A Free Market in Electricity: Will Michigan Get It Right?

After decades of electricity monopoly, with just two government-protected private companies sharing 90 percent of the market, Michigan is about to enter the modern world of customer choice and competition—if all goes well, that is.

In principle, electric power deregulation enjoys broad, bipartisan support—from Republican Governor John Engler to Democratic Attorney General Frank Kelley. State regulators at the Michigan Public Service Commission (MPSC) endorse it as well. The main questions to resolve are these: how fast do we do it, and how much should we pay utility monopolies to let us do it?

Michigan’s electricity rates are among the highest in the Midwest—15 percent higher on average—and are a major economic impediment. Technology now has made it possible to allow every customer the power to choose his electricity provider in a free and competitive market, a prospect which promises to cut rates and spur improvements in service. Experimental deregulation projects in states like New Hampshire have already reduced rates by more than 20 percent. In Great Britain, which has completely deregulated electric power nationwide, competition is intense and rates have fallen by 25 percent.

The MPSC wants to phase-in full customer choice over a five-year period. Under its plan, Michigan will not have a free market in electricity until 2002. The problem is, that’s a year later than big states like Texas, Pennsylvania and New Jersey, two years later than Maine and New Mexico, three years later than Vermont, and four years later than Rhode Island, New Hampshire, and Massachusetts. Indeed, the great majority of states are likely to get to a free market in electricity before Michigan, if the MPSC plan holds. For Michigan, the right path is clear—toward timely deregulation, and that means well before 2002.

Timetables, however, are dwarfed in significance to the biggest issue in the electricity deregulation debate—"stranded costs." They are defined as investments or assets owned by regulated electric utilities that are likely to become inefficient or uneconomical in a free and competitive marketplace. The two big utilities in Michigan, Consumers Energy and Detroit Edison, say they should be compensated for their "stranded costs" by way of surcharges on customers. Estimates of what that could amount to range from about $1 billion to as much as $7 billion, depending upon who is counting what.

A so-called stranded cost can be a piece of equipment or an entire power generating facility. The ultimate stranded cost, which not even the utilities have the chutzpah to include, are the expenses of lobbying politicians and regulators over the years to maintain monopoly protection.

The stranded cost issue, curiously, never arose when other industries were deregulated in recent years. Airlines, trucking companies, telecommunications firms, railroads, and natural gas companies all faced the uncertainty of a free market and did not receive compensation for having to undergo change. Customers were not taxed to underwrite their losses. Those firms simply adapted by becoming more efficient or writing off their unprofitable investments, or both. The concept of "stranded costs" is largely an invention of resourceful utility monopolies who view regulators as their customers almost as much as they do their ratepayers.

Under the monopoly rules that have governed for decades, utilities expected they would be able to recoup any losses they sustained by raising rates on captive customers who did not have the ability to switch to an alternative supplier. In a competitive market, however, these customers will be free to seek out new suppliers if prices rise or the quality of service deteriorates, a fact that will force the old monopoly companies to make some tough decisions.

But deregulation has been a train coming down the track for years. The regulated utilities should have seen it coming and planned accordingly. Their problem is that they have grown too accustomed to monopoly protection. They are not especially known to be supporters of the free market, for their own industry or anyone else’s. They’ve always played the political game well and now that it’s about to end, they want a golden parachute.

Michigan customers of electricity—which is just about everybody—should understand the implications of piling fees or surcharges onto power rates to bail out the big utilities. A recent report from the Mackinac Center for Public Policy argued that a generous stranded cost recovery program would cripple competition in its cradle by giving existing companies an unfair advantage over new providers, reduce the benefits of competition by keeping rates higher than a free market would sustain, and represent corporate welfare on a grand scale.

Many economists argue that some stranded cost recovery may be legitimate in one area only—investments that were clearly forced upon utilities by state or federal regulators. In addition, it seems legitimate that utilities receive fair compensation for the use of the transmission lines they’ve built through the prices they charge other companies to use them. Clearly, though, the higher the amount of stranded cost recovery foisted on customers, the less likely Michigan will ever have real choice and competition in electricity.