Direct Current vs. Alternating Current
In the late 1800s and early 1900s there was no such thing as an electric utility. Anyone could become an electric and lighting service provider. A provider could serve one customer, a few customers or a large community of customers. Prices for service were determined by private contract between supplier and consumer.
The first arrangements, pioneered by Thomas Edison, used direct current – meaning electricity flowed in one direction on the circuit. In Edison’s business model the direct current flowed a very short distance from a small generating unit to the lighting fixtures.
But Edison’s business model proved to be very inefficient. George Westinghouse pioneered a more efficient service model. He used alternating current and transformers to deliver electricity many miles from a remote central station generating station to multiple points of use. The competition between Edison and his direct current system and Westinghouse and his alternating current system came to be known as the Current War. See Post entitled The Current War. Westinghouse ultimately won the Current War and his remote central station generating facilities became the standard in the industry
The Emergence of the Monopoly Utility
Well financed suppliers built large efficient central station generating plants and reduced their operating costs. They undercut the prices of smaller suppliers and forced them out of business. By the early 1920s most communities were served by a single monopoly electric supplier. That supplier owned the generating stations that produced electricity and the transmission and distribution facilities that delivered the electricity.
The following Energy 101 video explains how electric suppliers used generation, transmission and distribution facilities to deliver electricity:
The Need for Government Involvement
The existence of a monopoly electric supplier caused some angst for both consumers and suppliers. Consumers wanted to prevent the investor-owned monopolies from charging exorbitant rates. And the investor-owned monopolies wanted to make sure that they could retain their monopoly status.
The investor-owned electric providers knew that they could not get away with charging excessive rates for long. So they considered giving up some control over pricing in exchange for some protection for their monopoly status. In other words, under the right conditions, they were willing to operate under government regulation.
The Regulatory Compact
Policy makers came up with a concept that balanced the interests of the investor-owned electric suppliers and their customers. They created something called the Regulatory Compact. Under the Regulatory Compact the investor-owned electric suppliers dedicated their systems to serve the public and they became public utilities.
The Regulatory Compact is basically an agreement between the utilities and the government. That agreement deals with both service and rates. The utilities promise to provide service to the public subject to government rate regulation. In exchange the government guarantees the utility a protected monopoly service territory and rates that cover its operating costs plus a reasonable return on its investment.
Virtually every state has now incorporated a form of the Regulatory Compact into its state Public Utility Act. Each of those Public Utility Acts creates a state agency known as a Public Service Commission or a Public Utility Commission.
Those state agencies establish utility service territories and rates for retail electric service. The service territories protect the utilities’ monopoly. And the rates for service enable the utility to recover just and reasonable rates defined as their operating costs plus a reasonable return on investment. See Post entitled How Do Regulatory Agencies Set Just and Reasonable Rates? for an explanation of the regulatory rate setting process.
In 1935, with passage of Title II of the Federal Power Act, Congress gave the Federal Power Commission (now named the Federal Energy Regulatory Commission) authority to set just and reasonable rates for wholesale sales between utilities. After passage of Title II of the Federal Power Act all activity of the electric utilities was subject to some level of utility regulation.
Who Owns the Electric Utilities?
Most of the early electric service providers were owned by private investors seeking to make a profit from their operation. Today, approximately 75% of the electric service is still provided by investor-owned utilities.
In many communities where there was no private investor providing service the municipality created a municipally owned electric utility. In some cases, municipalities created their own electric system to prevent private investors from owning the monopoly utility in town. Today, approximately 12% of electric service is provided by municipal utilities.
While electric service was available in most urban areas in the early 1900s, by the 1930s most of the rural areas of the country still did not have electric service. Rural residents could not enjoy the benefits of electricity and ran their farms like their parents and grandparents did. In 1935, with passage of the Rural Electrification Act, the Federal Government made low cost loans available for rural cooperatives to build the infrastructure needed to gain access to electricity. Today, these Rural Electric Cooperatives provide approximately 13% of all electric service.
By the 1990s policy makers determined that the generation component of electric service should be provided on a competitive, rather than a regulated, basis. Therefore, in 1995 the Federal Energy Regulatory Commission (FERC) issued its Open Access Orders requiring all utilities to unbundle their generation service from their transmission service and to provide non-discriminatory transmission to all generation owners. Since that time many utilities have sold their generation facilities and now own only transmission and distribution facilities. That part of the utility service, sometimes referred to as the “wires service,” remains subject to regulation under the regulatory compact.
Who Owns the Generating Facilities?
The IPP industry rapidly expanded after 1995 when FERC issued its Open Access Orders. Members of this industry stepped in to purchase the power plants that were being sold by the utilities. Most generating facilities are now owned by members of the IPP industry. These facilities are no longer regulated under the terms of the regulatory compact. Instead, IPPs sell their generated electricity into competitive power exchanges. See Post entitled Electricity Sales in the Competitive Power Market for an explanation of sales to these exchanges.
I. David Rosenstein worked as a consulting engineer and attorney in the electric industry for 40 years. At various times during his career he worked for utility customers, Rural Electric Cooperatives, traditional investor owned regulated utilities and deregulated power generation companies. Each of his posts in this blog describe a different aspect of the past, present or future of the electric industry.