In this episode of the Local Energy Rules Podcast, we feature host John Farrell’s interview with Scott Hempling for ILSR’s Building Local Power podcast. Scott Hempling is an author, expert witness, lawyer, and law professor specializing in utility regulatory issues. Their discussion covers the changing ideas around natural monopolies, the consolidation of such monopolies in recent years, and the improvements necessary to modernize the old utility system.
Listen to the full episode and explore more resources below — including a transcript and summary of the conversation.
|John Farrell:||For 100 years, electric utilities have largely operated without competition, as part of a compact with public officials to protect a (quote) natural monopoly. But what happens when that natural monopoly erodes but the public oversight doesn’t keep pace?
Scott Hempling is a lawyer, expert witness, law professor and author who has worked on utility regulatory issues for almost 40 years. We spoke in July 2020 for the Building Local Power podcast about how electric utility market power and mergers have diverged from the public interest, and how the rules of the system (and public regulators) need to change.
I’m John Farrell, director of the Energy Democracy Initiative at the Institute for Local Self-Reliance, and this is Local Energy Rules, a podcast sharing powerful stories about local renewable energy.
Scott, welcome to Building Local Power.
|Scott Hempling:||Thank you for having me.|
|John Farrell:||So, as I was saying before, when we talk about monopoly, folks are often using this term figuratively to talk about a corporation or even a government that exercises a lot of market power, but in the electricity in industry it’s literal. The entities that manage the electric grid are the only ones allowed to do it in a certain geographic area. And when we establish these monopolies, it was often because we considered them “a natural monopoly,” meaning it made the most sense economically to allow one business to have this government granted monopoly over power generation, transmission and retail sales. In terms of this concept of natural monopoly, it’s a term that comes out of economics, have there been things that have changed since the time that we set this up 100 years ago?|
|Scott Hempling:||Yes, the change is dramatic. Many of us have used the term natural monopoly so often, in so many different contexts that we’ve forgotten what it means. Technically, a natural monopoly is a service or a product whose per unit cost declines over the entire size of the market. And so when you have a natural monopoly, the way to minimize costs for all customers, is to have only a single company. If you had multiple companies, each one would have a cost structure that was higher than necessary. And so the assumption that was made over a century ago in the electric industry was that the combination of generation, transmission, distribution and customer service, putting that all together into a single company for a single service territory would make the most economic sense. Whether that was true or not back then, I don’t know. I wasn’t there, even I wasn’t born 100 years ago.
But the question today is how much of that assumption makes sense when we have the possibility for solar panels on the roof, neighborhood micro grids, small scale and large scale storage, what we call demand response, the ability of customers to group together and promise in the next day to consume less so that we can save costs? If these individual services are not natural monopolies, then there’s no reason to have the utility control them all. Small generation, small distribution, local transmission systems. All of these things represent technological change that are changing our understanding of what a natural monopoly is. And so that poses what is really the largest question in the electric industry today, which is where can we have competition? Where do we still need monopoly? And by the way, even for those services that remain natural monopolies, those services for which it makes economic sense to have a single company, who should that single company be?
For a state that has a senate election, you’re going to have only one senator for that particular election, but you don’t give it to the same guy every year for the last 200 years or the same woman, you have an election. We don’t do that enough in electricity. So, even in the situations where we have a natural monopoly, there’s a reasonable question as to whether we can have competition to be the person who exercises that natural monopoly.
|John Farrell:||For citizens or for electric customers who would like to see less official monopolies, less government granted monopolies and more diversity or more choices, what concerns should they have about the way that the market is structured right now?|
|Scott Hempling:||Well, I don’t put a sign out on my front lawn and say my wife’s available. And no monopoly puts a sign out on its headquarters building says their market is available. And so when you have a century of control in a particular company, that breeds a culture of entitlement and it breeds a huge self-interest in maintaining that monopoly. So, the first thing is to recognize just the natural human instinct to protect what’s yours. And a monopoly will do everything it can legally and sometimes unlawfully to protect that monopoly. So, what does that mean in this context? A couple of things. A utility does not want diverse players in its market and so when it sees the growth of solar power, the potential for community aggregation, the potential for micro grids, all of these things that are alternatives to its monopoly, what is it going to do? It’s got three choices.
One choice is to block everything by going to the legislature or going to the regulator or going to Congress and saying, “Introduction of new commerce is bad for the customer, bad for liability, bad for the local economy. Not bad for us, but bad for everybody else.” And so, you try to pass laws or promulgate regulations that protect your monopoly. Well, then there’s the, if you can’t beat them join them possibility, which is you see the writing on the wall, things are going green, things are going decentralized, things are going small. And so you promise to do all those things. You say, “I’m the person who’s kept the lights on for the last 100 years, let me be the solar company, let me do the micro grids, let me do the storage, let me do the wind.” And so what you can often do in effect is buy off the parts of the community that see that substantive desire and say, “I’ll do it myself.” And so you may gain some of the substantive benefits, but you’ll lose the benefit of diversity.
And I guess the third strategy that I’ve seen incumbent monopolies do is to play along. Is to say, “I’m all for these things,” but then create hidden obstacles so that you can see utilities say, “We’re all for solar panels,” but then they erect obstacles, like the difficulties in interconnecting with the grid, difficulties in financing, difficulties in getting siting approvals. And so those are the three things that I would do if I’m in monopoly trying to hang on to my century long control and that is what we see in the industry. And that is what a consumer or a resident or a citizen ought to be concerned about.
|John Farrell:||Yeah, I’m glad that you mentioned those items because it’s something that we’ve actually tried to cover in our research and reporting on this issue. I was just thinking about Xcel Energy in Minnesota often touts that it has the country’s largest community solar program on its website, in its publicity, but often is found at the legislature helping to draft legislation to kill that very same program because it allows third parties to come in and to produce solar and sell to customers or to help customers reduce their electric bills. So, plenty of examples of that unfortunately, that we’ve seen. One other thing I want to ask you about the monopolies is, we’ve talked about how the assumption was it there with these natural monopolies that we’ve made some additional assumptions about keeping the same firm in control of that monopoly, even though we could potentially change it.
But we’ve also seen some things changing in the electricity business with those monopolies. You’ve participated in many utility merger cases as an attorney and an expert witness and you’ve written extensively on the subject, you’ve got a groundbreaking major book coming out this fall and in a recent essay you’ve… You have these monthly essays where you do a great job of explaining a lot of these different issues about how utilities emerge. You explained how until the 1980s, most utilities were monopolies, but they were pretty simple and they were local. And you had this really interesting comparison of Madison Gas and Electric to Baltimore Gas and Electric. And can you just describe that example, because I think it’s a really good illustration of what’s been happening.
|Scott Hempling:||Madison Gas and Electric is an example of the opposite of the merger concentration trend. Madison Gas and Electric serves the relatively small city, the capital of Wisconsin. It’s got a simple corporate structure. 99% of its revenues come from ordinary plain vanilla electric service or the type we’ve all had since birth. 1% of its revenues comes from what we loosely call non-utility services. But even those non-utility services are energy related, like helping the local university startup its own micro grids, its own solar energy panels. So, it’s a simple corporate structure with two layers, there is a holding company at the top, but the utility itself is the 99%, a subsidiary and it has been that way for probably 50 or 60 years. Now, in around 1980, Baltimore Gas and Electric, BG&E, looked just like that. A simple electric company serving the Baltimore area.
Today, Baltimore Gas and Electric is one of nine utility subsidiaries of the holding company Exelon. Exelon has not only nine utility subsidiaries, it has about 325 other subsidiaries. Subsidiaries in coal generation, in gas generation, in nuclear generation, in what we call merchant generation, generation at risk, it has a set of trading subsidiary, it has wind, it has solar, it has renewable. It’s fundamentally a fossil fuel company with over 350 subsidiaries. And so when you look at the corporate diagram, you can see Madison Gas and Electric right smack in the middle of the page. When you look at the corporate diagram of Exelon, you have to hunt to find Baltimore Gas and Electric down there, a small box in the lower left hand corner.
And the results of the last 35 years of mergers in the electric industry is that today, most utilities are part of a complex, multi-layered corporate system like Exelon of which BG&E is only a 9% part and approximately only 20 and of what we were about 200 utilities 30 years ago. Only 20 out of 200 from 30 years ago remain independent and small like Madison Gas And Electric.
|John Farrell:||I just think that this is… It’s such a stunning thing for most people who just interact with the electricity system as a customer and they don’t even have to pick an electricity supplier. Most folks aren’t even having to select electricity supplier, they just move into their home or apartment and they call the one company that provides it and they sign up for it and they get their bill. And the name on the bill may or may not match the name of that big umbrella corporation. So many people I think don’t really appreciate the degree to which the market for electricity is so different than everything else that they’re used to.|
|Scott Hempling:||Well, when you think of the two things that we’ve talked about so far, there’s a real irony in the dissonance, because on the one hand, we have technology and consumer preferences heading in the direction of decentralized, local, customer controlled, neighborhood controlled power sources. And in sharp contrast, we have a trend of consolidation, concentration and complication of an industry over the last 35 years. And I wonder how many people, not just citizens, but professional regulators even understand the dissonance between those two trends and also the inherent conflict, because the more that a holding company piles up control of assets, the more resistant it will be to the very trend that we’re trying to encourage which is more local, more decentralized, more customer controlled. And it’s almost as if regulators don’t realize that on the one hand, they’re pursuing decentralization. And on the other hand, they are waving on through these major acquisitions that have potentially the opposite effect.|
|John Farrell:||Let’s talk a little bit more about how big of a trend of this is too for folks to understand. So, we have… I think you’ve laid it out really nicely here, this trend one way in terms of technology and consumer preference, which is for local and smaller and yet you have this trend in the larger economy frankly, not just in electricity business towards consolidation. Folks tend to hear about big mergers and understand them in other areas of the economy. I think about T-Mobile and Sprint. So, these are big brand names, folks are very familiar with choosing a cell phone provider. Those mergers have their own issues of course. Your book is going to be looking at the problems specifically of mergers between, of and by electric utility monopolies. Could you explain a little bit? How did this trend end up coming into the utility business? And I think you already mentioned it, but could you just emphasize how many fewer utilities we now have than 20 years ago, for example?|
|Scott Hempling:||Yeah, as I said, the trend really started in the mid 80s. Let’s go back to the beginning of the 20th century. At the beginning of the 20th century, there were hundreds and hundreds of very small municipally based utilities. There was a huge consolidation of those during the 1920s and the early 1930s, so that by approximately 1934, there were 13 holding companies that controlled all of the hundreds of other companies. 13 regional holding companies, whose subsidiaries assets, business operations were scattered throughout the country. These acquisitions occurred not because of engineering logic or financial logic or economic logic, these were acquisitions that were done simply to pile up wealth. Well, what happened is that investors lost a great deal of money because it turned out that the methods of acquisition, the means of financing them, their reasons for ownership were so distant from public interest values, that the industry essentially collapsed in terms of its financial trust. Investors took great losses, there were abuses, because you would have in one holding company system, a mixture of high risk businesses and then the traditional utility company.
And because electric customers were captive, they found themselves paying in their rates for costs associated with all the financial risks in all the non-utility businesses. So Congress in 1935, passed a truly groundbreaking statute called the Public Utility Holding Company Act. And it broke up these companies, not overnight, it actually took 15, 20 years. It took until the 60s or so for these 13 holding companies to be broken up into the 200 or so small, local, integrated utility companies that we had as of the early 1980s. Now, when I say integrated utility company, what the statute meant and what we meant, it goes back to that concept of natural monopoly. The concept of integration was, let’s make sure that the combination of assets and business operations that exist within a corporate family, have engineering logic, have economic logic, have logic that is channeled toward producing benefits to the customers.
There was a famous phrase in the statute that prohibited all acquisitions in the industry, unless they “tended toward the public interest by evolving toward the economical and efficient development of the industry, economical and efficient development.” That was the test that an acquirer had to pass in order to make an acquisition. And so, as of about 1980, you had a series of 200 or so utilities that met that integrated public utility system test. Financial logic, economic logic, engineering logic, associated with each of those companies. And then the trend began. Then the trend began. Why? Part of it is what we know about regulation, is that when regulation is passive, when it’s deferential, when it’s uninformed by a vision for the public interest, when it treats its constituent as the entity to be regulated rather than the public to be protected. What you get is a supermarket, where utilities would come in and I’m now referring to the Securities and Exchange Commission starting in the mid 80s, which began to say “Yes, yes, yes.” Whereas before, it would say “No, no, no.”
|And so people got wind that you could acquire a company, the company’s selling could make a gain by selling its control, the company acquiring… Who wouldn’t want to own a monopoly? The company acquiring gets a monopoly profit and a secure revenue flow. And people got the idea that this was easy. And of course, if your neighbor has just merged with somebody, now are you worried, “Well, they’re bigger than I am, maybe I better merge with somebody.” And so there was literally a keeping up with the Jones’s idea where shareholders would say, “Hey, so and so just got a big gain from being bought out, how come our company’s not being bought out?” And so the trend began that way. To keep the story relatively short, Congress eventually decided in 2005, to repeal the statute. And so now there is no federal statute that requires mergers and acquisitions to be consistent with that public interest standard that I mentioned, the economical and efficient development of an integrated public utility system. And the trend just continues one after another.|
|John Farrell:||We’re going to take a short break. When we come back, I ask about the standards regulators use to approve mergers and how they fall short; and how advocates need to think about mergers and utility market power as they advocate for state 100% renewable energy policies.
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Scott, one thing I think might be helpful for folks to understand is that, this tendency towards consolidation really happened then at the same time in the electric industry that it started in the rest of the US economy, that we saw especially in the 70s and 80s, a shift from the standard of public interest particularly, what had come out of the New Deal. There’s a famous congressman… Well, famous to those of us who spend time on economic theory and consolidation Wright Patman, who was really focused on the political power of merged companies and the idea that things could be too big to be healthy for a democracy. And that was thrown out the window for a more consumer focused standard, sort of famously in a way promoted by Ralph Nader and others who were really focused on the cost for the customers and less focused on some of these other implications.
So, let’s bring this back to the electricity business here. When regulators are assessing these merger transactions, you already talked about here that Congress basically threw out the statute that gave some guidance about or some rubric for regulators to follow when evaluating these mergers. Is there a different standard that we should be holding electric utilities to than businesses and competitive markets when we’re talking about consolidation?
|Scott Hempling:||It’s interesting you talk about competitive markets. I’ve long argued that there’s nothing wrong with competition, as long as people behave like competitors, as long as there are many competitors, as long as the interests of sellers are aligned with the interests of consumers, nothing wrong with competition. And so, I’ve always felt that in the electric industry, that should be our standard, that when we judge the performance of our monopoly utility, whether it’s in their rates, their quality of service, we should judge them according to what would the outcome be if we had effective competition. And the same goes with mergers. I’m not against mergers, I’ve often been told by opposing witnesses that Hempling opposes all mergers. What I oppose is the mergers that are not disciplined by competitive forces, the mergers that are not disciplined by performance being the priority rather than the acquisition price being a priority. My view is that, the more I oppose on economic illogical mergers, the more room there will be for logical economic mergers, the ones that actually serve the public interest.|
|John Farrell:||What I hear you saying is that in some ways, it’s really not a different standard in the sense that when we look at mergers in competitive markets, we look at these issues about how competitive will the market could still be? Are consumer interests still protected? Is there as you said, an alignment between the interest of sellers and customers? And that we need to apply that same logic to even these monopoly mergers hoping for the similar outcomes. Is that right?|
|Scott Hempling:||That’s right. Although, let’s refer to a point you made earlier about non-economic values. The typical regulatory statute at both the federal level and the state level requires that a merger be consistent with the public interest. The question is what is the public interest? There’s a famous case, NAACP, National Association for the Advancement of Colored People, versus Federal Power Commission. This was back in the 1970s. And the NAACP petitioned to the Federal Power Commission for a rule prohibiting racial discrimination by public utilities. And the NAACP said to the courts, “Look, the statute says that utilities have to act in the public interest and what could be more consistent with the public interest than prohibiting racial discrimination?” Well, the courts actually, the Court of Appeals and also the Supreme Court threw this out. And they threw it out because when we define the words public interest in a statute, we have to stay within the purpose of the statute. And what they said was that the purpose of the regulatory statute for electric utilities is economic performance, it’s not about racial justice. “It’s not that we don’t care about racial justice, is that that’s not our purpose.”
Now, I have some quibbling, more than quibbling with that particular decision and I’ve written about why at a technical level the decision is correct, but at a practical level, there is much we can do to make the industry more diverse. But putting that issue aside, that very current issue aside, let’s talk about what it means to do something in the public interest in our industry. Well, the public interest is not just about rates, it’s not just about safety, it’s not just about reliability. Isn’t it about responsiveness to the community’s needs? Isn’t it about looking to the future and saying, are we decarbonizing? Are we diversifying? Are we preparing for the day where our expectation that the lights will turn on every time we want them to won’t happen because of a terrorist attack because of a cybersecurity attack? And so the public interest needs to be thought of as something much broader than just economic and financial performance. I still think that the notion of holding utilities accountable to a competitive outcome is the right standard. It’s that we need to decide what is the purpose of the competition, what is our purpose.
And so… Well, I don’t as I’m just a noble doctor, I don’t get into the political control business, you’re right that political control is an accompaniment to economic control and if I put it though in terms of responsiveness to the customer’s needs and responsiveness to the community’s needs, I can talk about the public interest in my industry without becoming a political pundit and talking about political control.
|John Farrell:||I think it’s really interesting here, that you brought up that particular case in the way that it narrowed or I guess, reinforced the narrow interpretation of public interest. In your monthly essays, you write about these electric industry mergers and you highlight that state and federal regulators have a pretty low bar for approving a merger. And what is the standard that they are applying? Is it really just this economic issue? And what is it… Maybe even more interesting than that, is how does that standard… What implications does it have for the utility shareholders for example, on the one hand, the investors versus the utility customers?|
|Scott Hempling:||If regulators truly applied a purely economic standard, we would have had a lot fewer mergers than we have right now. Let me explain why. Let’s contrast the investor’s attitude with the regulator’s attitude. What does an investor seek? Maximum benefit to cost ratio. Actually, that’s what we all seek. When you go try to buy a car, you don’t say, “I’m going to pay $25,000, so I want to get $25,000 of value.” If you say that, you’re no better off, you want to pay $25,000 and you want to get $35,000 of value, because you value certain things, whether it’s the speed of the car, the color of the car, the look of the car, its environmental attributes. An investor, a consumer, anybody rational, looks to maximize the relationship of benefit to cost. That’s how the economy thrives, that’s what people get better off.
That’s what the acquirer of utility companies seeks, maximum benefit relative to cost. That’s what the seller of the utility is looking to achieve, maximum return on their investment. So, you would expect that a regulator in assessing mergers will ensure that the merger they approve is the one that provides the most benefits for the customer relative to the cost to the customer. And that is not the standard that any regulator has ever applied. The standard that regulators apply is essentially the standard of, “Don’t do me any harm.” Now, put those two things together, if you’ve got a set of shareholders that are maximizing the relationship of benefit to cost and you’ve got a regulator that’s saying, “Don’t do me any harm,” where do you think all of the gains from the transaction are going to go? They’re going to go to the shareholders, they’re not going to go to the customers. Now, I’m not going to start a war here between shareholders and customers, because it’s always been my view that the legitimate shareholder expectation and the legitimate customer expectation, these are all aligned. Customers need healthy companies, companies need satisfied customers.
There’s no reason to have a customer versus shareholder oppositional relationship, when everybody is seeking what is legitimately due to them, but when a regulator says, “Just do me no harm,” instead of saying, “Get me the best performer for my customers.” That is the essential problem that we have. And the roots of that, to me are not mysterious. There’s a passion gap. Investors just care a heck of a lot more about making money than regulators seem to care about protecting their consumers. It’s a differential in determination. And for me, it’s the biggest reason why we have through regulation approved these things. Because if the regulator was saying, “I will judge this merger based on whether it will be the best performer for the service territory,” then the competition among the potential acquirers will be about performance. It’ll be about merit. But right now, what is the competition about? Well, you’ve got the target company doing what? Literally working the phones seeking the highest price. And I have this from narratives that have been stated by companies to the Securities Exchange Commission. They have to prove to their shareholders that they’ve gotten the highest price.
|And so there’s literally narratives of the CEO working the phone saying, “I hear 55, can I get 60? I hear 60, can I get 63?” And so what you’re getting is an audition not based on merit, but on who can pay the most, which in a non-competitive market is not going to be the best performer. And that’s a big reason why we have what we have. The result is economic waste. It hurts everybody.|
|John Farrell:||Scott, why do you think it is that there is this passion gap as you described between investors who care obviously a lot about it and regulators? Why are regulators not as passionate maybe about supporting the public interest? What’s going on here?|
|Scott Hempling:||People talk about corporate power and how it overwhelms the political process and the regulatory process. I don’t buy it. I don’t buy it. I know too many people in regulation who make decisions that are the wrong ones, not because they’re scared of some powerful entity, but because they’re under informed. More specifically because they don’t have a vision. Let’s go back to the Public Utility Holding Company Act. It’s standard, that an acquisition had to serve the public interest by tending toward the economical and efficient development of an integrated system set a standard. And if I put into a statute a standard that said, “This acquisition must display and produce the highest possible benefit cost ratio for consumers.” And if that was my statutory vision and if I then, as a regulator said, “Let me pursue that vision by setting up by set of questions that the company has to answer before I will even think about their acquisition.” And so what I now have is a standard, a vision and a set of screens. If I have all that in place, it’s like a basketball player on defense.
If you position yourself in front of the basket, you’ve established a block and nobody can roll over you without committing a foul. But if you’re having done that, if you’re just being moved around by the other person, the other person is going to score that basket. And that’s what happens. So, what do I mean by vision? It’s a loose term and I don’t mean to make such a vague comment. Well, what a regulator has to have in mind is, what are the products and services that my community needs? What are the performance attributes that are most likely to produce those products and services cost effectively? What is the type of company whose CEO and shareholders will be behaving in a way that will assist the development of the skills that are necessary to produce those outcomes? And then does this acquire or qualify?
And I have asked and asked and asked of colleagues in the regulatory business commissioners, what is your vision for performance in the industry? And very few people have one. And it’s into that vacuum, that comes a very simple logic on the part of the target company, “Who’s given me the higher price?” And on the part of the acquirer, “How lucrative will the service territory be?” Those transactions succeed because of the vacuum left. The void left, because regulators tend not to have visions. Here’s the way it put it and I wish this was funnier than it sounds. But I will often ask regulators that they should have a merger policy and I get one or two answers. One is, “Well, we have a merger pending, so we can’t talk about it.” And the other is, “We have no merger pending, so we don’t care about it.” And I’ve been asking that question for 35 years, don’t you want to have a merger policy? And I’ve getting that same answer. And that’s a big reason why we have what we have.
|John Farrell:||What do you see as some of the things that we can do to fix this? So, you just articulated how important it is for state regulators or federal regulators to have some sort of vision absent there being a merger pending in front of them right now. But some sort of independently defined performance standard or vision for how the system should work. Are there other things that would really help?, Do we need to define that for example? Does the legislature need to define that for regulators? Or is that generally an ask we should be making of regulators? I know there are other things that we need in order to make this process of mergers better serve the public interest.|
|Scott Hempling:||Much of this thinking is already being done by forward thinking regulators. Let’s be optimistic. There’s no question that green is taking hold. I’ve been doing a lot of work in South Carolina lately, you would not necessarily have associated a state that is nuclear heavy and coal heavy and gas heavy with renewable energy. But South Carolina has got a serious conversation going on about greening. Utilities that were four years coal oriented are now talking green. So, there is… I won’t say is a consensus, but there’s a strong trend toward thinking green. People care about safety, people care about diversity, people do care about small, people do care about reliability, resilience, storms, cyber attacks, terrorist attacks. When you think about it, nobody is sleeping, either the concerns or the solutions under the rug. What’s missing is policymakers, both legislators and regulators who are combining all of those urges into a plan for industry structure. It is, I’ll say it again, the least studied, but I think most important subject in regulation is industry structure. And what I mean is, who should the players be and what are they selling?
So in a sense, we often have the ingredients of a vision, but we don’t have the process by which we pick and choose who’s going to be carrying out that vision. And it does go back to something I said earlier. If for a century, you’ve been comfortable with monopolies because it’s worked. The fact is, that the United States electric industry has been recognized by engineers as the engineering accomplishment of the 20th century, there is much to be proud of about our industry. We do have lights on all the time. And so when you’re comfortable with the industry that you have, number one, number two, when the typical utility regulator is in office for fewer than five years, when the typical utility regulator is a humble human being, who doesn’t think they have any business, changing the whole industry structure during their short five years.
When you have regulatory staff that are paid roughly one third or less of what their counterparts are earning in the industry, when an awful lot of them are my age and retiring because they got hired in the 70s and 80s, so they’re headed toward the mid 60s and 70s now And you have many newcomers who aren’t familiar with the relationship between industry structure, market power, monopolies and the opposition to diversity. You have all the institutional ingredients for a continued inertia. And so, my argument to you is that it’s less about having the ingredients in place, it’s more about putting them into a strategy and supporting that strategy with a political infrastructure and a regulatory infrastructure that will support the difficult decisions that are ahead of us. And I don’t think continued concentration and complication of the industry, a trend that is 100% opposed to the diversity and decentralization that we want to see is the right direction.
|John Farrell:||So I want to wrap up by asking you about how states are doing some of this vision setting. We have Virginia and New Mexico prominently in the last 12 months adapting 100% clean energy standards that will apply to their largely monopoly utilities. And a lot of these policies are built in the style of state renewable portfolio standards before them. In other words, they’re relying on these incumbent monopolies to meet the new mandates. You have I think really, really well articulated the danger of continuing to allow consolidation to happen in terms of market structure in opposition to the vision and the interests of customers in decentralization. Do you see in some of these policies, do you have a similar concern about or maybe opportunities that might be missed in relying on the incumbent utilities to take us through this clean energy transition?|
|Scott Hempling:||Yes. The error is to think performance and performer. Like I said, at least in the context of green, we know about performance. When somebody says I want 100% renewables by the year 2030, they’re identifying performance. Now I’m a classical musician, if a conductor says, “I want a new clarinet player because I want to hear more from the clarinets.” The next question is going to be, how are we going to get the best clarinet player? The answer to that question is not let’s just stick with whoever we have, right? The question is, how do we get the best person? And by saying that, what do you do? You create a whole ripple effect all the way down to high school students like I was practicing four hours a day, you go to schools that have auditions to get in there. World class teachers at these music schools that screen out the students who are only okay and keep only the ones that are best and then you have orchestrators that hold auditions.
I’m overstating my classical music point, but that’s the difficulty that we have in our industry, is that we don’t connect our desire for performance with a process by which we ensure the performer. And it’s a short term error because we think that only the local company can do this. And here’s the related error and the opportunity. The fact that the local company is there doesn’t mean it’s the best one to do what we’re talking about. Look, if we were asking for something conventional, just keep the lights on. Maybe there’s an argument for keeping the same old person here. But what’s fascinating about today is everything we’re asking for is brand new. Storage, micro grids, solar, wind, demand response, energy efficiency. These are all new things. We can be looking for new people to get them. And so, the dangerous trend is that we’ll get these things, but we won’t get them at the lowest possible costs and the best possible performance. And then what happens? Then the public sours on the concept and then you lose the political support for exactly what you wanted in the first place.
So to repeat the point, couple the desire for performance with a plan to get the performers. Use competition to get the best, have a standard that always insists on maximum benefits for the cost and now we’re having regulation replicate the forces of competition that everybody wants.
|John Farrell:||Scott, that was beautifully put. I think it’s funny too. I was just thinking as you were describing this problem of performance versus performer that we seem to be in the electric industry in particular, guilty of. I think it was Einstein said that the definition of insanity is to keep doing the same thing over and over again and hoping for a different result. And what you’re getting at there is by not confronting that question, basically inviting that problem by inviting this insane nature to expect that the company just because they’re there will be able to do all of these different things. And they continue to rely on them would be a mistake. And not to say that they can’t do some of these and we have seen some really interesting innovation like Green Mountain Power in Vermont comes to mind a lot when we talk about how the incumbent performer can in fact give us the performance we might want. Well, great questions to fuel those further conversations. Scott, thanks again for joining me for this conversation. I really appreciate it.|
|Scott Hempling:||It’s my pleasure and thank you for the work that you’re doing.|
|John Farrell:||Well, I’d be remiss if I didn’t mention that Scott Hempling, a lawyer, an author and with 40 years of experience in utility regulatory business will be releasing a book very soon on utility mergers and consolidation in the electric industry. If you haven’t already read some previews in his monthly essays, I highly recommend getting on his list and looking for that book when it comes out. We’ll have links to some of that material in the show notes and on the show page. Scott, thanks again. It was great to talk to you.|
|Scott Hempling:||Thank you.|
|John Farrell:||That was Scott Hempling a lawyer, expert witness, law professor and author of the forthcoming book Regulating Mergers and Acquisitions of Public Utilities: Industry Concentration and Corporate Complication. We spoke in July 2020 about the ways public regulation and electricity market structure need to change to deal with the divergence of the public interest from the behavior of monopoly electric utilities. You can get a preview of Scott’s book from his monthly essays, published on his website – scotthemplinglaw.com – and linked on our show page. You can learn more about the problems of utility mergers from ILSR’s 2017 report on Mergers and Monopoly as well as our recently released State and Local Policy Guide to Fighting Monopoly.
While you’re at our website reviewing this and other resources, you can also find more than 100 past episodes of the Local Energy Rules podcast.
Until next time, keep your energy local and thanks for listening.
Introducing Competition After a Century of Control
Scott Hempling has nearly 40 years of experience working on utility regulatory issues as a lawyer, expert witness, law professor, and author. Through his research and practice, Hempling is a foremost expert in regulatory policy and the landscape around utility monopolies. His monthly essays and books where he digs deeper into the policy can be both be found on his website.
A “natural monopoly” is a service or product that gets cheaper as the market grows. Hempling says that the idea of a natural monopoly has changed dramatically in recent years and that many have lost sight of natural monopoly’s place in energy markets.
In the past it made sense to monopolize utility services, but does it make sense now? Considering the ever-increasing access to solar energy, co-op and neighborhood power, and independence from electrical utilities, where can we afford to compete? Hempling addresses these integral questions on the future U.S. energy landscape.
Drawing a comparison to elected officials, Hempling says there may be a need to introduce competition in utility contracts to ensure that utilities do enough for customers. Many companies have “a century of control” over a market that has never been challenged, due their natural monopoly status.
[A] monopoly will do everything it can legally, and sometimes unlawfully, to protect that monopoly.
Utilities Combat Competition
Hempling explains that monopoly utilities fear the growing impact of distributed energy opportunities on their bottom line. In the face of direct challenges, monopolies react in one of three ways:
- Block everything by lobbying legislators or regulators under guise that new competition will hurt the consumer.
- Take the “if you can’t beat them, join them” philosophy and take over the organization of micro grids, solar arrays, etc.
- Finally, some monopolies will play along, yet make the path to community energy more difficult by introducing insurmountable financial and logistical barriers.
Farrell mentions the example of Xcel Energy’s community solar program. Xcel advertises its community solar program as the country’s largest, while actively working to kill the program through legislation.
Hempling Testifies Against Utility Mergers
Utility mergers are on the rise and have been since the 1980’s. The subject of much of Hempling’s work in the courtroom and at the writing desk, mergers create a convoluted power structure in utility companies and block community power from growing.
Hempling says that there are two opposite forces at play: the consumers seeking decentralized, renewable, cheap power on their own, and the utility giants inflating their acquisitions and limiting community input.
There’s a real irony in the dissonance, because on the one hand, we have technology and consumer preferences heading in the direction of decentralized, local, customer controlled, neighborhood controlled power sources; and in sharp contrast, we have a trend of consolidation, concentration and complication of an industry over the last 35 years.
There is a certain role that regulators play in this process, Hempling says, simultaneously encouraging “more local, more decentralized, more customer controlled” energy, while still permitting massive mergers of giant utility commissions.
The difficulty that we have in our industry is that we don’t connect our desire for performance with a process by which we ensure the performer.
Listen to Episode 104 with Maggie Shober of the Southern Alliance for Clean Energy to learn about their efforts to combat one of the biggest monopolies in U.S. energy.
How Did We Get Here?
The effort to consolidate the electric utility industry didn’t start in the 80’s, Hempling explains.A consolidation of over 200 local municipal utilities under just 13 holding companies during the early 1900’s prompted Congress to draft the 1935 Public Utility Holding Act.
The act halted consolidation in the market for a while, but the U.S. utility industry began consolidating again in the 1980’s. Hempling says that a large part of the problem were the passive, often deferential regulations that lost sight of their mandate to protect the public interest.
There’s nothing wrong with competition as long as people behave like competitors, as long as there are many competitors, as long as the interests of sellers are aligned with the interests of consumers.
To discover ways that communities can beat back corporate control in the electricity sector and beyond, explore our new guide to Fighting Monopoly Power.
Evaluating Utility Consolidation
Hempling says that the value of these mergers and other power grabs by utility companies should be judged by what the outcome would be if they had effective competitors in the market. He makes a point of saying that mergers aren’t always unnecessary, it’s when they’re not seeking the public interest that these purchases and consolidations become unneeded.
Hempling and Farrell refer to the possible “non-economic values” that are within the public interest. In the 1970s, the case of the National Association for the Advancement of Colored People (NAACP) vs. the Federal Power Commission brought this question forward, with the NAACP arguing that racial discrimination is directly against the public interest. The power commission said their focus was on economic performance first and won the case, a decision that Hempling has issues with. He concedes that on a technical level the ruling is correct, but admits that he and many others realize that it is very detrimental in practice.
In fact, Hempling unpacks the growing, changing concept of ‘the public interest’ and says that there is a much wider definition beyond economic performance alone. People need protections from future threats like climate change, and they need responsiveness from these services. Where the public interest ceases to be served is through what Hempling calls “a passion gap” –the investors care more about making money than regulators care about protecting the customer.
What you’re getting is an audition not based on merit, but on who can pay the most, which in a non-competitive market is not going to be the best performer. […] The result is economic waste. It hurts everybody.
There’s a certain amount of ambivalence around mergers from regulators that makes utility regulators ineffective evaluators when a utility comes to them with a request, says Hempling. The changes the industry needs to see is a transition to performance-minded thinking that addresses more than the economic issue, but the social, access, and other issues through an active regulatory process, too.
I don’t think continued concentration and complication of the industry, a trend that is 100% opposed to the diversity and decentralization that we want to see, is the right direction.
See these resources for more behind the story:
- Our 2020 report exploring an alternative to electricity monopolies, Community Choice Energy
- Our 2016 report that explores Is Bigger Best in Renewable Energy?
For concrete examples of how cities can take action toward gaining more control over their clean energy future, explore ILSR’s Community Power Toolkit.
Explore local and state policies and programs that help advance clean energy goals across the country, using ILSR’s interactive Community Power Map.
This is episode 109 of Local Energy Rules, an ILSR podcast with Energy Democracy Director John Farrell, which shares powerful stories of successful local renewable energy and exposes the policy and practical barriers to its expansion.
Featured Photo Credit: Mike_fleming via Flickr (CC BY 2.0)