SIC 9631

The primary participants in this industry grouping are government establishments which regulate, license and inspect utilities. The utility operations include the generation and delivery of electricity regardless of fuel, and the delivery of gas, water and sewer services.

NAICS Code(s)

926130 (Regulation and Administration of Communications, Electric, Gas, and Other Utilities)

Industry Snapshot

Utility operations directly affect almost everyone in the United States. The way they do business and how much they charge for their services is determined by federal, state and municipal commissions through a complex series of often overlapping regulations. Utility services include water, sewer facilities, electricity, natural gas, telephone, and cable television. The industry participants also monitor and regulate air and water quality and nuclear reactors. The U.S. Department of Energy's spending totaled $21.8 billion in 2002. Of this amount, $2.7 billion was earmarked for energy resources and $3.3 billion for science and technology. Spending in these categories was expected to remain relatively constant in 2003 and 2004. These dollars include, but are not limited to, regulation, monitoring, and research for alternative energy.

Of increasing interest and concern over the years is whether commodities which, at one time, were optional indulgences to make life easier or more enjoyable, but which now have become absolute necessities in today's world, should be regulated by any government entity, or should be left alone to operate within the free enterprise system upon which capitalism is built. The answer lies somewhere in between. In recent years, governmental "deregulation" of utilities has been both contentious and problematic in many areas. However, it has ostensibly served to control price gouging and unfair market practices by utilities owners and suppliers.

Organization and Structure

The following organizations are the main national regulatory commissions:

The Federal Energy Regulatory Commission (FERC), which was established in 1977, replaced the Federal Power Commission (FPC) which was formed in 1935. FERC controls all electric generation, distribution, and transmission involving wholesale transactions.

The Nuclear Regulatory Commission (NRC), which replaced the Atomic Energy Commission, was established in 1975. The NRC regulates all nuclear generation power plants and the transport and disposal of nuclear waste.

The Federal Communications Commission (FCC) consolidated the telecommunications authority of the Federal Radio Commission (1927) and the Interstate Commerce Commission in 1934. The FCC regulates telephone and telegraph services, satellites, broadcast and cable television, and newspapers.

The Environmental Protection Agency came into being in 1970 as an independent agency of the federal executive. It consolidated all federal environmental laws into a single administrative body.

The National Association of Regulatory Utility Commissioners (NARUC) provides a forum for state and municipal regulators.

Background and Development

The evolution of the current regulatory system began with a concept referred to by Paul Gioia in an April 1989 issue of Public Utilities Fortnightly as "the regulatory compact." By the beginning of the twentieth century, utility services were seen as essential to the welfare of the public and the growth of the economy. Since their intricate distribution systems required large investments of capital and public lands for right-of-ways, control of such early utilities became concentrated in a few hands. This tendency toward a "natural monopoly" prompted experiments in utility regulation that continue today.

The extensive land requirements of transmission systems gave control of most gas, water and electric utilities to municipal governments before the turn of the century. This was primarily because, by 1880, most states turned over control of public streets to their cities. However, U.S. law required special permits or franchises for the use of such public property. Consequently, the municipalities controlled the privately owned utilities by granting franchises and sought to maintain control through competition by issuing overlapping franchises. This system predominated between 1879 and 1907, but complaints of excessively high prices, poor service, discriminatory marketing practices, and unsafe systems sparked public investigations that resulted in regulatory changes.

Matters came to a head in New York State when Charles Evans Hughes was elected governor. Despite the findings of his own investigation a year earlier, which confirmed all the charges against private utilities, Hughes favored continuing the system and adding a strong regulatory oversight commission manned with a professional staff. He had been opposed by William Randolph Hearst who proposed public ownership of all utilities. By 1907, however, Hughes established the first public utility commission. Wisconsin did the same and was followed by 27 other states between 1907 and 1914.

These policies shifted power away from the municipalities into the hands of state regulatory commissions and insulated legislators from the influence of utility operators. Consequently, legislators were able to enforce more uniform regulation and stem corruption and competitive waste. State regulations granted monopoly powers to utilities in specific regions in exchange for the ability to protect the public by setting price schedules which yielded a "fair rate of return" to the companies, while pushing costs down by taking advantage of the natural monopoly. Here, the important characteristic of the natural monopoly was that one company could operate more efficiently than two, thus minimizing costs for both the utility and the public.

However, current moves to deregulate utilities have prompted reexaminations of such concepts. Gregg A. Jarrell examined prices and profits for electric utilities around 1917. His study showed utilities in states which adopted regulation before 1917 were already the most efficient in the industry. The move to state regulation brought them, on average, a 25 percent increase in price and 40 percent increase in profits. In a 1992 article in Regulation, R. Richard Geddes quoted Jarrell and argued that the municipal system of overlapping franchises did foster competition and proved more effective than state regulation in controlling utilities. In fact, the move to state regulation actually insulated utilities from competition and allowed them to operate more freely as monopolies.

By 1925, the move to state regulation essentially was complete, but the abuses continued. In 1928, Congress reacted by ordering the Federal Trade Commission to investigate the gas and electric utilities and their holding companies. It found that such companies typically had a pyramid structure: the operating utility was at the bottom and was owned by intermediate holding companies, which were in turn held by another parent company. Apparently, the arrangement provided operating capital for the utility, but in reality the parent companies were siphoning off profits with imaginative bookkeeping techniques. Parent companies were able to make far more profits than the utilities alone, because regulations essentially stipulated a limit on utility profits.

The Public Utility Holding Company Act of 1935 (PUHCA) attacked the pyramid structure for the electric and gas utilities, but left the telephone holding companies alone. The act requires all such companies to register with the Securities and Exchange Commission (SEC) and file reports on their organization, financial structure, and operations. The SEC then broke up the large companies with interests in several states, requiring all surviving companies to operate as coordinated, integrated systems within a confined geographic area. This reorganization, however, was not completed until 1960.

The effect of PUHCA was to overlay federal authority onto state regulation of electric and gas utilities. It also established control of wholesale power distribution with the creation of the FPC in 1935. The FPC became the FERC in 1977. Wholesale electricity sales are transactions between the producer and the utility, and often involve interstate transmission of power. The federal government also began producing its own power with the Tennessee Valley Authority (TVA) and promoted the spread of electric services outside of cities with the Rural Electrification Administration (REA). That program provided farm cooperatives with subsidized loans and access to federal power.

Between 1925 and 1970, the cost of generating electricity dropped steadily as technology and economies of scale improved. In response, the utilities regularly requested and received rate decreases from regulators, but decreases took time to implement because of the regulatory process itself. The "regulatory lag" allowed utilities to realize returns on investment which exceeded their cost of capital.

In the early 1970s, the system suffered its first major challenge and failed. During the 1960s, growing public concerns about the environment prompted increased environmental regulation, which escalated the cost of power plant and transmission line construction and the average construction time. Technological innovation had slowed and nuclear power was proving far more expensive and unreliable than first thought. Subsequently, the OPEC oil embargo of 1974 doubled the cost of oil and affected the plants directly by dramatically increasing the price of all fossil fuels and the cost of generating electricity. It also affected the economy as a whole, slowing economic activity and reducing demand for electricity. Still operating on optimistic demand forecasts of the 1950s and 1960s, however, the utilities continued to replace inefficient oil and gas turbine plants with modern coal and nuclear facilities. The industry moved from a position of no-excess generation capacity in 1973 to 12-percent excess in 1975. Moreover, during this period electric rates increased 49 percent. This resulted in increasing rate-payer hostility and a growing tendency on the part of regulators to resist further price jumps. New construction began to tail off by the end of the decade when the second OPEC oil shock hit. Between 1972 and 1982, utilities canceled 100 nuclear plants.

The traditional rate-setting practice that allowed utilities to earn a fair rate of return on their operations began to unravel as consumers demanded an accounting of management practices. In 1985, regulatory commissions began to impose "prudence reviews" on new plant construction. Under these reviews, any questionable decisions that resulted in waste in the form of construction delays or cost overruns could come back to haunt the utility. The cost of these mistakes had to be absorbed by the utility company and were not allowed to be passed on to consumers through rate increases. This became particularly important to companies involved in nuclear plant construction. Changes in safety regulations mandated by the NRC forced utilities to make expensive alterations or sometimes complete reconstruction of plant facilities. Regulators also adopted the "used-and-useful rule" to bar the inclusion of abandoned plants in the rate base. This policy penalized utilities for stopping construction on plants and in many cases disallowed some or all of the output from new plants because a surplus of generating capacity existed. By 1991, utilities had been forced to write off about $14.7 billion worth of new generating capacity. That figure represents about 13 percent of all shareholder investment in utilities. As Gioia points out, this policy satisfied rate-payers by keeping current costs down, but it also convinced utilities to not engage in long-term capital investments like new generating equipment. Gioia believes that this situation foreshadows the possibility of shortages and reductions in service levels early in the twenty-first century.

This policy also created an opening for the increasingly important non-utility generators (NUGS). NUGS are small producers of electricity, usually industrial users, who supply their own power and sell the excess to utilities. Utilities always have viewed the NUGS' contributions as unreliable and too expensive compared to their own large scale operations. The Carter administration's Public Utility Regulatory Policies Act of 1978 (PURPA) has led many in the industry to consider NUGS as the wave of the future. The original intent of the act was to encourage the development of alternate fuels like solar, wind, hydroelectric, and garbage, as well as promoting cogeneration and other conservation initiatives. Utilities were required to buy power from these small generators at a rate equal to their avoided costs, which are costs associated with producing or buying power normally available to the utility.

Initially, the utilities objected to the NUGS incursion into the generating domain. Subsequently, however, they discovered they could use the act to build small plants in other franchise areas. The strategy allowed them to make higher profits because these new plants were not subject to regulatory rate approval. It also answered the capacity problem. By 1990, the amount of new generating capacity brought into service by the utilities through the traditional rate base construction programs dipped to less than that built by independent producers. By 1992, non-utility generating capacity amounted to 45,000 Mw, or 5 percent of all U.S. generating capacity, and displaced the equivalent output of 40 nuclear plants.

Until the mid-1980s, gas pipeline companies bought gas on long-term contracts, and sold it to local distribution customers under "take-or-pay" contracts. In the early 1980s, the supply of natural gas turned into a glut and resulted in the creation of a low-priced spot market. In response, the FERC abolished the take-or-pay arrangements and mandated open transmission access for the pipelines. Local distributors were no longer financially prohibited from abandoning long term contracts in favor of spot market purchases, and pipelines were required to transport the gas for them at a reasonable rate.

Similar developments occurred in the communications sector of the industry. Regulation in this segment began with the Manns-Elkins Act, which placed control of telephones and telegraphs into the hands of the Interstate Commerce Commission in 1910. The move, supported by AT&T, reduced competition from local telephone companies and reestablished AT&T's predominance, especially in the long-distance market, after its major Bell telephone patents expired. In 1934, the Commissions Act transferred regulatory authority to the FCC. As the FCC allowed private users to obtain transmission licenses in the late 1950s, AT&T's monopoly position began to erode. In the 1960s and 1970s, the courts forced the FCC to end the AT&T equipment monopoly by allowing clients to attach their own equipment to phone lines. Finally, in 1984, an antitrust decree forced AT&T to divest from all its local operating companies.

For the cable companies, the FCC control began to slip in 1984 with the Cable Communications Policy Act. The act deregulated pricing in competitive markets which were deemed to comprise all but the very smallest. It also prohibited phone companies from offering cable television services on their lines. When the average cost of cable service rose more than 40 percent, Congress, in 1992, allowed states and municipalities to reestablish rate regulation.

In the early 1990s, the movement toward deregulation was picking up steam as more utility operations faced competitive challenges. However, critics warned that deregulation policies would jeopardize supplies, quality, and safety. They have pointed out that base-load electric generating facilities like nuclear plants and large coal-fired plants are not being built. Instead, gas turbines are becoming popular because natural gas is relatively inexpensive. Such systems are less efficient than the base-load plants and consequently, the price of gas could rise. More importantly, unlike utilities which are able to switch fuels, gas turbines cannot operate if the supply of gas is curtailed.

Electric companies also found themselves embroiled in deregulation controversies. A bill was introduced to Congress in 1996 that would mandate federal retail wheeling of electric power by December 15, 2000. According to Eastern Maine Electric, "generation utilities will no longer have ownership or control of transmission and/or distribution facilities." The new legislation is intended to break up "vertical monopolies," which control generation, transmission, and distribution of electricity. Basically, the new proposal will lead to competition between retail electric companies. Consumers will have the right to choose which company they will purchase electricity from. Critics worried utility companies will no longer be able to initiate new development because of the uncertainty of the number of base clients.

Also in 1996, Congress passed the Telecommunications Reform Act. This act substantially deregulated the cable TV industry, along with other services. One of its key components was the introduction of the V-chip for TV sets, which allows parents to block programs they feel are inappropriate for their children.

By the late 1990s, electric power generation had become an industry twice the size of the global auto industry, bringing in an estimated $800 billion in revenues annually. As such, it is no wonder that the century ended without the complicated and contentious deregulation that many had hoped for. Notwithstanding, Congress appeared poised to act soon thereafter on a bill which would, in fact, deregulate the industry. In 1999, Congress accelerated activity on issues attendant to deregulation: viability of competition to drive prices down; antitrust concerns; and the reality of electricity restructuring in a deregulated industry. As of late November, 1999,H.R. 2944, the Electricity Competition and Reliability Act of 1999, had gone through its second draft and was headed for a full legislative hearing. Studies by consumer advocate groups and academia assert that utility companies have held back on power output to control prices, and that the industry could realize between 13 to 25 percent more output annually without adding any more equipment. They believe that deregulation of the industry would equate to a real-world savings of about $30 per month on the average household electric bill.

In the communications arena, antitrust concerns over the pending mergers between AT&T and Tele-Communications Inc., Bell Atlantic and GTE, and Ameritech with SBC Communications Inc. dominated the 1999 calendar. To be avoided were the "vertical monopolies" so characteristic of the electricity industry. There were an estimated 65 million mobile phone users by early 1999, and 70 million Internet users. As fast as fiber-optic technology hit the global market, its biggest competitor, satellite communications technology, also entered the arena of soon-to-be-deregulated industries.

Current Conditions

During the late 1990s, California became one of the first states to open its electric power markets to competition. Initially successful, this ultimately led to problems. In 2000, prices soared and power supplies were strained when the state failed to add enough capacity to meet rapid economic growth that was taking place. Subsequently, a combination of weather- and market-related conditions exacerbated the situation. As the FERC explained in its 2001 Annual Report, a hot summer was proceeded by a cold winter, hydropower generation was hindered by a significant drought, and demand was relatively unchanged due in part to fixed rates. Taking action to avert further problems, the FERC "acted to mitigate the sharp price increases of electricity and natural gas in the Western states. These measures provided customers with relief from the most extreme spot market prices. The Commission also removed a series of regulatory obstacles to expedite providing increased energy supplies to the West." Following the FERC's intervention, prices stabilized in the western United States.

In order to increase vigilance and enforcement over the operation of gas and electric markets, the FERC established the Office of Market Oversight and Investigations (OMOI) in January 2002. The new entity, which called for a staff of 110 employees in fiscal year 2003, issues regular surveillance reports concerning market conditions to the FERC chairman and commissioners. One of OMOI's objectives concerns the prevention of anti-competitive business practices. The office was involved in the investigation of illegal trading at energy firm Enron, as well as "gas price anomalies" in New York. As part of its operations, OMOI works in tandem with other government agencies, including the U.S. Department of Justice, the Securities and Exchange Commission, and the Commodity Futures Trading Commission. Each agency specializes in different aspects of an investigation.

Natural gas consumption is expected to continue growing at about 2 percent per year, and according to EOG Resources, growth is expected to nearly double by 2020. The Gas Research Institute predicts that the natural gas share of the total energy market will jump from 24 percent in 1997 to 28 percent in 2015. The largest demand growth is in the electric power generation sector.

By the early 2000s, mergers and acquisitions had occurred at a rapid pace within the telecommunications segment of the industry. For example, by 2003 only four of the seven regional Bell holding companies created by the breakup of AT&T in 1984 remained: Verizon Communications, Inc.; SBC Communications, Inc.; BellSouth Corp.; and Qwest Communications International, Inc. Three of these companies—BellSouth, SBC (Cingular), and Verizon (Verizon Wireless)—benefited from ownership stakes in the nation's two leading wireless telephone companies. Verizon and SBC also had obtained FCC approval to offer traditional long distance service in certain states.

Further Reading

Abel, Amy; and Parker, Larry. "IB10006: Electricity: The Road Toward Restructuring." 12 August 1999. Available from .

"Barton Introduces H.R. 2944, The Electricity Competition and Reliability Act." News Release, 15 October 1999. Available from .

Burke, Robert G. "Deregulation Changing Structure of Satellite Communications." Offshore, July 1998, 100.

Chambers, Ann. "Natural Gas Use Rising, Prices May Follow." Power Engineering, 1 October 1999.

Executive Office of the President of the United States. Budget of the United States Government, Fiscal Year 2004, 7 June 2003. Available from .

Federal Energy Regulatory Commission. 2001 Annual Report, 2001. Available from .

——. 2002 Annual Report, 2002. Available from .

Jansen, Bart. "FERC to Address California Power Woes." Associated Press, 15 December 2000.

Maloney, Michael T.; Robert E. McCormick; and Raymond D. Sauer. "Customer Choice, Consumer Value." Prepared for Citizens for a Sound Economy Foundation, 1998. Available from .

Silva, Jeffrey. "Kennard Hints at More Deregulation." Radio Communications Report, 11 January 1999, 4.

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