Table Of ContentPOWER STRUCTURE
Ownership, Integration, and Competition
in the U.S. Electricity Industry
POWER STRUCTURE
Ownership, Integration, and Competition
in the U.S. Electricity Industry
by
John E. Kwoka, Jr.
George Washington University
kd
KLUWER ACADEMIC PUBLISHERS
Boston/Dordrecht/London
Distributors for North America:
Kluwer Academic Publishers
101 Philip Drive
Assinippi Park
Norwell, Massachusetts 02061 USA
Distributors for all other countries:
Kluwer Academic Publishers Group
Distribution Centre
Post Office Box 322
3300 AH Dordrecht, THE NETHERLANDS
Library of Congress Cataloging-in-Publication Data
Kwoka, John E.
Power structure : ownership, integration, and competition in the
U.S. electricity industry / by John E. Kwoka, Jr.
p. cm.
Includes bibliographical references and index.
ISBN 0-7923-9843-2
.1 Electric utilities--UnitedStates. 2. Electric utilities-
-Government ownership--United States. 3. Privatization--United
States. I. Title.
HD9685.U5K87 1996
333.793 '2'0973--dc21 96-47148
CIP
Copyright © 1996 by Kluwer Academic Publishers. Third Printing 2000.
All rights reserved. No part of this publication may be reproduced, stored in
a retrieval system or transmitted in any form or by any means, mechanical,
photo-copying, recording, or otherwise, without the prior written permission of
the publisher, Kluwer Academic Publishers, 101 Philip Drive, Assinippi Park,
Norwell, Massachusetts 02061.
Printed on acid-free paper.
Printed in Great Britain by IBT Global, London
Dedication
In honor of my father, John Kwoka, and in memory of my mother, Mary Kwoka.
Contents
Preface ix
1 Introduction 1
1.1 Historical Perspective on the U.S. Electric Power Industry 3
1.2 Outline of the Current Industry 7
3.1 Plan of This Book 9
The Issues
Public versus Private Ownership and Regulation
of Electric Utilities 31
2.1 Economic Models of Public Ownership 31
2.2 Empirical Research into the Effects of Ownership 61
2.3 Investor-Owned and Publicly Owned Utilities in the U.S. 20
Economies of Scale, Vertical Integration, and the Role of
Competition 37
1.3 Economies of Scale and Vertical Integration in
Electric Utilities 73
3.2 Competition in Distribution 34
3.3 Utility Structure and Costs: Some Preliminary
Insights 46
3.4 Summary 45
The Evidence
Costs and Their Determinants 57
4.1 The Choice of a Cost Function 57
4.2 Specifying and Estimating a Net Cost Function 59
4.3 Economies of Vertical Integration and Scale 76
4.4 Specifying and Estimating a Total Cost Function 37
4.5 Cost Structure of a Large Public System:
The Case of Los Angeles 79
4.6 Summary 18
viii
5 Price and Markup Behavior 85
5.1 Theory and Evidence on Utility Pricing 68
5.2 A Model of Average Cost Pricing 98
5.3 Markup Pricing by Utilities 39
5.4 Evidence on Ownership, Competition and
Markups 96
5.5 Summary 001
Extensions to Simultaneous Equations and
Customer Classes 103
6.1 A Simultaneous Equations Model 401
6.2 Background to Customer Class Effects 111
6.3 Evidence by Customer Class and Mode of Ownership 211
6.4 Summary 611
7 The Political Economy of Ownership and Regulation 119
7.1 Theories of Public versus Private Ownership 021
7.2 The Determinants of Ownership and Election 221
7.3 Conversions to and from Publicly Owned Status 721
7.4 Summary 631
The Implications
8 Conclusions 931
1.8 Ownership, Integration, and Competition 931
8.2 Restructuring the Electric Power Industry 241
Appendices:
Appendix A: Data Definitions and Sources 741
Appendix :B Cities with Competitive Utilities 371
Bibliography 771
Name Index 191
Subject Index 391
PREFACE
Most books are long journeys. The first step for this project took place in the fall
of 1990 when I was asked about my possible interest in researching the relative
performance of publicly owned versus privately owned electric utilities in the U.S.
The question was intriguing for several reasons. In contrast to conventional
economic wisdom that predicts lower costs and prices under private ownership,
many if not most studies of electric power show that public ownership results in
superior performance. The reasons for this apparent anomaly have long been
disputed. Understanding them would seem to be increasingly important in an era
when many countries have been undertaking, or at least contemplating,
privatization of their electricity industries.
In addition, the U.S. electric power industry has been poised on the
threshold of its own fundamental restructuring. Here the principle issues are not
ownership but, rather, vertical deintegration of generation from transmission and
distribution, and the potential role of competition. Utilities in this country,
however, already exhibit considerable diversity in their degree of integration and
of competition. That diversity could be used in the research to gain at least some
insight into the effects of the more sweeping changes under consideration. And
looking ahead, a further useful outcome of this project would be to establish
benchmarks of performance for evaluating a host of such policy initiatives.
Cinching the case was every economists' irresistible lure -- new data.
Data had recently become available covering many more publicly owned systems
on a basis comparable privately owned utilities. This opened up the possibility of
substantially more definitive research on all of these issues than previously
possible.
1 therefore soon agreed to undertake the project. What I did not appreciate
at the time was the full extent of the odyssey on which I was embarking.
Compilation of the necessary data proceeded (offand on, to be sure) for nearly four
years and was not entirely complete even then. Another year was devoted to
obtaining the core analytical results. Writing the present monograph consumed an
additional year and a half, although throughout there have been the usual
interruptions from the academic schedule and other commitments.
The outcome of the project has nonetheless been very satisfying. The
substantive results cast light on key determinants of the cost and price performance
of U.S. electric utilities: vertical integration versus deintegration, public versus
private ownership of enterprises, and retail competition versus monopoly
distribution. Many other questions are addressed as well. These include the effects
of power pools, holding companies, incentive regulation, combination gas and
electric utilities, utility commission characteristics, and differences among
customer classes.
These questions are matters of longstanding interest for the U.S. electricity
industry. In addition, they have direct relevance for the restructuring of the electric
power sectors both here and in other countries. It would be presumptuous to
suppose that any single piece of research could definitively answer such questions,
of course, and this research no doubt has its limitations. But it is not unrealistic to
hope that its conclusions will contribute to a deeper understanding of these issues
and at the same time advance the policy debate on electric power reform. To the
extent that it does, this book will have succeeded in its objectives.
This project has benefitted crucially from assistance from numerous
individuals and institutions. For their comments on various interim results, I wish
to thank seminar participants at the George Washington University Economics
Department, the 1994 American Economics Association session "Regulation and
Competition," the Harvard University Economics Department and Kennedy
School, MIT Sloan School, the Antitrust Division of the Justice Department, tile
Brookings Institution, Resources for the Future, the Williamsburg Conference of
the Institute for Public Utilities, the American University Department of
Economics, and the Department of Justice/Federal Trade Commission Electricity
Workshop.
I also owe a debt of gratitude to a number of individuals for helpful
discussions, suggestions, information, or manuscript-reading. These include Paul
Joskow, John Mayo, Michael Pollitt, Robin Prager, Steve St. Marie, Chris Snyder,
and Larry White. Assistance in data compilation and analysis and in manuscript
preparation was ably provided by Kevin Roth and Theresa Alafita. I owe special
thanks to Aimee Dimmerman for bringing the pieces of the manuscript together at
the very end. Some research assistance was supported through the Center for
Economic Research at GWU.
Much of the actual writing of this book was done while I was on
sabbatical from George Washington University, first as Visiting Professor of
Economics at Harvard and then as Guest Scholar at Brookings. I owe Dick Caves,
Bob CrandaU, and Henry Aaron my thanks for the opportunities to reside in the
productive environments of their institutions. 1 also wish to thank Joe Cordes, my
department chair at George Washington University, for his unwavering support
throughout this project, and Zac Rolnik, my editor at Kluwer, for his enthusiastic
and efficient stewardship.
My debt could not be greater to John Kelly and the American Public
Power Association. At Lorel Wisniewski's suggestion, it was John who, as Director
for Economics and Research at APPA, made the initial inquiry as to my interest in
the project. The APPA subsequently provided financial assistance for project
formulation, for my initial research into the ownership issue, and for some follow-
up activities. They also undertook the truly enormous tasks of data compilation
and reconciliation. Kaylyn Hipps, Diane Moody, and Julie Murphy deserve special
xi
thanks for their efforts, as does JoAnn Hutchison for facilitating countless matters
between myself and APPA. Throughout the process John Kelly contributed most
of all, patiently responding to an endless stream of questions and requests for
additional data, while insisting on the highest standards of research objectivity
regardless of the conclusions that might emerge from this work.
I should note, of course, that none of these individuals or institutions is
responsible for any errors in this volume, nor do they necessarily endorse any of
its conclusions.
Finally, I would like to acknowledge those who in so many other ways
have helped on my longer personal and intellectual joumey to this point. My
parents who years ago gave so much for my education; teachers, colleagues, and
students who subsequently have taught me industrial organization economics; and
my wife and daughter for their continuing support and patience deserve
recognition. In a very real sense this book is the product of their efforts, too, and
I am grateful to all.
Chapter I
INTRODUCTION
The electric power industries in the United States and most other countries have
long been structured in accordance with a simple paradigm. In the belief that
electric power is a natural monopoly where a single company can provide service
most efficiently, this paradigm involves large franchised utilities with exclusive
service territories and which are integrated into generation, transmission, and
distribution. Concerns over price and cost distortions from monopoly power are
addressed by regulation if the utilities are privately owned, or by outright public
ownership.
Over the past two decades, however, this conventional paradigm has been
subject to fundamental challenge. Numerous countries have grown dissatisfied
with the performance of their large, integrated, monopoly electricity sectors,
whether state-owned or regulated. Some have adopted thorough-going policies of
privatization, deintegration, deregulation, and direct competition among sellers.
Other countries have sought to reduce, if not eliminate, the role of government in
the decisions and the operations of industry. These policies have represented an
historic alteration both in the governance of enterprises and in the role of
government itself.
These changes have already had discernible effects in the electric power
industry, but in reality they represent only the beginnings of a sweeping
restructuring. Over the next decade many more countries will adopt alternative
means of achieving the objectives of efficiency in electricity production and prices
that reflect minimum economic costs. While change is certain, the diversity of
approaches currently employed and being considered makes it difficult to predict
the final structure of the transformed industry.
In some ways, the United States electric power industry corresponds to the
traditional paradigm. The largest and most familiar segment of this industry
consists of about 200 privately owned companies. These "investor-owned utilities"
(IOUs) are individually very large and vertically integrated, typically represent
monopolies within their service territories, and are subject to both state and federal
regulation. Their structure results from the paradigmatic belief in the importance
of economies of scale; economies from coordinating generation, transmission, and
