“Although intended to counteract the problems caused by an earlier violation of property rights—the legalized monopoly status that utilities gained under ratebase regulation—the forced opening of the grid was itself a violation of property rights.”
“In the wake of a liberated electric grid based on property rights and private ownership of the rights-of-way, the imaginations, ingenuities, and profit motives of scientists, engineers, and financiers would produce all manner of possibilities.” (Raymond Niles, below)
Raymond C. Niles is one of those people who has “forgotten more than I know.” His insights from 13 years ago in electricity history and policy (one of his many interests in political economy) ring loud in the wake of the Great Texas Electricity Blackout of February 2021.
I recently came across Niles’s May 2008 essay, “Property Rights and the Crisis of the Electric Grid,” published in The Objective Standard. It called out the mainstream (even classical liberals) for characterizing a new regulatory regime in electricity as “deregulation”; exposed mandatory open access as a mass violation of private property rights; and made a case for true deregulation and free market reliance.
Today, the mandatory open access model, necessitating central-planning of the grid, such as the PUCT/ERCOT model, is in political trouble. It should be in intellectual trouble too. What happened in California in 2000/2001 should have led to fundamental pro-market reform, just as Niles argued. Now with Texas, another very expensive lesson has been leaned.
Read Niles in 2008–and apply it to 2021. Here are some major parts of the article (full essay and footnotes can be found here).
The independent generators’ agitation to sell their excess power resulted in a series of laws and regulations that, beginning in 1978, forced the utilities to transport electricity produced by third-party competitors. The goal of these rules was to transform the transmission grid that had been created by and was rightfully owned by the utilities into an enormous common carrier through which any generator could transmit its electricity.
Although intended to counteract the problems caused by an earlier violation of property rights—the legalized monopoly status that utilities gained under ratebase regulation—the forced opening of the grid was itself a violation of property rights. The utilities had paid for and produced the transmission lines.
The secondary fact—that the government had granted them a legal monopoly—does not alter the essential fact that the lines belonged to the utilities by virtue of their thought, their time, their money, their effort. The government’s new mandate was the equivalent of forcing FedEx to transport packages for DHL. Unsurprisingly, this new violation of property rights, which was absurdly labeled a “deregulation,” had further negative consequences.
To begin with, alongside this so-called “deregulation,” the utilities remained tightly regulated in the traditionally recognized manner. All of the transmission wires and the majority of generating plants continued to operate under ratebase regulation; state utility boards continued to set retail rates in nearly all jurisdictions.
According to 2006 data, approximately 83 percent of the utility infrastructure consists of regulated local and long-distance grids and regulated generation, while about 17 percent consists of “unregulated” third-party generation.
Further, the supposedly unregulated third-party generators have become subject to increasing controls on the prices they charge. After wholesale prices were decontrolled in 1996, various caps and rules were imposed on the prices these third-party generators can charge. In 1996, in most regions, a generator was free to set its own rates for the power sold from its plant. However, after a series of electricity price spikes in 1998, 1999, and 2000, the government imposed legal price maximums in all regions.
California Debacle: 2000/2001
The unstable mix of controls and partial decontrols inspired by pseudo-deregulation culminated in the California Power Crisis of 2000–01. A state “deregulation” law passed in 1996 froze California utilities’ retail rates, the rates charged to utility customers, while leaving decontrolled the prices charged by generators in the wholesale market (those prices had been decontrolled by the federal government in 1996).
The goal of the California government was to decouple most of the generating capacity from the regulated utility monopolies and to create a common carrier transmission grid between the two groups, controlled by a state operated agency. This meant forcing the utilities to sell the bulk of their power plants to independent generating companies, forming a wholesale market of power suppliers. The utilities were then to purchase the power they needed from the wholesalers and receive that power on the state controlled transmission grid.
However, because electricity cannot be stored, the wholesale price can fluctuate greatly with changes in supply. If, for example, extremely low-cost hydroelectric generation becomes unavailable due to very low reservoir levels, then much more expensive gas or coal-fired generation must be substituted. California is particularly vulnerable to the problem of low reservoirs. Because it gets a relatively large proportion of its electricity (nearly one-fifth) from hydroelectric power, changes in the water level of its reservoirs have a disproportionate effect on the price and supply of electricity in the state.
In the spring and summer of 2000, California’s reservoirs were very low due to a disappointing snowfall the prior winter. Aggravating the problem of low hydroelectric capacity, the summer of 2000 was hotter than normal, which stoked electricity demand for air conditioning.
The combination of expensive supply and greater-than-normal demand caused wholesale prices to rise significantly, eventually reaching a point at which the California utilities, whose retail rates were fixed, paid more for electricity in the wholesale market than they could legally recoup from their customers in the retail market.
As the California utilities bled cash to buy electricity at higher wholesale rates and sell it at lower retail rates, their creditworthiness deteriorated and pushed wholesale prices still higher as generators began demanding a price premium to compensate them for the risk that the utilities might go bankrupt and not pay their bills.
Eventually this happened. The largest electric utility in the state, Pacific Gas & Electric, filed for bankruptcy, and the other large utility, Southern California Edison, approached insolvency.
Only San Diego Gas & Electric weathered the storm because, unlike the other two utilities, it could raise its retail rates to pass along the higher cost of wholesale power. San Diego Gas & Electric had complied with a provision of the “deregulation” law that allowed utilities to charge “market-determined” retail rates if they had sold most of their generating plants. The other utilities had not yet done so.
As the two larger California utilities approached bankruptcy, regulators could have averted the immediate financial crisis by allowing retail rates to rise, as they had with San Diego’s utility, thus allowing the utilities to make money instead of losing it on each kilowatt-hour they sold.
Instead, in a misguided effort to lower the price that the utilities paid for electricity, regulators imposed a cap on wholesale electric rates, which they progressively lowered from $750/megawatt-hour in May 2000 to $250/megawatt-hour in August 2000. Imposing wholesale price caps did not make power available to the utilities at lower prices. Instead, it created a shortage of power available at the legal price.
Contra-California: Oregon, Nevada, and Arizona, Lessons
In the surrounding states of Oregon, Nevada, and Arizona, wholesale prices were not capped. As the market price of electricity in California exceeded the legal maximum, the power generators began shipping power to the surrounding states to take advantage of market prices. The result was rolling blackouts in California.
It is an elementary corollary of the law of supply and demand that price controls cause shortages. Controls on the price of bread led to bread shortages that helped cause the riots that led to the French Revolution. Controls on the price of oil caused long gas lines in the 1970s. And in California, controls on the price of electricity have led to rolling blackouts. By capping wholesale electricity prices, the government effectively made it illegal for generators to make a profit in California, so the generators sought profit elsewhere.
Another consequence of price controls is the inevitable corruption that ensues in the business world when businessmen are prohibited from setting prices in accordance with the demands of the marketplace. In the 1970s, oil companies struggling to operate under price controls sought to circumvent them via elaborate bookkeeping schemes; these companies were denounced, prosecuted, and fined billions of dollars.
In similar fashion, during the California Power Crisis, generators and traders sought to circumvent the price caps by such means as setting up phony out-of-state “round-trip” trades. In these trades, the power never left California, but it was marked as having been sold in Oregon in order to take advantage of the unregulated rates there.
Ironically, by breaking the law in this manner, traders such as those at Enron kept power in California—power that would otherwise have left the state—and thereby reduced the frequency and intensity of its rolling blackouts. This is not to say that what Enron did was right; rather, it is to show that what the government did was wrong. The government’s price caps were an attempt to violate the law of supply and demand, a law of nature. Such an effort can have only negative consequences.
In microcosm, the California Power Crisis illustrates key problems inherent in America’s current electric grid. Price controls on electricity were the proximate cause of the crisis. The fundamental cause of the California debacle was governmental regulation of the power industry in general—regulation that began in the industry’s earliest days with government control of the utilities’ rights-of-way.
The Path Forward: Private Property
The crises, blackouts, and price disparities associated with the electric utility industry have led to a vigorous debate about the root cause of the industry’s problems and how to solve them.
On one side are the advocates of regulation who blame the problems of the industry on the “deregulation” of the past few decades, and who long for a return to the “good old days” of 100 percent ratebase regulation.
On the other side are the advocates of the kind of “deregulation” that involves the forced opening of the grid, who now argue that the grid must be “freed up” even more than it was before.
Both sides are wrong. The only way out of this intractable dilemma is to begin recognizing and protecting property rights in the electric utility industry.
This approach to the problem would lead to genuine deregulation of public utilities; to the removal of all manner of state control over prices, profit levels, and usage of the transmission lines; to an electric utility industry that is both moral and practical—moral in that it would respect the rights of producers to the use and disposal of the product of their effort, and practical in that it would obey the law of supply and demand, thereby making possible the integration of market prices and production requirements.
Importantly, this approach requires recognition of the fact that utilities morally own the rights-of-way that they made valuable. The space through which they run their lines, in conduits underneath the city streets and in overhead lines attached to poles, morally belongs to the utilities.
This moral fact must be legally recognized. The failure to acknowledge such ownership in the industry’s earliest days is what led to all the subsequent rights violations and consequent catastrophes.
To undo this tragic mistake, we must recognize the propriety of utilities establishing claims to the commons, just as the homesteaders did, and of buying access to rights-of-way from private owners, just as they would buy buildings or machinery or any other goods necessary to their operations. In addition to respecting the rights of producers, this would respect the rights of utility customers by getting rid of forced monopolies thus enabling them to choose their power source.
The recognition of property rights in the electric utility industry would enable utilities to compete with each other all the way to the power plug in a customer’s wall. All parts of the grid, from the generating plant to the transmission and distribution wires, would become open to the entrepreneurial energies of creative businessmen, scientists, and financiers.
This would result in the rebirth of the entrepreneurial spirit of the industry’s early days, when Thomas Edison invented his central station generation, when George Westinghouse made it better by incorporating alternating current technology, and when Samuel Insull radically improved the economic efficiency of utilities by inventing new business methods that achieved undreamed-of economies of scale.
Imagining Market Entrepreneurship
Full recognition of the property rights of utilities would radically alter the industry for the better. Today, extremely large central station generating plants that are generally far away from customers distribute power over a grid to millions of interconnected users. This is the model that Samuel Insull perfected in the 1920s, but it is a model unlikely to survive today in a genuinely competitive industry based on property rights.
The main consequence of recognizing property rights to rights-of-way beneath and above the streets is that competitive newcomers could reach customers that they are today legally prevented from reaching. Anyone with a generator, large or small, could potentially compete with the incumbent local utility by creating his own transmission lines. He could homestead the space he needed to run his lines using legal procedures established for that purpose.
Or, he could buy space from existing owners. For example, an electrical company could buy a portion of the right-of-way belonging to the cable television or telephone company, and use the purchased right-of-way to run electric cables all the way to the customer’s premises.
Subject only to reasonable rules that govern digging streets today, such as not blocking traffic and digging during reasonable hours, the utility entrepreneur would lay down his grid and compete. (Incidentally, this principle applies to all other users of the rights-of-way, and its recognition would facilitate competition among telephone, data, and cable companies, and would likely spawn endeavors that today cannot even be imagined.)
The emergence of entrepreneurs who can lay down their own grids as a matter of right would require the incumbent utility to compete on both price and reliability of output.
No longer would the local utilities be assured, as they are under ratebase regulation, of a guaranteed return on their investments in power plants, distribution lines, and wasteful overhead. No longer would government-protected stagnation pass as acceptable service. No longer would customers have to pay artificially inflated prices for electricity or suffer repeated blackouts caused by the government’s attempts to violate economic laws.
One type of competition that could emerge is a large utility running power lines to customers in a neighboring region that is currently off-limits to it. Without monopoly franchise regulations holding it back, a New Jersey utility could run a cable under the Hudson River and supply power to large buildings in Manhattan.
This would render the utilities in New York and New Jersey in competition with each other, which would result in lower prices. Further, the construction of more transmission lines—driven by the desire to compete and earn a profit rather than by regulatory fiat—would result in the grid becoming more reliable and less prone to blackouts.
Competition could also develop involving entirely new technologies and business structures for delivering electricity. For instance, in a seeming reversal of the triumph of Westinghouse’s alternating current over Edison’s direct current in the 1880s, and in defiance of the model that Samuel Insull perfected in the 1920s, small, neighborhood-based generators might compete head-to-head with the large central station plants of yore.
The basis for their advantage would probably not be efficiencies in generation; the larger plants would still have greater economies of scale in production and thus be able to generate electricity at a lower cost.
Instead of plant efficiencies, the newcomers’ advantage might lie in their ability to bypass the huge expense (about half of the assets of a typical utility) of the many miles of distribution cables that connect customers to the central power plant; they might be able to deliver electricity at a lower cost.
A network of smaller power plants located closer to the customer and requiring only short transmission lines could improve reliability by reducing blackouts caused by failures along the miles of transmission lines needed by a traditional utility to deliver power to its customers.
My speculations as to the future are only obvious ones. In the wake of a liberated electric grid based on property rights and private ownership of the rights-of-way, the imaginations, ingenuities, and profit motives of scientists, engineers, and financiers would produce all manner of possibilities. Who will be the next Thomas Edison, George Westinghouse, Samuel Insull—and what marvelous goods will they deliver?
Recognize property rights, America, and we will see.