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 set 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 electric 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. 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. And by the early 1920s most communities were served by a single monopoly electric supplier. The monopoly supplier owned the generating stations that produced electricity and the transmission and distribution facilities that delivered the electricity.
The following depicts utility owned facilities and how they were used to deliver electricity from a generating plant to the end-user customer:
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 did not lose 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 called it the Regulatory Compact.
The Regulatory Compact is basically an agreement between the utilities and the government. That agreement deals with both service and rates. The investor-owned electric suppliers agreed to use their facilities to provide service to the public under terms regulated by the government. They became public utilities.
In exchange for the suppliers’ agreement to provide service the government agreed that it would guarantee the utilities a protected monopoly service territory and that it would approve rates that covered the utilities’ operating costs plus a reasonable return on 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.
The state public utility acts deal solely with service between utilities and their end-use retail customers. 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 or FERC) authority to set just and reasonable rates for wholesale sales between utilities. Between the state public utility acts and Title II of the Federal Power Act all activity of the electric utilities are subject to some level of utility regulation.
Who Owns the Electric Utilities?
Most of the early electric service providers were owned by private investors. 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, municipalities created their own electric systems. Today, approximately 12% of electric service is still provided by municipally owned utilities.
Electric service was available in most urban areas in the early 1900s. However, by the 1930s, most of the rural areas of the country still did not have electric service. Rural residents were operating their farms just like their parents and grandparents did in the nineteenth century. In 1935, with passage of the Rural Electrification Act, the Federal Government made low cost loans available for customer owned Rural Electric Cooperatives. Those Cooperatives used the borrowed funds to build the infrastructure needed to gain access to electricity. Today, the Rural Electric Cooperatives provide approximately 13% of all electric service.
By the 1990s policy makers determined that there was no longer any reason for the generation component of electric service to be considered a part of the regulated service. Therefore, in 1995 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. The transmission and distribution services, sometimes referred to collectively as the “wires service,” remains subject to regulation under the regulatory compact.
Who Owns the Generating Facilities?
Most of the country’s generation facilities are now owned by non-utility Independent Power Producers (IPP). The IPP industry expanded rapidly after 1995 when FERC issued its Open Access Orders. Members of this industry built new facilities and purchased the power plants that were being sold by the utilities. The members or the IPP industry are not utilities and are not governed by regulatory compact. They do not have monopoly service territories and their rates are not regulated by any government agency. Instead, IPPs sell their generated electricity into competitive power exchanges. See Post entitled Electricity Sales in the 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.