The bias of the US regulatory system towards central generation needs to end. The result will be lower power prices, reduced pollution, and a vastly less vulnerable national power system

Tom Casten, Chairman, and Michael Brown, Executive Director WADE – the World Alliance for Decentralized Energy, Edinburgh, UK

On August 14th, 2003 at around 2:00 pm, a 31-year-old, 650 MW power station in Ohio, USA failed. Transmission controllers struggled to route power from remote plants, overloading transmission lines. At 4:06 pm, a 1200 MW transmission line melted, starting a failure cascade. Lacking local generation, system operators could not maintain voltage and five nuclear plants tripped, forcing power to flow from more remote plants and overload regional lines. By 4:16 pm, the northeastern US and Ontario, Canada lost power.

Only weeks later, almost the whole of Italy endured the worst European blackout for over 50 years. This was caused by a failure of one of the transmission lines that connect Italy with its neighbours to the north. In the meantime, Hurricane Isabel devastated part of the eastern USA, including the transmission and distribution networks in many areas. Again, the lights went out.

What is the connection between these events, and the many that have preceded them through recent years? The common feature is that supply has been interrupted not through a lack of generation capacity but through the inherent vulnerability of the transmission system that is required to connect remote central power plants with faraway consumers. Increasingly, the need to transport electricity over hundreds or thousands of kilometers is a challenging task. Rather like walking a tightrope, security lies at both ends – but in between the smallest deviation will cause calamity.

The World Alliance for Decentralized Energy (WADE) believes that greater reliance on decentralized energy (DE), defined as high efficiency cogeneration and on-site renewable/recycled energy, will reduce the growing vulnerability to supply curtailment because it does not depend on transmission and because it reduces congestion on the transmission system.

An entangled web

Years of active discouragement of all local power by the Ohio and Michigan utilities left the grid vulnerable to sagging voltage. Local generation can alter its output automatically to support voltage and enable lines to carry full design power.

In neighbouring Indiana, NiSource encouraged local power at the steel mills they serve. It formed an unregulated subsidiary in 1994 that invested over $300 million in 460 MW of DE. Had the Ohio and Michigan steel mills recycled energy to produce on-site power, the plants would have supported the voltage and allowed the wires to carry more power to other consumers. All other things equal, the blackout would not have occurred.

Furthermore, such actions are good for the economy and the environment. Unfortunately, laws and regulations block DE. The industry and its regulators are caught in an overloaded, wire-entangled web that blocks innovation.

A historical perspective

Electricity, commercialized in 1880, is arguably the greatest invention of all time. But early developers faced a big problem: finding money for wires to transport electricity to users who didn’t think they needed it. To manage the risk, developers asked city councils for five-year exclusive franchises. Thousands of small electric companies sprang up and state monopolies spread.

States established regulatory commissions to approve capital investments and set rates that assured utilities fair returns on capital. Under rate-based regulation, investments in efficiency improvements increase the rate base, but all savings go to customers. This approach does not allow utilities to profit from increasing efficiency.

Banks cheerfully loaned money to monopoly-protected utilities fueling a race to grow and acquire other systems. Power entrepreneurs borrowed huge sums to gain control over vast areas of the country. In 1929, the bubble burst; demand for electricity sagged, and over leveraged trusts could not pay debt service. Utility bankruptcies deepened the Great Depression. Congress’ response – the Public Utility Holding Company Act (PUHCA) – prevented utility amalgamation and assigned federal watchdogs to oversee finances. Profit-seeking utilities had two options: sell more power; and invest more capital in the rate base. Both strategies favoured central generation over local power.

Electric distribution companies have an understandable bias against generation that bypasses their wires and cuts potential profits. Utility monopolies long made it ‘Job One’ to preserve the monopoly. The electric industry sponsored ‘Ready Kilowatt’ campaigns and skillfully coached (and paid) governments to block distributed generation.

For eight decades, central generation was the optimal technology. The regulatory approach delivered nationwide electrification and real prices fell by 98 per cent. Electrification not only improved standard of living, but also played a strong role in positive social change.

The good times end

By 1960, as competition withered away, utilities began pursuing questionable strategies. With no way to recycle byproduct heat, fuel efficiency never moved beyond 33 per cent. Utilities and their regulators rushed to convert many coal fired power plants to oil, just in time for the OPEC embargo in 1973. Many utilities committed to build massive central plants that required up to ten years to construct, far beyond safe planning horizons. When rising prices induced conservation, electric load growth flattened and left the industry with massive overcapacity.

Then came nuclear. The utility industry committed vast sums, underestimating complexity and safety concerns. Some nukes were built near budget, but others broke the bank. From 1970 to 1984, real electric prices rose 65 per cent.

Regulatory responses nearly got it right, flirting with local generation. The 1978 Public Utility Regulatory Policy Act, or PURPA, sought to improve efficiency by exempting plants that recycled some heat from Federal Power Act regulations and required utilities to buy power from these plants at avoided costs. But subsequent changes removed the pressure to build plants near users, and nascent DE was again driven back.

Next came Three Mile Island. State commissions, fed up with nuclear cost overruns and rising prices, challenged the prudence of utility investments in nuclear plants, claiming mismanagement. Historically friendly regulators ordered CEOs to remove billions of dollars from rate base and reduce electric prices.

The two changes did stop electric price inflation; prices dropped to 1969 levels by 2000. But utility managements went into shock. They curtailed in-system investments, but still needed to put massive cash flow to work. Smarting from independent power producers’ (IPPs’) ‘poaching’ of their generation under PURPA, many utilities funded unregulated subsidiaries to ‘poach’ generation in other territories. Never questioning the central generation mantra, utility subsidiaries began a disastrous race to build remote gas turbine plants, ignoring this strategy’s vulnerability to rising gas prices.

Real US electric prices (1996$)
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In the 13 months following May 2001, the 11 largest merchant power plant builders destroyed over $200 billion of market capitalization. Enron, NRG, PSE&G and Mirant have since declared bankruptcy while, Dynegy, CMS and Mission struggle to pay creditors. Industry players that embraced gas-fired remote merchant plant development have seen their credit ratings lowered to junk status.

Major transmission failures did not start immediately. Spare transmission capacity, built in the days of compliant regulation, absorbed load growth until 1996, when a falling tree set off an 18 state blackout throughout the west. By then, load growth had made the non-growing transmission and distribution system vulnerable to extreme weather, human error, and terrorists.

As costs and environmental concerns mounted, States began to experiment with partial deregulation, but never eased protection of wires, leaving utilities free to continue fighting DE by charging excessive backup rates and denying access to customers. Commissions allowed generators to sell to retail customers, but set postage stamp transmission rates, charging the same to move power across the street or across Texas. Wholesale power prices give little recognition to the locational value of generation.

Environmental regulations also suppress distributed generation. The 1976 Clean Air Act and subsequent amendments penalize efficiency. Almost all emission permits are granted based on fuel input, with no relationship to useful energy output. All new generation plants are required to install ‘best available control technology’, while existing plants retain ‘grandfather’ rights to emit at historic levels.

The costs to all stakeholders from the central generation worldview extend to other societal problems. The balance of payments suffers from needless fuel imports. The US demand for fossil fuel begats military adventures. Inefficient generation raises power costs, hurts industrial competitiveness and makes electric generation the major source of greenhouse gas emissions.

Future choices

There are two distinct paths to avoid more blackouts: spend $50-100 billion on new and upgraded transmission lines or save money by removing barriers to distributed generation.

The first path will raise electric rates by 10-15 per cent and exacerbate other problems. The second will cost taxpayers nothing and mitigate other problems.

To follow the second path, governments must:

  • Allow any provider to sell backup power
  • Enact standard and fair interconnect rules
  • Void laws that ban third parties from selling power to their hosts
  • Give every power plant identical emission allowances per unit of useful energy
  • Recognize the locational value of generation
  • Allow private wires to be built across public streets.

These changes will transform the $390 billion US heat and power business into a dynamic marketplace of competing technologies and allow DE’s competitive advantages to prevail. Utilities and IPPs will build new DE capacity to serve expected electric load growth and reduce transmission congestion.

Ending central generation bias will upset vested interests and require a great deal of political effort, but the rewards for this leadership will be immense – lower power prices, reduced pollution, reduced greenhouse gas emissions, and a vastly less vulnerable national power system.