported and heavily influenced by Baltimore Gas & Electric (BG & E), Potomac Electric Power Company (PEPCO), Allegany Power, and other power suppliers in the state, included a provision that kept rates capped until July 1, 2006, at which time they would be allowed to “float” to market prices.

BG & E made the decision to split into a holding company, Constellation Energy, and an operating company or retailer,
BG & E. Constellation would be the owner of the real estate assets of the company – specifically the generating plants and
distribution network – while BG & E would maintain the sales and service structure. From the consumer standpoint, nothing seemed to have changed, and no one was talking about the looming deadline in the summer of ‘06. Meanwhile, across the country, one of the effects of deregulation was the steady increase in mergers (often complicated by the schizophrenic nature of the deregulatory process) of utility companies. For the first time since the Great Depression, utilities were casting their nets across state lines, much like banks have done since the ‘80s. In 2005,
following the industry trend, Constellation
Energy announced a merger with FPL, the holding company that owns Florida Power & Light.

That announcement caused some uneasiness among consumer advocates and eventually opened up the conversation about the looming rate increases, which suddenly seemed to
emerge from nowhere in January of 2006. It was as if somebody had awakened from a seven-year sleep and said, “Gee, we better tell everybody what’s coming,
then get out of Dodge ‘til the shooting stops.”

It was, in a sense, a perfect storm about to happen. PEPCO’s rate caps had been eliminated in 2004 and the consequent rate increases were not monumental.
BG & E, however, would be a different story, in part because the price of their raw materials, oil in particular, had increased so significantly over the past year – especially after the hurricanes that hammered the Gulf Coast at the end of last summer and the ever-present crisis in the Middle East.

At that point, it became clearer to both PSC members and staff (as well as the utility companies) that rates would have to go up significantly in 2006 – 72% in the case of the typical BG & E customer. Then, BG & E announced the FPL merger and acknowledged that those extreme rate hikes were beyond the point of speculation; they were really going to happen. The merger wasn’t really tied to the new, market-based rate structure, but it was impossible to disassociate the two in the minds of shocked and angry consumers. It looked like capitalism run amok, even if logic said otherwise.

Rhetoric and Posturing
The legislature then jumped into the fray with all its collective feet, saying all the right things for consumer consumption and offering a potpourri of bills that ranged from efforts to extend rate caps to halting the merger to eviscerating the PSC to finding a means to dampen the rate increases.

The governor, while expressing concern about the degree of the rate increases and their impact on lower-income families,
essentially supported the “dereg” concept and said that there should never have been rate caps and that if the market had been allowed to work its magic, rates would have risen but in a much more palatable way. Legislators who had voted against “de-reg” in 1999 were saying, “I told you so,” and most Republican leg- islators were lying low because the ones who had been around in ‘99 had generally supported the idea. continued

The bottom line: There was plenty of rhetoric and finger pointing and posturing about consumer protection, but most
legislators realized, as did the governor, that there was no practical way to put the “de-reg” genie back in the bottle.

However, it is an election year, and everybody needed a “de-reg” story to take back home. So legislation was passed to phase in the new rates and fire the PSC, with a new PSC to be appointed
by the legislative leadership. The governor vetoed those bills and “de-reg” was left in limbo for a few weeks. A suit challenging the PSC’s rate decisions was
filed in Baltimore City Circuit Court, and a judge ruled that the PSC needed to re-open its deliberations, a notion grudgingly
accepted by the PSC with the sense that whatever revised rate plan it devised would not look much different from its old one.

This was followed by a special session of the legislature called by the president of the Senate and the speaker of the House.
This resulted in the passage of an emergency bill that was almost identical to the bills passed in the regular session, combined in one 50-page legislative tome. If you really want to, you can go
the Maryland General Assembly’s website and pull up Senate Bill 1, then read the entire thing, which gets pretty complicated very quickly unless you are familiar with existing utility industry statutory and regulatory law. In a nutshell, it did two things: It put into place a requirement to allow consumers options that would phase in the rate increases over 18 months (so-called rate stabilization);
and it fired the PSC, replacing it with a legislatively appointed group.

The rate story is still confusing, but you shouldn’t be seeing those high double-digit increases at this point, unless you
opt to pay them now instead of dribbling them out. Either way, you’ll pay for the full rate increase within an 18-month period, and it is unlikely you will see those rates go down as long as our society is heavily dependent upon fossil fuel-based energy.

Political Power Grab

The PSC? Well, that’s another story.

Anticipating that the firing of the PSC would not be well received either by the PSC members or the Ehrlich administration, the legislature wrote into the new statute a provision that required any suit over the changes in the PSC appointments process to be filed in Baltimore City Circuit Court, presumably
because that court would likely be more favorably disposed toward the legislative majority’s views of recent PSC behavior.

The expected suit was duly filed by PSC Chairman Ken Schisler, who was joined by most of his fellow commissioners, and
is now in the hands of the circuit court, whose ruling could come at any time (although it might not occur until mid- or
late fall). The basic argument is over whether or not the legislature exceeded its constitutional authority in firing gubernatorial appointees and setting up a
procedure to wrest away from the governor all future appointments to the PSC.

Stripping away all the intellectual arguments, was this a power grab? Absolutely. Was it warranted? Depends on whose ox is being gored. Is it legal? It
will probably be awhile before the courts reach a final conclusion on that
(meaning when all appeals have been exhausted).

What does all this mean to you, the consumer?

Well, on the utility front, it means you need to get used to the idea of living in a quasi-de-regulated world.

Whatever the experience with utility deregulation in various states, the need to change the status quo in the world of power production was evident by the
early ‘90s, so there was an inevitability to the process, if not the execution. Could things have been done differently? Un-
doubtedly, especially in the area of public education and information.

What is clear at this point is that BG & E, PEPCO, Allegany Power and other Mary-
land utilities will be buying their power from a number of sources in the future, and will be much more subject to the whims of the marketplace than ever be-
fore. That means they will have to be more nimble than in the past, and one has to hope that the market for both energy raw materials and production and
distribution capacity reaches a rational equilibrium level, an uncertain proposition in a global economy.

Meanwhile, there are efforts underway in Maryland – including a handful in the agricultural community – to develop alter-
native sources of power generation utilizing agricultural and forestry by-
products to generate electricity that can be used by the producers and sold to the
distribution companies. Though none of this is meaningful at the moment, it will become more so as the price of energy continues to climb. This is certainly an area where government could lend a
boost by providing tax incentives or facilitating loans to assist fledgling start-ups and technology development.

If you ever had any doubts about the need to be alert and active on the political front, those should be put aside forever.

Editor’s Note: Timothy Capps is the former executive vice president of the Maryland Jockey Club and, before that, the Maryland Horse Breeders Association. He is currently working as a consultant in the industry.



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