Thomas Walkom
The Star
April 2, 2002

MEDICINE HAT, Alta. – To the casual observer, this small Prairie city doesn’t seem much like Los Angeles.

The houses are modest, the glitter definitely limited. Downtown at Top Pizza Family Restaurant, the lunch-time crowd is watching curling on television. No one is dressed in all-black.

But in one key way, Medicine Hat is L.A. When everyone else was hopping aboard the electricity privatization bandwagon, this city – like Los Angeles – refused to take part.

Instead, both held on to their publicly owned generating plants and continued to provide power at cost.

The result: amid the turmoil of electricity deregulation in Alberta and California, Los Angeles and Medicine Hat are islands of stability.

Rates in the city of Los Angeles are about a quarter of the California market price. While San Francisco and neighbouring cities in Los Angeles County, such as Beverly Hills, have suffered blackouts, L.A. proper has endured none.

So, too, in Medicine Hat. Large industries pay about a fifth of what their counterparts are charged elsewhere in Alberta.

Residential rates are about half of what they are in Calgary just 300 kilometres away (although the provincial government has narrowed the gap by paying massive subsidies to Calgarians and other Albertans affected by deregulation).

From his office overlooking the icy South Saskatchewan River, Medicine Hat Mayor Ted Grimm explains why his city declined to take part in Alberta’s free-market experiment.

“This a conservative city,” says Grimm. “But it’s a small c-conservative city. We’re not just ideological. We’re pragmatic.

“Our thinking was: If it works, let’s keep doing it. Let’s not just switch just because there’s a new fad.”

Now, like Los Angeles, Medicine Hat is sitting pretty.

Both are making money (neither city will admit exactly how much) from selling their excess power at market rates to neighbouring cities.

“It all looks great, and it is at the moment,” says Grimm. “But we don’t brag about it. As I say, every dog has its day.”

In Los Angeles, Department of Water and Power spokesperson Darlene Battle is equally cautious, saying only that her city is making “hundreds of millions” from selling its surplus electricity to the rest of California.

“We don’t like to publicize it too much,” she says.

Jeff Jodoin, a regulatory analyst with the Alberta Consumers Coalition, has a theory to explain Medicine Hat and Los Angeles.

“The real winners from deregulation are the places that stayed regulated,” he tells a reporter.

In a curious way, his analysis explains not only Medicine Hat and Los Angeles but deregulation’s success stories – Pennsylvania and Britain.

But first, the renegade cities.

When, in the mid-’90s, Alberta and California embarked on their crusade to bring the benefits of the free market to electricity, each faced a complex domestic situation.

In California, roughly one quarter of the state’s power was provided by municipally owned utilities. Most didn’t have their own generating plants. Rather, they bought power, at regulated rates, from private generators.

The city of Los Angeles was the most visible exception. Since 1917, the city – which occupies only a portion of the sprawling megalopolis known as Los Angeles County – has not only distributed but generated its own electricity.

Over time, Los Angeles acquired plants across the southwest, including one in Utah and a share of the Palo Verde nuclear plant in Arizona.

But by the mid-’90s, explains Randy Hough of the city’s Department of Water and Power, Los Angeles – like almost everywhere else in North America – had figured that deregulation was the wave of the future.

In 1996, the city’s residential power prices were 20 per cent lower than those in the rest of the state. But to pay for this, its industrial rates were higher. Los Angeles was sure it would be left out as the efficiencies of the private market worked their magic on the rest of California.

“We thought we’d be caught in a death spiral,” says spokeswoman Battle. “Our debts were high, which meant we couldn’t cut rates. Industrial customers would flee our high rates. That would mean that those who were left would have to pay higher rates to cover the debt, and on and on.”

The city’s game plan, says Hough, was to take a few years to reduce its debt, trim costs and then join deregulation in 2002.

“No one is saying that now,” says Battle, grinning.

Now, it is those private utilities which gambled on the competitive market that are in the death spiral, forced to buy power at exorbitant market prices and sell it at low, government-regulated rates.

The state is spending billions to subsidize consumers and plans to spend billions more to bail out these private utilities. But Los Angeles is doing what it always did: generating power and selling it to the city’s 3.9 million citizens at cost.

In Alberta, both Edmonton and Medicine Hat owned generating plants. Premier Ralph Klein’s government wasn’t about to let Edmonton opt out of market-opening. The city is one of the biggest electricity generators in the province. If it stayed out of the market, there could be no market.

By contrast, Medicine Hat’s utility was small, serving only the city. It could be excluded from deregulation without jeopardizing the entire scheme.

As well, public power was part of the city’s tradition. Granted its own natural gas fields in the late 19th century, Medicine Hat has been using that gas to generate electricity since 1904 – before Alberta became a province.

Still, public ownership was not without controversy.

“It costs money to buy a gas field or rebuild a generator and people never like that,” Grimm says. “A lot were enamoured by deregulation – some for ideological reasons, some because they thought it would be cheaper.”

When Klein announced his province was moving to a deregulated electricity market, other municipalities eagerly embraced the idea.

But Ted Grimm – and Medicine Hat – held firm.

“We have a history of self-sufficiency,” Grimm says. “We know what local control means.”

Whenever the topic of electricity deregulation arises, supporters like to bring up Pennsylvania.

Ontario Energy Minister Jim Wilson has pointed to Pennsylvania’s competitive electricity system as a model for this province. (His other example, an unfortunate one in hindsight, was California.)

“Good competition will bring us the best guarantee of low prices,” Wilson said in 1998.

But Pennsylvania is not Ontario.

As Eric Montarti, a pro-market policy analyst with Pittsburgh’s Allegheny Institute points out, Pennsylvania is a state in decline. Its steel-based economy is fraying, its population stagnant.

Those who remain in Pennsylvania tend to be old. The young, Montarti says, are getting out.

“Obviously, there’s no Silicon Valley like California’s,” he says.

As well, Pennsylvania has an excess of power. Ontario doesn’t.

But the key difference between Pennsylvania and Ontario is that Pennsylvania never really adopted the kind of free-market model Ontario is planning.

It just said it did.

Before 1996, electricity rates charged by Pennsylvania’s eight private utilities – the so-called incumbents – were set by regulation.

Now, under what the state calls “electric choice,” they still are.

The 90 per cent of Pennsylvanians who stayed with the incumbents will be protected from rate increases by the state’s Public Utility Commission until at least 2004. In some areas, regulation will last until 2010.

Ontario, by contrast, plans to eliminate rate regulation for all consumers as soon as it opens the electricity market (originally scheduled for last fall but now postponed indefinitely).

While Ontarians may receive some temporary cushioning from rate increases thanks to government rebates, the plan is to have consumers pay prices that more accurately reflect those set by the spot market.

If the spot market price of electricity jumps, as it almost certainly will once Ontario dives into deregulation, consumers will pay more.

None of this occurred in Pennsylvania. In fact, electricity prices fell after 1996, mainly due regulations. For example, PECO Energy Co., the Philadelphia incumbent, was ordered by regulators to give consumers a temporary 8 per cent rate cut.

Pennsylvania did, however, allow other utilities to compete with the incumbents. In some parts of the state, it made sure the regulated retail rate was set high enough that these new retailers would be able to make money. The state could do this, says the Public Utility Commission’s Kevin Cadden, because the wholesale price of electricity at the time was well below the regulated retail price.

In Philadelphia, a new retailer could buy power cheap on the wholesale market, undercut PECO’s regulated price and still turn a profit.

Elsewhere in the state though, where there was less difference between the wholesale price of power and the regulated rate, little or no competition evolved. And in still others, competing retailers went out of business as the wholesale price of electricity began to move up again.

In the end, about 568,000 customers – or about 10 per cent of the total – switched from incumbent utilities to another retailer. This was enough to let state governor Tom Ridge declare Electric Choice an unqualified success.

“We have plenty of juice, we’re plugged in, consumers have greater choice,” Ridge crowed.

The governor says the average 3 per cent decline in electricity bills resulting from deregulation has saved his state’s consumers $3 billion. What he doesn’t say is that the vast bulk of these savings are not the result of deregulation but of regulation – the mandatory rate cuts ordered by the state’s Public Utility Commission.

“No one was worse off and some people were better off,” says Irwin (Sonny) Popowski, the state government’s Consumer Advocate. “So in that sense it (deregulation) was a success.”

Still, Popowski concedes that the same savings may have resulted if the state had simply kept its regulated rates lower.

As for the Public Utility Commission’s Cadden, he insists that Pennsylvania’s market opening was always about more than mere money. “This was about opening up to competition not just slashing rates. It was about choice.”

Pennsylvanians now have the option of buying more expensive “green power” from environmentally sound generators, he points out. And, he says, a small number (he doesn’t know how many) do.

In 1990, Britain, under former Conservative prime minister Margaret Thatcher, was one of the first countries to privatize its state-owned electricity industry.

The first years under privatization were difficult and marked by controversy. Not until 1998, under a Labour government, was the market finally opened to residential consumers.

Now, the British system is considered a success. Price are down and consumers are happy.

However, a closer look suggests that here too, all is not quite as it seems. In a 1997 article done for the Washington-based, pro-market Cato Institute, economist John Kwoka wrote that there was “less to the (price) declines than met the eye.”

First, the government had artificially boosted rates in the last year of the old regulatory regime. After market opening, rates fell back to their old levels and the government declared a political success.

(Interestingly, the Ontario government seems to have borrowed a leaf from Thatcher’s playbook as it prepares to open the market. Late last week, it announced it was boosting the regulated wholesale price of electricity by 18 per cent, from 4 to 4.7 cents a kilowatt-hour. Ontario residents will pay an extra 8 per cent for electricity starting June 1.)

Second, Kwoka notes, the 1990s were a time of falling coal and gas prices across Europe. What that means, he writes, is that British electricity prices would have fallen anyway, even under regulation.

By one calculation, Britain’s electricity prices, adjusted for fuel costs, actually rose during the first years of deregulation.

In part, as economist Catherine Wolfram writes in the American Economic Review, this is because Britain’s market opening had a perverse result. Those private firms which dominated the new market were able to manipulate it. In the parlance of the trade, they were gaming – adjusting their output to keep prices artificially high.

Wolfram calculates that gaming kept British electricity prices about 20 to 25 per cent higher under deregulation than they should have been.

But perhaps the most telling detail of the British story is that, for residential consumers, regulation is still front and centre.

When the government opened up the residential consumer market to competition 2* years ago, it carefully kept a price cap in place. Then, to give consumers a break, it cut that regulated price cap by about 8 per cent.

What that meant was that the 75 per cent of British householders who stayed with their incumbent utilities got an 8 per cent rate cut – not because of deregulation but because of regulation.

The remaining 25 per cent who did switch to alternate suppliers did get, on average, a bigger rate cut – about 15 per cent.

But as a recent report from Britain’s National Audit Office points out, most of those benefits went to high-income earners. Poor and rural families found, in some cases, that their electricity rates had gone up.

“The U.K. is the success story” of market opening, says Tom Adams of Toronto’s Energy Probe, a public interest group which has long supported bringing the discipline of free markets to the electricity business.

“But even there, the benefits have been really modest.”

So. What will happen when Ontario makes its move into the world of free-market electricity?

Certainly, rates will continue to go up. The government has admitted as much. Premier Mike Harris has vowed that this province will be able to avoid the pitfalls experienced by California and Alberta.

But Adams, who until recently was a director of the Independent Market Operator (the body charged with running Ontario’s competitive market), is far less optimistic. “Right now, we’re headed toward higher prices and less reliability,” he says.

While still a believer in liberalized electricity markets, Adams says the experiences of California and Alberta have forced him to re-evaluate the wisdom of plunging along that path.

“A success in electricity restructuring can give you modest gains. A screw-up can take you back to the dark ages . . . It’s not rational to do this (move to a competitive market) unless you’re relatively sure of a big gain.”

He is not alone in rethinking deregulation. In Alberta, Dan Macnamara, the head of the big-business lobby group that actively promoted electricity deregulation, now says it was a terrible mistake.

His advice to Ontario: “If you’re not sure you can connect all the dots, don’t rush into it. Don’t rush into something you can’t sustain.

“When the politicians say `We’re just going to plow on,’ my advice is don’t do it. If you go ahead and it doesn’t work, it’s too late. By then, some people have money in their pockets. Once you’ve created winners and losers, you can’t undo what you’ve done.”

But perhaps California provides the a final irony. North America’s pathbreaker in the world of competitive electricity markets now thinks public ownership looks good.

Partly to bail out its bankrupt utilities, but partly to regain control of its chaotic electricity system, Governor Gray Davis now wants to take over the state’s privately owned transmission grid. And some of the same legislators and officials who sent their state on the road to free-market electricity are now pushing for publicly owned generation as well, using the same arguments Adam Beck – the father of Ontario Hydro – made in in this province 95 years ago.

“There’s been a lot of glorification of private markets the last few decades,” state treasurer Phil Angelides told the Los Angeles Times recently. “We should never fool ourselves into thinking they’re perfect devices . . . “There’s a set of goods we long ago decided we needed in society, things we needed to do in the public interest because you couldn’t depend on the private sector . . . transportation, housing, health care.

“Electricity is a vital commodity.”

If the state’s nascent public-power movement succeeds, Angelides says, “we’ll be out there creating new power and selling it at cost.”