Abstract
The Public Utility Regulatory Policies Act (PURPA) of 1978 contributed to the restructuring the American electric utility system. It did so by providing incentives for nonutility companies to produce power using energy-efficient generating equipment and renewable-energy resources. By making electricity as cheaply as existing utilities in many cases, the new power companies injected competition into a formerly said, monopolistic industry. The law’s unintentional consequences motivated policy makers to consider the value of introducing other free-market principles, some of which became elements of the Energy Policy Act of 1992.
INTRODUCTION
As one part of President Jimmy Carter’s comprehensive energy strategy, the Public Utility Regulatory Policies Act (PURPA) of 1978 sought to encourage the efficient use of electricity and stimulate the production of power in nontraditional ways. For the first time, PURPA gave special privileges to nonutility companies that produced electricity using fossil fuels less wastefully than utilities and to firms that employed renewable resources. In the process, the law removed barriers that had previously hindered entry into the generation sector of the power business.
More important, some of the new nonutility producers sold electricity at prices that compared favorably to those offered by regulated power companies. By doing so, they challenged the status of utility companies as natural monopolies—companies that deserved special privileges because they could deliver services more cheaply and efficiently only if they remained in a noncompetitive business environment. The law’s implementation further helped spur the introduction of free-market principles, and it forced some policy makers to reconsider the merits of traditional regulation. It, therefore, played a major role in efforts that led to deregulation and restructuring of the American electric utility system.
ORIGIN OF LAW DURING THE ENERGY CRISIS
Even though the so-called energy crisis had occurred more than 2 years earlier, newly inaugurated President Jimmy Carter felt much needed to be done to fix America’s energy infrastructure.1-1-1 He recalled how Arab members of the Organization of Petroleum Exporting Countries had imposed an embargo on the shipment of oil to the United States and other countries that supported Israel in its October 1973 war. After the embargo, oil flowed again, but at greatly increased prices that wreaked havoc on the economy and everyday life. Automobile drivers, who had grown accustomed to cheap and easily available gasoline found themselves on long lines for expensive and sometimes rationed fuel. Fortunately for these consumers, the lines disappeared fairly quickly, though gasoline did not return to preembargo prices. The next 2 years saw relatively stable prices for all energy supplies, and many Americans became complacent about energy policy. But President Carter worried about the increasing amount of imported petroleum being used by the United States— rising from 36% in 1973 to 42% in 1976. As his first major initiative after taking office in January 1977, Carter promoted an energy policy that would make the country more energy efficient and less dependent on foreign fuel.
Hoping to rally Americans to fight a “moral equivalent of war,” Carter sought to win support for his National Energy Plan. The plan offered tax credits to people who employed energy-efficiency measures in homes and businesses, realizing that conservation was “the quickest, cheapest, most practical source of energy.”[2] It also included a set of taxes on those who wasted energy, such as owners of gas-guzzling cars that failed to meet fuel-economy standards. Another proposed tax would have added 5 cents to the price of a gallon of gasoline each year that total gasoline consumption exceeded government-established goals. Additionally, Carter sought to remove price controls on oil and natural gas, which would have allowed the fuels to become more expensive and which would have encouraged users to be more efficient due to economic self interest. He also proposed new measures to spur nuclear power and the use of domestic coal rather than imported oil.
Though legislators may have lauded the president’s goals, they proved unwilling to accept all the president’s measures, especially those that would have called for potential sacrifice and hardship for their constituents. Instead, they took more than a year to ponder the president’s plan and passed a watered-down version of it in the form of five specific laws. At a signing ceremony in November 1978, Carter admitted that the laws did not accomplish everything he had hoped. Nevertheless, they constituted a first step toward a more sound energy policy.
FOCUS OF LAW
Of the five weakened measures, the PURPA had already been viewed as the least consequential. Consisting of 61 pages of text and 78 sections, the law focused on encouraging greater efficiency in the use of electricity.[3] It did so by calling attention to the way electric utility companies charged customers for electricity. Consequently, industry insiders earlier referred to it as the “rate reform” bill. Typically, customers (especially residential customers) paid higher prices per unit of electricity (a kilowatt-hour, or kWh) for the first increment of energy they used each month. This greater cost generally included a large amount of the fixed customer and capital costs associated with the production and distribution of electricity. Subsequent increments cost less per kilowatt-hour, representing only the cost of energy needed to generate the power. This “declining block” rate structure had been used for decades and was popular because it often encouraged customers to use more power, since later increments became relatively cheap. During an age of declining costs for the power industry—an age that lasted from the beginning of the twentieth century until around 1970—the rate structure made perfect sense. But with energy prices increasing, PURPA required utilities and state regulators to reconsider (but not necessarily replace) these rate structures and design new ones that encouraged wise use of electricity. Lobbyists for the utility industry viewed the law as tame, since it did not mandate too much change from the status quo.
SECTION 210
With PURPA’s focus on rate reform and with concerns over more severe provisions of other laws that came out of the National Energy Plan (such as the requirement to shift from oil and natural gas to coal for producing power), utility executives and lobbyists paid little attention to the apparently inconsequential Section 210 of PURPA. Dealing with production of power from small-scale generators, the section reflected President Carter’s hopes to produce more electricity through unconventional means, thus reducing the amount of oil, coal, or natural gas needed by traditional utilities to make electricity. As one promising approach, a cogeneration facility looked like a tiny utility power plant, but with a twist. It heated water using fossil fuels, and the steam went through a turbine that turned a generator, which then produced power. Instead of venting the waste heat into the environment, like utilities did, a cogeneration plant employed the heat for industrial processes (such as for manufacturing paper or chemicals) or for space conditioning. It, therefore, achieved a higher efficiency of converting raw fuel into economically valuable products. (Basically, cogeneration won double duty from fuel.) An old process, being common in the United States early in the twentieth century, cogeneration lost favor, as utilities found they could exploit economies of scale and produce cheap, central station power for industrial customers. With the new need to improve energy efficiency in light of the energy crisis, President Carter wanted to see a resurgence of cogeneration technology.
Public Utility Regulatory Policies Act’s Section 210 provided the means by which cogeneration would become more practical. For example, it eliminated the major impediment for cogenerating firms by requiring utility companies to purchase excess power from the nonutilities. Implemented by state regulatory authorities, this requirement gave industrial companies an incentive to install equipment that produced process steam and electricity. The firms would use some of the power themselves, but they could also sell surplus electricity (produced more efficiently than utilities) to power companies, which would then distribute it over their grid to customers. Previously, if nonutility companies wanted to sell excess electricity, utilities had no obligation to purchase it, and they often offered low rates to sellers. Now, PURPA required utilities to buy the electricity at a rate that equaled the utilities’ cost of producing the power themselves.
This section of PURPA also contained similar incentives for companies and individuals that wanted to produce power from renewable sources of energy. These sources typically used the movement of water in rivers, the flow of air, and the effect of sunlight to produce electricity in ways that did not require the combustion of fossil fuels. Research and development on water turbines, wind turbines, and solar-electricity conversion technologies had been going on slowly for decades, and the 1973 energy crisis provided a spur. But provisions in PURPA gave these efforts more momentum because they created a guaranteed market for the electricity produced by these nontraditional generating technologies.
IMPLEMENTATION OF THE LAW
Implementation of PURPA became a job first of the Federal Energy Regulatory Commission (FERC). Under the terms of the law, FERC needed to hold hearings and codify parts of the law for the country’s regulatory commissions to employ when dealing with the new, privileged nonutility generators, known as qualifying facilities (QFs). In most cases, FERC chose to interpret elements of “Section 210″ in ways that benefited these companies. It relaxed administrative procedures so the nontraditional power firms would not be subject to the same government oversight as regulated utilities. Federal Energy Regulatory Commission also interpreted the law liberally so cogenerators and renewable energy generators earned relatively high rates for the power they produced. Overall, FERC sought to encourage these new firms with as many incentives as possible.[4]
After completion of this review process—as well as two U.S. Supreme Court decisions that maintained FERC’s interpretations—PURPA found its way to the states, where public utility commissions defined how the law would be put into practice. In most cases, implementation of PURPA did not elicit much excitement. However, in California, the law became one tool in the state’s efforts to obtain environmentally sound electricity supplies. Moreover, energy efficiency and renewable energy fit nicely into the political agenda of Governor Jerry Brown, who took office in 1975, and to several of the activist members of the California Public Utilities Commission (CPUC) appointed by the unconventional chief executive.
The CPUC sought to make it easy for QFs to deal with utilities by designing “standard offer” contracts that contained the relevant terms and conditions for the producers and buyers of power. To provide flexibility to the QFs, the CPUC designed several standard offers, with the interim Standard Offer 4 becoming popular after its issuance in 1983. This contract provided for per-kilowatt hour payments from utilities that rose over the first 10 years of a 15-30 year contract period. The rising prices were designed to keep track of the cost of energy, which analysts believed would continue increasing during the 1980s. Moreover, the long-term contracts offered certainty to the fledgling nonutility companies and allowed them to obtain financing more easily from investors. Because of these generous provisions—especially the escalating prices that contrasted the declining price of energy in 1984 and later—scores of nonutility generating companies signed up for the interim contracts, promising to build as much as 15,000 MW of capacity. Though the companies suffered no penalties if they failed to live up to their promises, regulators realized that they could see a glut of unused capacity if they allowed more companies to accept this offer. Consequently, the CPUC suspended it in 1985 and developed other standard offer contracts for nonutility developers. Nevertheless, those firms that had obtained the Standard Offer 4 contract could still take advantage of its lucrative terms.[5]
SPUR FOR TECHNOLOGICAL INNOVATION
Combined with tax incentives offered to small power producers by federal and state governments, PURPA accomplished its goal of spurring innovation in several technologies. Cogeneration technology had roots that went back to the early 1900s, but the law encouraged manufacturing companies to make improvements in it to exceed requirements to obtain at least 42.5%-45% thermal efficiencies. (Utility power plants typically converted only about 35% of raw fuel into electricity.) More important, perhaps, manufacturers exploited mass production techniques for several of the cogeneration plants’ components, allowing construction of a plant for between $800 and $1200/kW in 1986. This capital cost compared favorably to utility costs for traditional fossil fuel and nuclear plants, which cost between about $900 and $5000/ kW in 1984. And despite the lack of economies of scale, something that utilities prized in their huge plants, the cogenerating companies produced two salable products— electricity and heat—which enabled them to earn money while simultaneously meeting PURPA’s goal of producing electricity in a more efficient fashion. Not surprisingly, cogeneration took off, making up 56% of all nonutility produced power in California in 1990 and 59% of nonutility power capacity nationwide in 1991. By 1992, almost 40,700 MW of the country’s capacity came from cogeneration sources, up from 10,500 MW in 1979. In short, PURPA stimulated a new segment of the electric power business, as companies, such as Cogentrix, AES Corporation, and affiliates of Bechtel Power, General Electric, Mobil Oil, and Destech Energy, exploited the law’s provisions.
Public Utility Regulatory Policies Act also stimulated the use of gas turbines used for making electricity. This technology had a long heritage, used for turning generators and producing electricity during peak usage times. But the small turbines (usually rated from 10 to 25 MW) had a reputation for poor reliability and low fuel efficiency. During the 1980s, however, research on gas turbines expanded, largely because of funding from the U.S. Department of Defense, which wanted smaller and more energy-efficient gas turbines for use in military aircraft. Manufacturers of these aeronautical turbines, such as General Electric, shrewdly realized that the technology could easily be transferred for stationary use in power plants, and they produced improved turbines for this application. To employ the turbines in the manner sanctioned by PURPA, manufacturers created systems that recovered energy produced from the gas engine’s exhaust and reused it to heat water in a conventional steam turbine generator. These “combined cycle” units reached thermal efficiencies of > 40% in the 1980s. Small and easy to install, these units also gained popularity in the mid-to-late 1980s, when the price of natural gas declined. At the end of 1992, nonutility companies employed gas turbines to provide almost 39% of their capacity. The cost of their delivered electricity ranged from about 3.2 to 5.5 cents/kWh, comparing favorably to the average cost of power produced by regulated power companies.
Beyond these more traditional technologies, wind turbine technology developed rapidly as a result of PURPA. Though used for pumping water and for producing small amounts of electricity on farms for decades, wind turbine technology had previously not been exploited to produce enough power for distribution by electric utilities. After the energy crisis, the federal government spent heavily to produce large wind turbines for utility use—some as large as 3.2 MW each—but the hardware failed. Much more successfully, entrepreneurs working under the impetus of PURPA fashioned smaller turbines (between 0.05 and 0.5 MW) to use in clusters, with the aggregated electricity sold to power companies. Some components of the small turbines could be mass produced or adapted from other applications, thus allowing the wind companies to pare costs. And because of the beneficial terms of California’s standard offer contracts, many wind firms took root in the Golden State, even though wind resources may have been better in other parts of the country. Wind powered generation increased dramatically in California, rising from 50 million kWh produced in 1983 to 3268 million kWh generated in 1994.[6] Research and development in the technology continued, such that the technology in 2005 produces power at costs comparable to fossil fuel (including natural gas) generators, and more cheaply than any other nonhydro renewable resource.[7]
Technologies that employed the sun to make electricity also benefited from PURPA (and other laws, especially in California). Entrepreneurs working on solar photovoltaic cells, for example, designed and tested novel designs and could obtain some income because of PURPA’s guarantee of a market for the cells’ power. Largely because of the research, the cost of solar cell electricity declined from about 90 cents/kWh in 1980 to about 20 cents/kWh in 1995. Though still not commercially viable without additional subsidies, except in niche applications, photovoltaic technologies nevertheless improved dramatically. Meanwhile, another solar technology almost reached commercial success as a result of PURPA. Explicitly taking advantage of the law’s provisions (and, again, other incentives offered in California) Luz International, a small entrepreneurial firm, built a system that employed parabolic mirrors to focus sunlight onto tubes containing oil. The heated oil transferred energy to water, which turned into vapor and powered a turbine-generator to produce electricity. Between 1984 and 1990, the company built several iterations of the system and produced power that dropped from 25 to 8 cents/kWh during that period. Overall, PURPA stimulated the development of novel power generation technologies, a fact noted as early as 1985 by analysts at the Congressional Office of
Technology Assessment, which viewed the law as the motivator of several “first generation commercial applications” of technologies that may have great value in the future.[8]
PURPA AND DEREGULATION: UNINTENDED CONSEQUENCES OF THE LAW
Beyond its stimulation of research and development on small-scale technologies, PURPA unintentionally began the process of deregulating the American electric utility industry.[9] It did so largely in two ways. First, as noted earlier, PURPA eliminated the barrier to entry in the generation sector of the utility business. Under the regulatory framework that had existed since the beginning of the twentieth century, utility companies enjoyed status as regional monopolies that permitted them to generate, transmit, and distribute electricity without competition. But PURPA gave a special class of unregulated companies the right to produce power, effectively enabling them to compete with the formerly protected firms. In short, PURPA invalidated the notion that only integrated monopolies could effectively operate in the utility business.
Second, and perhaps more important, the success of some PURPA QFs in making a profit by selling power to utilities suggested that the regulated power companies no longer had a legitimate claim as natural monopolies. Going back to the late nineteenth century, the notion of natural monopoly helped justify the existence of regulation of utility companies in the first place. The academic and political principle held that in some industries (such as the railroad, streetcar, water delivery, and electric power industries), companies needed to invest heavily in technology and would only do so if they obtained guaranteed markets. Competition would also be detrimental to the public good because of the need for duplicate equipment, which raised costs, to serve the same customers. (Before regulation, streets of some cities were cluttered with wires from different companies, each seeking to serve the same lucrative customers.) Moreover, when several firms competed for a fixed number of customers, none could exploit the largest and best generation technologies that emerged in the early twentieth century. Steam-turbine generators, in particular, showed huge economies of scale. If two or more companies contested the same customer base, none could employ the biggest generating unit. But if only one firm served all customers, it could buy the largest equipment and reduce its unit cost for the power. Swaying politicians, this logic encouraged the creation of regulatory bodies that oversaw the natural monopoly utility companies, ensuring (in principle), that the benefits of the utilities’ unusual status would flow to customers in the form of lower rates and good service.
The Public Utility Regulatory Policies Act challenged this rationale for regulation and, therefore, started discussion of further deregulation of the utility industry. It did so by spurring creation of nonutility companies that produced power at competitive prices. Even though the QFs did not exploit economies of scale like utilities did, they produced power with higher thermal efficiencies (in the case of cogenerators), and they sold the heat byproduct to gain economic advantages over utilities. They, therefore, often could beat utility costs by a margin of 5%-15% in the mid-1990s. This fact was noted by some politicians and regulators, who argued that the financial success of some QFs indicated that utilities no longer constituted natural monopolies. After all, natural monopolies supposedly produced power more efficiently and more cheaply than could competitors. But some PURPA QFs demonstrated that they could produce lower priced electricity than could the protected utilities. Following this logic further, the questioning of the natural monopoly rationale led to challenges to the notion of regulation. Congressmen, federal regulators, and some utility leaders themselves started asking why regulation should exist when utility monopolies no longer could be justified as “natural” anymore.
This questioning of regulation in the utility sector did not occur in a vacuum. Throughout the 1970s and 1980s, economists and politicians in the United States and elsewhere began challenging the value of regulation of various industries as the best way to provide services to customers. Starting with President Carter’s efforts, the airline industry began the process of deregulation. Similar moves to introduce market forces occurred in the natural gas, petroleum, railroad freight transportation, and financial services industries, only to be followed (during President Reagan’s tenure in office) by deregulation of the telecommunications industry. Similar deregulation of various industries occurred in England and several other countries, yielding (in many cases) declining prices, improved services, and technological innovation in industries that had previously appeared stagnant.
With the questioning of natural monopoly status in the power industry, stimulated partly by the experience of PURPA, and the apparent success of deregulation in other businesses, many people called for restructuring of the electricity infrastructure. President George H.W. Bush heeded these calls and proposed, after the Gulf War of 1991, to employ market forces to increase domestic fuel production and to improve the efficiency of energy use. One provision of the Energy Policy Act of 1992 gave states the right to allow their transmission network to serve as a common carrier so any electricity producer could sell power to any customer. Essentially, the law enabled states to begin competition on the retail level. Taking advantage of the legislation, several states in the late 1990s established competitive retail frameworks. By September 2001, 23 states (and the District of Columbia) had passed restructuring laws, while other states used the regulatory process to reduce their oversight and introduce more market forces into the industry.[10]
CONCLUSION
While PURPA contributed to the deregulation of the power industry, that same deregulation also minimized the importance of PURPA. Though the law remains on the topics, despite the best efforts of repeal propo-nents,[11] who think the law has led to overpriced and unneeded power, terms of the Energy Policy Acts of 1992 and 2005 make some elements of PURPA less significant. For example, the 1992 law created a class of independent power producers known as exempt wholesale generators. While these generators do not receive guaranteed payments from utilities, as do QFs, they also are not bound by PURPA’s requirements for overall energy efficiency. Entrepreneurial companies have taken advantage of this feature of the new law and have built scores of plants that sell power to an open market of customers. They have eclipsed QFs as the primary nonutility providers of power to the nation’s electricity grid.[12]
Nevertheless, the significance of PURPA should not be overlooked just because the law no longer has as much practical meaning as it did in the 1980s. Intended largely to reform the way utility companies charged customers for electricity, the statute unexpectedly had at least two major consequences. First, a benign-looking part of the law provided the financial incentive that motivated entrepreneurs to perform research and development activities on small-scale renewable energy technologies, such as wind turbines and solar energy systems. Combined with tax breaks offered by some states, these technologies saw rapid improvement and the ability to produce electricity at greatly reduced costs. Second, the law helped undermine the rationale for utilities’ status as regulated natural monopolies. It did so by encouraging firms to improve cogeneration and gas-turbine technologies and to make them commercially feasible in small sizes. Owners of the PURPA-induced qualifying facilities employed these technologies to break down the barriers to entry in the utility business by allowing them to compete with utility companies in the generation sector. In the process, they challenged the notion that utilities deserved recognition as special noncompetitive enterprises and that they required oversight by government regulatory bodies. Within a political environment that valued the deregulation of industries, PURPA’s questioning of regulation motivated, to a large extent, the restructuring of the utility industry. That restructuring process continues into the early part of the twenty-first century.
