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Privatization of the Power Marketing Administrations

Regulatory Comments and Testimony

Title

Privatization of the Power Marketing Administrations

TESTIMONY OF CLYDE WAYNE CREWS, JR. FELLOW IN REGULATORY STUDIES COMPETITIVE ENTERPRISE INSTITUTE BEFORE THE:

SUBCOMMITTEE ON WATER AND POWER RESOURCES COMMITTEE ON RESOURCES U.S. HOUSE OF REPRESENTATIVES

Good Morning, Mr. Chairman, my name is Clyde Wayne Crews, Jr. and I am the Fellow in Regulatory Studies at the Competitive Enterprise Institute. I am very grateful to the subcommittee for the opportunity to appear today. It is a great pleasure for me and for my organization. CEI is a Washington-based public interest group established in 1984 with an annual budget of about $2 million and a current staff of 24. CEI works to educate and inform policymakers, journalists and other opinion leaders on market-based alternatives to political programs and regulations. CEI also engages in public interest litigation to protect property rights and economic liberty.

The Competitive Enterprise Institute wholeheartedly supports efforts to privatize the Power Marketing Administrations (PMAs). We view the current interest in privatization as merely one manifestation of today's wide scale public commitment to fundamental governmental reform and taxpayer savings. In last year's elections, Americans unambiguously called for limited government and an end to federal overreach. This is a time for stripping away large layers of government rather than halfhearted efforts to make inherently indefensible or inefficient programs work. We need to do this not to cause pain to consumers, but for precisely the opposite reason: to remove artificial benefits to some producers and consumers that threaten to prevent all Americans from sharing in the benefits of the coming deregulated energy environment.

OVERVIEW

The 129 federally owned plants that make up the five PMAs generate about 6% of the electricity sold in the United States according to the Congressional Budget Office in its February 1995 document Reducing the Deficit: Spending and Revenue Options. The PMAs sell wholesale power to legally stipulated "preference customers," the municipal utilities and rural electric cooperatives. Current law requires that the power generated by the PMAs be sold at cost rather than the market price that non-preferred customers face. These non-preferred customers are the investor-owned utilities who sell most of the power generated in the United States.

While we may debate the proper selling price for the PMAs, or the precise techniques needed to protect current affected customers in the event they experience "rate shock" beyond a tolerable level during the transition to a fully private system, certain issues of fairness should be beyond debate but unfortunately are not. The core issues in this debate are two, and they center on the basic legitimacy and fairness of the PMAs:

 

(1) Certain groups are getting preferential access to cheap federal power while others do not enjoy this privilege. The roughly 75% of power consumers who are serviced by investor-owned utilities ought to have the right not to subsidize--whether directly or indirectly--the 25% who are serviced by the PMAs at below market rates. While the PMAs have something of a noble history in electrifying the U.S., "rural" is no longer synonymous with "poor," and the most blatant abuses of subsidized energy have started to benefit the well-off in embarrassing ways. You'll look a long time to find poor farmers in "rural" Hilton Head and Vail. And as far as the subsidies to Las Vegas are concerned, Martin Gross put it best in his book The Government Racket: Washington Waste from A to Z. When you "stroll leisurely down the gaily lit Strip (at Vegas), remember that you're about to lose twice. Once at the slots, and the second time when you realize that it's your electricity that's lighting up the night."

(2) Power generation is a commercial activity in which the government has no business and no rational basis for being a player. This is especially true today, given that government's continued involvement--particularly the selling to preferred parties--will prove highly disruptive to retail and wholesale wheeling innovations as they become more widespread and their benefits to consumers become more apparent. Soon we are likely to have choices among power companies paralleling those we now have in long distance phone companies. We are moving toward a fluid marketplace in which all power is market priced rather than regulated based upon cost, as has been the case historically. The existence of the PMAs should not be allowed to undercut this revolution.

Certain developments provide hope. As everyone knows, the Clinton administration has proposed selling marketing rights for three of the five PMAs for an estimated $3.7 billion, although there is legitimate debate about whether that price is too low. And the Senate, less than 48 hours ago by a vote of 74-25, passed S. 395, a bill to authorize the sale of the Alaska PMA. Given these developments, plus other positive signs like unprecedented interest in Congress, provisions in the Energy Policy Act of 1992 that serve to promote wholesale competition in electricity, the increasing importance of the independent power producers, and the constantly improving interconnection of utilities, we have an opportunity now to significantly improve competitiveness in the electricity market. This opportunity should not be sacrificed merely for the sake of special interests that benefit from below-market-price sales.

There are two key ways in which continued existence of the subsidized PMAs threaten the future competitiveness of the energy market. One is the investor-owned utilities' lack of access to power generated at PMA facilities. The other impediment is that even though municipals and co-ops in any given PMA region legally may purchase power generated outside the PMA region, they have no incentive to do so, since even the economies generated by wheeling are not yet a match for the guarantee of at-cost purchase. A system that will be most efficient for energy consumers is one in which all producers are free to sell to any buyers, and any buyer is free to purchase from any seller. The PMAs preclude the existence of such a marketplace.

 

 

 

ADDRESSING THE ARGUMENTS AGAINST PRIVATIZATION

In addressing the arguments against privatization--primarily the claim that the PMAs are not subsidized--it ought to be pointed out at the outset that it is technically illegal for the government to study the question. Thanks to an amendment attached by Senators McClure and Sasser to the Continuing Appropriations Resolution for FY 1983, and to renewals in subsequent law thereafter, the use of funds by the government for the purpose of conducting "any studies relating to or leading to the possibility of changing from the currently required 'at cost' to a 'market rate' method for the pricing of hydroelectric power" has been prohibited. That means it is technically against the law for the executive branch to even consider this issue.

This law is hard to fathom as anything other than a way to hinder the determination of the nature of the subsidy PMAs receive and to protect PMAs and their beneficiaries from losing their current comfortable status.

Argument #1: PMAs cover their costs and are not subsidized

The PMAs are demonstrably subsidized in several ways, all of which serve to tilt the playing field in favor of the municipal utilities and rural co-ops relative to their investor-owned counterparts:

(a) Favorable rates to preferred parties: Current law requires that PMAs sell power to municipals and co-ops at cost. CBO states in Reducing the Deficit that the average price charged for electricity by the PMAs to municipal utilities and rural electric cooperatives (the "preference customers") is 2.5 cents per kilowatt-hour (kwh). At the same time, CBO reports that the 1992 average price of electricity for non-PMA wholesale transactions was 4.5 cents, meaning the PMAs are selling power to their preferred customers at just a little over half its market value. Other estimates find PMAs selling power for less than half its market value. CBO proposes that marketing this power to the highest bidder would result in an additional $1 billion per year to the Treasury, which is an approximate and conservative measure of the rate subsidy provided to the PMAs by taxpayers and non-PMA ratepayers. Those who are not either municipal utilities or rural electric cooperatives rarely have access to these low prices. Also it is not clear that PMAs are passing these low rates on to their customers.

(b) Low-rate loans with flexible terms: PMAs as a group owe the federal government more than $10 billion for the cost of construction of existing plants, but they are paying it back on extremely flexible repayment schedules such as 45 or 50 year repayment periods. Further, they are paying that money back at a subsidized rate of about 3.25%. Since the government borrows money at about 8%, taxpayers eat the difference. The PMAs can selectively pay off debt, paying off higher rate debt first while leaving lower rate debt on the books, an option rarely available to private firms. Nor do PMAs depreciate their assets according to Generally Accepted Accounting Principles as private concerns do, and thus they overstate revenue.

(c) Tax advantages: Investor-owned utilities must pay taxes. Municipal utilities are exempt from federal and state taxes, and co-ops often are exempt. Municipal utilities also may issue tax exempt securities, while co-ops receive subsidized credit through the Rural Utility Service (formerly Rural Electrification Service). This "business" structure--in which PMAs price at cost in a discriminatory manner while their municipal and co-op customers enjoy favorable capitalization and often pay no taxes--is on a collision course with private competitors who do not have these advantages. Either the favorable treatment must go, or the new competitive developments must go, because they ultimately cannot coexist in the electricity marketplace of the future.

(d) Annual federal appropriation: The PMAs received an appropriation of $345.3 million in fiscal year 1994 and $272 million in fiscal year 1995. These sums mean that over a billion dollars go to the PMAs every few years. Needless to say, investor-owned facilities do not get this benefit.

Some might say, even if PMAs are subsidized, why is that so bad? Aside from the issue of relative disadvantage for competitors due to selective access to the low cost power, subsidies are actually damaging to society. Taxes, for their part, are widely known to create "deadweight" losses to society by driving a wedge between supply and demand and cutting off trades that otherwise would have taken place. These lost trades are unseen by the public: they do not make the nightly news but simply evaporate. Less well known but equally important is that subsidies like those the PMAs enjoy create deadweight losses as well. Artificially lowering the cost to the producer will make him willing to supply more at any given price--or in economic jargon, shift out his supply curve. But the real resource cost represented by the original pre-subsidy supply curve does not change, and an excess of resources is consumed by power purchasers over what they actually paid for them. These resources are lost forever to society despite the fact that they would have been more highly valued in other uses.

Argument #2: Electricity rates will increase for PMA customers

The problem of rate increases is overstated since PMAs are rarely the exclusive or dominant supplier of power, but to the extent it is true privatization of PMAs can be structured such that impacts are negligible or otherwise minimized, or even a net plus for the PMA consumer. No matter the legislative or logistical difficulties, the problem is not so insurmountable that we need to sacrifice the prospect of an electricity industry of extraordinary productivity for the sake of the survival of an essentially socialistic enterprise. The reason for sale of the PMAs is not to cause pain for customers but to improve the efficiency of the industry so that all customers and future generations benefit from the coming waves of innovation. Moreover, the corollary to subsidized power users paying too little for their power and potentially facing a rate shock is that non-subsidized users are paying too much. The economies to be gained from combining and integrating PMAs with existing infrastructure are critical to benefiting consumers overall. Freeing up the entire market for a future in which electricity is wheeled across state and regional lines with consumers able to select vendors as they select phone companies promises to keep everyone's rates as low as they can possibly be.

Argument #3: PMA consumers have an "equity ownership" in the PMAs

This argument stems from a serious misconception of the concept of ownership. The core features of ownership are the rights of disposal and transfer of the property in question. PMA customers certainly do not enjoy this right, but merely the right to the electricity that they have contracted for and consumed. The fact that PMA customers through their bills have partly paid to service the debt of the PMAs is not relevant: every customer of every firm that has borrowed money in some sense helps cover that firm's financing costs, since all private firms must charge enough for their product to at least break even.

If customers actually owned the PMAs, the PMAs would already in a sense be privatized, and we could set about negotiating with current owners about buying the facilities rather than waiting for the government, the owner in fact, to make a privatization sale. Furthermore, it is especially ironic for a user of a subsidized service or product to claim an ownership stake in the firm that produces it. Investor-owned utilities and their customers who have been paying the market rate for electricity from non-utility generators--more than what customers of PMAs pay--are not claiming that they own the non-PMA generating facilities or that they have a right to halt the sale of such facilities. In reality and in justice, since taxpayers have been paying full price for their own electricity while also subsidizing the PMAs it is more accurate to say that they are the "owners" of the PMAs and thus have the right to transfer ownership of them through privatization.

 

Argument #4: Selling the PMAs will result in environmental degradation

CBO noted in Reducing the Deficit that selling electric power at below market rates, since it increases demand and leads to overconsumption of electricity relative to what consumers would purchase at market rates, is inconsistent with the government's energy conservation objectives. And the deadweight losses generated by energy subsidies, some of which may be environmental in nature, have already been discussed. In fact, it is the PMAs themselves that are susceptible to the charge of damaging the environment. Moreover some privatization proposals, such as President Clinton's, seek to minimize environmental impacts by selling only transmission facilities. Issues that would arise in a more comprehensive privatization, such as the impact of the privatization of massive federal dams on irrigation systems, wetlands, flood control, wildlife preservation or recreation can be addressed through reasonable conditional sales that reinforce these goals where they are appropriate.

 

Argument #5: Privatization proceeds could not legally be used for deficit reduction

The simplest response to this criticism is that Congress has the power to do what it wants in this regard. If it so chooses, it can alter budget process law so that proceeds from PMA sales reduce the deficit. The President's FY 1995 budget indicates that he will request a legislative fix so that sale proceeds would apply toward deficit reduction. Draft language to privatize the PMAs prepared by Congressman Foley (R-FL) would accomplish this objective by crediting sales proceeds to "miscellaneous receipts" in the budget.

WHAT SHOULD BE DONE

We are a country whose leaders of both political parties in many a speech applaud foreign nations that are undergoing painful transitions to market economies. The pain they endure is caused not by the arrival of capitalism, but the previous absence of it, because it is difficult to shake out established political interests as our own PMA debate illustrates. Nations around the world are taking steps toward privatizing their power generation assets and other infrastructure, and U.S. financial services and consulting firms, some of whom I believe are present today, have provided much of the know-how. These firms can certainly apply that knowledge and experience to the U.S.A., which is merely a mixed economy rather than a centrally planned one.

Ironically, at the same time our executive branch is prohibited by law from studying the impact of a switch to market pricing of hydroelectric power from cost-based pricing, last year's foreign operations appropriations bill provided several hundred million dollars in funding for Russia and the other former Soviet Republics to ease their transition to a market economy, a transition which includes at least partial privatization of the energy sector. In addition, $8 billion of the Mexico aid package has already been distributed to Mexico and another $2 billion is about to be. One condition placed on this funding is that in exchange for support of the Peso, Mexico is to vigorously pursue privatization of its governmental programs, including the energy sector.

We should do at home as we ask others to do. Congress should heed the call of the electorate for smaller government and take the following actions with regard to the PMAs, recognizing all the while that the interests of current PMA consumers can be taken into account and satisfactorily addressed.

(1) Restrictions on government studies of proposals to switch hydroelectric pricing from cost-based to market-based should be eliminated immediately.

(2) While all PMAs should be privatized, the Congress might consider initially dealing with the problem by establishing a commission similar the Military Base Closure Commission. The commission would assemble a package of facilities to privatize, perhaps across PMA regional lines, submit it to the President for revision, and then hold an up or down vote. This procedure obviously can be generalized to the government at large, as Senator Mack has done with his Spending Reduction Commission which looks at the broad array of government programs, but here I emphasize just PMAs. Alternatively, the Congress could attempt to privatize the five PMAs individually from the easiest case to the hardest, applying the knowledge gained to the greater difficulties at the next level. This has begun with Senate passage earlier this week of the bill to privatize the Alaska PMA, widely considered the simplest case since there are only 2 power plants at issue in Alaska.

(3) Congress should specify legislatively that the proceeds from privatization shall go deficit reduction.

(4) As we take steps toward full privatization, Congress should begin to implement full market pricing for the PMAs as CBO suggests, which would reduce the deficit by approximately $1 billion annually. This could facilitate the march toward privatization if user groups are given an opportunity to purchase a certain percentage of their PMA on favorable terms during the transition to market pricing.

NOTE ON THE MECHANICS OF PRIVATIZATION:

While I'm happy to simply make the previous suggestions and leave the mechanics of privatization up to the investment bankers, the Heritage Foundation suggested a method in 1986, based on the British experiences with Britoil and British Telecom, that may be worth investigating since it helps to address the concerns of customers who potentially could face rate shock but also allows a certain less-than-majority percentage of the stock of the newly privatized firm to be sold at higher post-initial-offering rates, thereby heightening the amount of deficit reduction. The idea is to create a package whose benefits are distributed in such a way that all parties--PMA customers and taxpayers--can potentially be better off with privatization compared to the status quo. In rudimentary and simplistic terms it could work something like this:

(a) a 51% controlling interest in the PMA would be offered to the public at the initial valuation, with current customers of each PMA given the option to purchase stock in proportion to their use of power (perhaps to be paid for in installments on future electric bills). A minimum of 10% of this 51% block of stock could be reserved for small investors like residential or small business customers of the PMA. These small buyers would also receive an option to buy additional shares in the future at the original price if they hold their shares for a prescribed minimal length of time. Heritage states that this allows small investors or former customers to benefit from any increase in value that privatization brings.

(b) The remaining 49% share of stock would be temporarily retained by the government and then sold at the most attractive price. This way the taxpayer wins from any increase in stock value post-privatization, because all the additional funds could be earmarked for deficit reduction.

CONCLUSION

Privatization of the PMAs is long overdue, but even it is merely a first step, a test case, toward limiting the reach of a government that seems to regard no activity as beyond its capability or proper scope. While not easy, there are ways to minimize or even eliminate any hardship associated with PMA privatization, and the benefits to be gained make privatization an unambiguous plus for consumers.

The core issues in this debate are the unfairness of requiring one class of Americans to subsidize the power needs of another, and the impropriety of having government run commercial enterprises competing against and even excluding large chunks of the private sector from access to their output. The latter is especially ominous because government's presence in the marketplace threatens the potential for lower nationwide electricity rates down the road as competition in interstate and inter-regional wheeling heats up and electricity vendor choice becomes a reality for consumers. The notion that some buyers of electricity should be prohibited by law from bidding--without subsidies--on the output of a large chunk of our nation's electricity generating capacity is alien to American business practices and to what we know to be the prerequisites for efficiency and minimum prices in the nationwide marketplace. The potential participation of all of America's generating and transmission capacity is essential in the future marketplace of retail wheeling if we are to supply the electricity needs of Americans most efficiently and at the least cost.

If PMAs do disrupt the otherwise inevitable coming of retail wheeling and consumer choice, their annual costs to society will be far greater than their annual appropriation, the below market rates, and the tax advantages municipal utilities and rural co-ops now enjoy--only the public won't be able to directly perceive those costs. These are the pernicious "hidden costs" of economic regulation that are difficult to tabulate but that nonetheless make the nation worse off whenever and wherever they are imposed.

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