More than 3,000 electric utilities in the United States provide electricity to sustain the Nation's economic growth and promote the well-being of its inhabitants. At the end of 1996, the net generating capability of the electric power industry stood at more than 776,000 megawatts. Sales to ultimate consumers in 1996 exceeded 3.1 trillion kilowatthours at a total cost of more than $210 billion. In addition, the industry added over 9 million new customers during the period from 1990 through 1996.

During the transition, many issues are being examined, evaluated, and debated. This report focuses on three of them: how wholesale and retail prices have changed since 1990; the power and ability of independent system operators (ISOs) to provide transmission services on a nondiscriminatory basis; and how issues that affect consumer choice, including stranded costs and the determination of retail prices, may be handled either by the U.S. Congress or by State legislatures.

Of a total of 3,195 electric utilities in the United States, nearly two-thirds have no generating capability. They buy electricity from other utilities to meet the requirements of their customers. As a result, about 55 percent of total domestic consumption of electricity represents sales by other utilities and nonutilities. Wholesale power sales and purchases thus represent market forces in which prices affect both the generation and the retail markets.

An analysis of EIA data on wholesale and retail trade transactions during the period from 1990 through 1996 offers the following insights:

• The market has historically exhibited a willingness to pay a significant premium for assurance of supply. Accordingly, wholesale electricity commands a premium in price when purchases are negotiated on a firm basis. Correspondingly, nonfirm purchases are priced lower.

• Even as trading practices change, it is not certain that the premium for firm supplies will decline. Existing long-term contracts that incorporate premium payments will continue in place, but will expire over a period of time in the future. Accordingly, the premium will continue to exist for the foreseeable future.

• Industrial customers, in the aggregate, have secured price reductions during the 1992-1996 timeframe, paying retail prices that are approximately equal to the wholesale prices for firm power. During this time period, the national average electricity price for the industrial sector declined from 4.8 cents per kilowatthour to 4.6 cents per kilowatthour. In contrast, residential prices increased in most regions from an average of 8.2 cents per kilowatthour to 8.4 cents per kilowatthour.

Many electric utilities owning bulk power transmission facilities are collaborating to create regional ISOs to manage and operate the transmission grid in their regions. These new entities will provide nondiscriminatory access to the transmission grid. Although the ISO concept has gained momentum in recent years, utility participation is fragmented, and many unresolved issues remain. The following are highlights of changes and issues related to the creation of ISOs:

• Four ISOs-California ISO, ISO-New England, the Pennsylvania, New Jersey, Maryland ISO, and the Electric Reliability Council of Texas-Texas ISO-have started operating, and seven others are being planned (Figure ES1).

• Properly designed, ISOs have the potential for improving the operating efficiency of the transmission system by creating a unified regional transmission tariff, and by designing more efficient methods for pricing transmission services using market-oriented approaches. 

• Many utilities have not joined an ISO, creating gaps in the ISO coverage of the transmission system. Fragmented coverage negates many of the benefits that an ISO would bring to a regional transmission system.

• Maintaining a reliable and secure regional transmission grid has received wide attention with increased competition. The ISO's responsibility and authority with regard to this issue are under study by industry leaders.

A number of States are introducing retail competition in electricity, enabling customers to choose their suppliers. Twelve States have passed legislation establishing retail competition, and the public utility commissions in six other States have issued regulatory orders introducing retail competition (Figure ES2).

In the process, they have invariably succeeded in securing rate reductions for customers in exchange for providing their utilities with the opportunity to recover stranded costs.

States that have negotiated a workable consensual arrangement with the stakeholders appear to have a reasonable chance of success in implementing competition at the retail level. Denying an opportunity for full recovery has resulted in slowing the transition to competition, as in the case of New Hampshire.

Pending full implementation of competition, some States have adopted performance-based ratemaking (PBR) as an alternative to traditional ratemaking.

Under  the traditional cost-of-service-based approach, utilities have little or no incentive to reduce costs. The primary aim of PBR is to encourage efficiency improvements (or productivity enhancements) by offering financial incentives to utilities to lower costs and, ultimately, rates. Incentives usually take the form of caps either on prices or on revenues. Another variant-the sliding scale-keeps the rate of return within a certain band, with adjustments for earnings outside the band.

To the extent that PBR plans lead to a decline in rates, their implementation may be preferable to the traditional regulatory approach. This possibility rests on the capability of PBR plans to respond more effectively to external changes than may be feasible under traditional regulatory schemes. The danger is that focusing exclusively on cost reduction may cause other quality-of- service issues to be overlooked. Inadequacies in monitoring and evaluation could also lead to unintended results. PBR plans surveyed in this report are all relatively recent. As such, their effectiveness in reducing costs has yet to be determined.

On their own initiative, or by legislative or regulatory orders,  utilities  in  10  States  have  started  retail pilot programs to test the feasibility of retail competition. These pilot programs allow participating customers to purchase electricity from alternative suppliers, while taking delivery using the incumbent utility's facilities.

Experience so far indicates that industrial customers show more interest in participating in the pilot programs than do commercial or residential customers. The low rate of participation by the latter groups is caused by a number of factors: insufficient cost savings, ineffective recruitment of participants, or burdensome participation procedures. Although problems exist, both regulators and the utilities have obtained valuable experience and feedback from pilot programs, which will help them implement full retail competition.

It is possible that additional issues will emerge as universal retail access gains momentum in the States and the overall demand for power continues to grow, eliminating the capacity excess that currently prevails systemwide. The success of fully competitive markets depends on the ability of the system to add capacity as needed and without undue constraints. Opening generation to competitive forces while concurrently retaining the current siting and licensing powers for new power plants and transmission lines may possibly limit the benefits that competition can bestow. Under these conditions, it is possible for current facility owners to seek and recover prices higher than those prevailing under fully competitive conditions.

Legislation introduced in the 105^th Congress covers diverse spheres of restructuring activity. Some bills are comprehensive-expanding on initiatives in the Energy Policy Act of 1992 and building on Federal Energy Regulatory Commission actions-to facilitate retail competition by a date certain. Others focus on a variety of selected issues. The Administration released its Comprehensive Electricity Competition Plan in March 1998. Consensus-building efforts among stakeholders still seem to be ongoing while an agreement is sought.

States generally do not consider Federal legislation as a requirement for promoting retail competition. They concede, however, that a carefully defined Federal framework would be useful in advancing the economic and social benefits of competitive markets. Some States support Federal legislation in areas where jurisdictional conflicts may be a possibility, or where such legislation would mitigate or eliminate impediments to competition.