Stopping the Spread of Monopolies — Episode 195 of Local Energy Rules

The generators, the transmission wires, the substation, the distribution wires, the service line to the home, the meter, all of that is owned by single firms. And regulation basically in starting in 1907 with state PUCs and then moving forward has kind of enshrined that vertically integrated business model and put legal boundaries, legal territorial boundaries around them all. And the idea is because this infrastructure is so capital intensive, but it also reduces production costs so much that you have what’s called economies of scale that for a given market, given size of demand, the least cost way to produce electricity was to have a single firm do it. And of course, from a regulatory perspective during the populist era in the U.S., that set off the warning bells of, but hey, then that firm can price like a monopolist and we don’t want that, so we’re going to regulate them.

So regulation is trying to hit that sweet spot of getting that regulated rate that consumers pay to be right at the average cost of the utility. So we start vertically integrated, but then of course, so think of it as you set the timer in 1907 and then roll forward, and as you roll forward, there’s technological change that happens. So our origins in this industry are very large scale and very predisposed economically towards having centralized generation, large scale wires networks. But since the 1980s with the combined cycle gas turbine, and then more recently with rooftop solar and batteries and other smaller scale innovations, technologies are now economical and cost effective and provide different value streams at smaller scales, right? It is not an apples to oranges comparison. They’re very different from the big coal plant, the big hydro plant. And so you get this decentralizing smaller scale technological change.

And then of course in the mid nineties, which we started really implementing in electricity in the mid two thousands, you have the development of digital networks, so digital communication networks, broadband, the internet, wireless and so on. So you put all those together and you have these very strong decentralizing tendencies. And in the case of electricity, where do you still have the economies of scale and scope that characterize what we call a natural monopoly? In economics, it’s in the wires network, but in generation, smaller, all these different scales and different value propositions can compete against each other. And in retail, all these different value propositions can compete against each other. From a regulatory economic efficiency perspective, you want to quarantine the monopoly and not have the incumbent monopolist be able to exert some anti-competitive force in upstream or downstream markets.

And this actually hooks into the reason I mentioned telecom earlier is that this principle showed up in the 1980s in the antitrust lawsuit against AT&T, right? The bell, the breakup of the bell system. And so the assistant attorney general for antitrust at the time, Bill Baxter, so this is known as Baxter’s Law, but it’s also known as quarantine monopoly. He basically said, if you have an incumbent regulated firm and it can have an anti-competitive effect on an adjacent market, don’t let the incumbent firm compete in that market. And this was one of the main analytical justifications for the AT&T settlement. So now let’s take that to things like rooftop solar or EV charging. A few years ago in Florida, the Florida utilities were like, sure, we’re fine with rooftop solar as long as we own it. Like, okay, Solar City and Sunrun and Sunnova would like to have a word because there is an existing market that if you come in and compete against them as the incumbent, that could have very strong anti-competitive effects. And we’ve seen this in the restructured states in the U.S., the states that implemented regulatory restructuring in New England, the mid-Atlantic, Ohio, Illinois, and so on, that the only state that really has implemented good retail competition is Texas because the other restructured states have retained incumbent default service. So you can stay with the incumbent utility or you can go to a competitor, and this is a big entry barrier for retail competition. So now let’s apply that to EV charging where we have a good half dozen growing private innovative entrepreneurs in this industry. What effect would it have for Xcel or other regulated utilities to come in and build EV charging? It’s going to have an anti-competitive effect on a competitive industry that already exists, even though it’s nascent, right? It’s young.

And of course that’s a deliberately vague concept and has been in the common law for centuries, but at least in the U.S. it’s enshrined in the Munn versus Illinois 1877 or 1887, losing my dates, lawsuit that basically established the legal justification for regulation in the public interest. So I think that’s one argument. There’s of course a whole lot of concern and analysis from public choice economics about the independence of regulatory decision-making with respect to utilities and undue utility influence and maybe if not on the regulators then on state legislators. So there are two different potential focal points for industry influence in a public choice setting. So I would just say that caveat about the regulatory accountability, but one thing that I think would be a reasonable compromise would be because the private EV charging companies are going to want to build out their network in places that are going to be profit maximizing for them.

So they want to build in places where there’s a lot of traffic, there’s a lot of circulation, lots of people who have cars, who have EVs, and you can already see the way Tesla has built it out where they’re at big box stores and hotels. And I think that that’s a good indication of the kind of places in addition to existing service stations where you would expect to be able to see a build out of a private charging network. And it was funny, about three years ago, the first time somebody raised this question to me, and I hadn’t really thought about it very deeply, and it has I think just developed ever since, is the question of equity, energy justice questions, right? That if you’re a for-profit firm, are you as likely to build EV charging infrastructure in low-income neighborhoods where people may not necessarily yet have EVs, but you have the chicken and egg problem of do you build the infrastructure first or do you have the car ownership first? And we had this with the build out of gasoline stations in the early 20th century as well. The chicken and egg problem is unavoidable and they have to, they’re going to interact and evolve in co interaction. So one compromise can be allowing the utility to build EV charging infrastructure and put those assets in their rate base in neighborhoods that are identified as low-income energy justice focus locales. And that seems to me to be in keeping with the regulatory mission of serving the public interest but without harming competition.

I guess what I’m thinking about is, it’s interesting because the way you described it, you’re like, well, these for-profit companies are going to be profit maximizing. And I’m like, well, the utility is a for-profit company too, so they’re going to be profit maximizing but in a different way. So the private EV provider is going to profit maximize by being somewhere where they can capture as much charging revenue as possible. So they’re going to want to make sure they build in a good location and that their uptime is really good so that they’re available for people to charge the utilities incentives on the other hand are I build it and then I get my rate of return on it. And so my concern is yes, they would build charging in places we might need it, but would those chargers be working? How do you deal with some of those kinds of incentives? And so few utilities I think are really motivated on the customer service side.

That is a really important aspect of building out the EV charging network and doing the investment and planning the investment and thinking about the return on investment that you’re going to get. One interesting thing to do is to do international comparisons of this. I was recently in the UK and in a large city like London, everybody parks on the street, but basically every other lamppost has a charger in it now and there are quite a few electric vehicles. I mean, it’s still in the single digits in terms of percentage of the market, but it’s a growing share. So I think the maintenance question is really important regardless of who the provider is. And utilities probably have less of an incentive, but I would for me, since I kind of steelman the utility ownership argument, now I’m going to go back to the private market argument, which is where I would argue we should be. The biggest argument against utility ownership of EV charging infrastructure or anything else that is around the edge of the distribution network is for me, the dynamic innovation argument.

Because if the utility is going to own the asset, typically the regulatory process defines the asset, defines the quality of the service, encases that in amber and then implements, the utility has to implement that and they’re held accountable for that. So if you think that we have gotten to the superior end state, final be all end all fabulous, best ever EV chargers that are ever going to exist on the planet, then having the utility be the owner and operator is not going to have as much of a cost. But if you think that there’s going to be more innovation and you think that we have not come to the be all end all end state of EV charging technologies, having utility ownership and operation of EV charging will slow down the innovation processes because of the restrictions that regulation puts on them. It’s much easier for a Tesla and an EV Go and all of the different companies to be rivals in developing their technologies and trying to figure out what is it that’s really useful, where can we put these that would be the most useful because for them to make a profit from doing it, they have to put themselves in the mindsets of their customers in a way that utilities don’t necessarily.

But at the same time, it also has some implications on the trajectory of innovation and technological change. And so I think if you want to enable technological dynamism that the economics of the regulatory restructuring are the way to go. So I would say my preferred model is the Texas model where you’ve quarantined the monopoly in the wires and you’ve got competition on both sides. So the wires is the regulated things sandwiched in – I should caveat all of that to say of course, the past two years have been fraught Texas for the mid-Atlantic states with winter storms and then obviously in the plains states and then down into Texas with summer challenges. So all of this is not to say that take the Texas, the Texas restructuring as implemented in 1999, encase it in amber, that’s what we should do. No, it’s take the Texas restructuring that we did in 1999 and recognize the fact that that model itself is also not perfect and really needs to the market design and the market rules and the regulation have to be able to evolve to changing conditions.

And I think with the reliability challenges that we’re seeing in markets as well as in vertically integrated states, we’re seeing that both market designs and regulatory institutions have not evolved to account for some of the reliability challenges associated with more wind and solar on the grid. So to answer your question, I think utility scale solar in my ideal world would not be owned by utilities. It would be like in Texas where you have big independent companies and then they transact in the wholesale market. You have retailers who buy from them, and a lot of what they do is on long-term contracts. And that is what gives you the assurance and the affordability for the customers of those retailers. And so it’s a both and for me that you can have the large scale, but that the rooftop is actually, again, it’s an apples and oranges because a lot of people say, well, why are we even having rooftop solar? Because utility scale is so much cheaper. I’m like, that least cost mindset is completely the regulatory mindset, whereas rooftop is actually giving you something different from a value and preferences perspective. So on the demand side with consumer preferences, it’s giving you something different and maybe they’re willing to pay for it.

The cost-based argument against rooftop solar is kind of like saying, well, why do we all have smartphones? Because my princess phone back in 1987 was cheaper. It’s not a direct analog obviously because phones have evolved, but the value proposition of distributed resources is different from the centralized resources. And that doesn’t mean that we only have one or the other. It just means that we should draw some pretty clear regulatory lines between them. And for me, that means vertical unbundling.

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And so it was at a much smaller scale just to residential customers and so on. And then with the combined cycle gas turbine invention in the 1980s and some regulatory changes at FERC, at the federal level, natural gas was now a very economical and appealing fuel for generating electricity. And then add on top of that, the fact that it’s got half the carbon footprint of coal and so compared to coal, gas is like winner, winner chicken dinner on both economics and environment. And so you get this massive investment due to restructuring in the nineties in gas infrastructure, but that means that you now have a gas system and an electric system that have more interdependencies than A, they were built for and then B, they had historically. And then you add on top of that in Texas, and I usually am not this frank, but I’m going to be frank in this case, you have a big case of regulatory capture, which is the Texas Railroad Commission, and the stated mission of the Texas Railroad Commission is to support and develop the interests of the natural gas industry in Texas.

So their mission is to do what is good for the natural gas industry. And after the 2011 storm weatherizing, the gas production and delivery infrastructure was not something that the gas industry wanted to invest in because it’s a boom bust industry. Some years they have very small margins. Some years they have negative margins. The other thing that there’s not a lot of natural gas storage in Texas because it’s usually whenever anyone wants it, we can just pull it out of the ground and send it. And so if a gas company and electric generator have a firm contract for firm delivery, it’s usually not a problem. So we’re talking, this is really, really far out in the tail of the distribution, but it’s a problem and it’s something that I think there are a lot of policy conversations going on about how to deal with this interdependence, especially when you don’t have the regulatory oversight in one part of the interdependent systems that the other part of the interdependent systems needs to be able to rely on.

And one way that you put this was essentially, and again, this is a telecom analog that you need permission to connect stuff to the grid. The way the bell system operated was the same way that you needed permission to connect stuff to the grid, and there were a whole bunch of lawsuits in the 1950s challenging AT&T for basically saying you can’t put a cup over the phone handset to concentrate your voice. That’s an illegal attachment. Like what? That’s crazy. And so this idea of a standardized set of interconnections and that if you meet the technical standard for interconnection, you don’t have to ask permission, making the grid more plug and play. And that’s going to be more challenging because with digital bits, and it’s easier to queue because it’s essentially a direct current type system. So you can use switches and stuff more readily in an alternating current system that just plug and play has some more engineering challenges, and I know we can work those out, but that’s just going to mean it’s going to take some time.

But small generator interconnection, I know it has been a focus for like 20 years. Other device interconnection, the IEE has done a lot of work on things like digital inverters, plug your rooftop solar into an inverter because the solar panels produce direct current, but you have to connect it to the grid, which is alternating current, so you need an inverter. But having a digital inverter that’s basically plug and play. So we’re making progress on those, but I think it’s the mindset. It’s the mindset of interoperability and modularity and interconnection. That is something that would really help us make some more progress.

New Hampshire Electric Cooperative has introduced this year a transactive energy tariff that their customers can sign up to, and it’s a prices, two devices, transactive tariff, so it’s what we call a type one transactive tariff where NHEC will take the ISO New England price and push it to the people who are on the transactive rate, and they can choose what their trigger price, what they’re willing to respond to. I am working with my co-author at Slack, Dave Chapen at Slack National Laboratory, and with the Post Road Foundation, we have a DOE Connected Communities grant to work with New Hampshire Electric Cooperative to introduce a kind of type two transactive system where devices can bid, in addition to being able to respond to prices, that devices can bid in their willingness to pay if they’re a consumer, or if you’re a battery, you can set a willingness to pay price and a willingness to sell price.

And so you can charge and discharge out of your battery to help both to sell energy to other people, but also to help with grid services. So I think there are a lot of insights you can get from the co-ops. Some of them can be extremely innovative because they don’t have this additional regulatory layer, and so they can be a little more nimble. And so that’s, I guess my challenge to regulators is to ask yourselves, how can you be more nimble and how can you help your utilities be more nimble in the service of the public interest?