The Power Game

The New York State electricity market is no longer a regulated monopoly. Consumers now have a range of choices when it comes to electrical power providers. This ongoing series will examine the reasons behind and the impacts of the new energy market on New York State residents and the possible implications for the future of the power industry in the entire Upper Delaware region.

A brief history of electrical power and regulation, part II

By CHRIS CONROY

One decade into the 20th century, regulated, state-sanctioned monopolies had become commonplace in the power industry. This was based on the idea that some things, such as electrical power, could more efficiently and effectively be produced and delivered if one entity were in control of the entire process. Known as a “natural monopoly,” this trend continued for more than three quarters of a century.

Regulations were put in place to prevent abuse of the situation by enterprising businessmen, an all too common practice still remembered at the time from the railroad empires. Reasonable prices and reliable services were guaranteed for consumers while legitimized monopoly status and companies gained a stable economic field. In the beginning, it seemed like a win-win situation.

For power companies, the economics of the deal were so stable that they found they could easily raise money to increase power generation and supply capacities, while still making reasonable profits. This fundraising was done mostly through the issue of stocks and bonds. Existing before the Securities and Exchange Commission (SEC) came into being, the fundraising activities of the utilities were unregulated.

The main job of the people and groups in charge of regulating the companies was to ensure the utilities kept up their end of the bargain, meaning that power was generated and distributed continuously at a fair price. While regulators had little to do directly with the fundraising done by companies, their presence alone was enough to assuage many economic fears, lending an air of stability and security to the idea of investing in a power company. This lead to lower interest rates for the power companies and aided in obtaining public funds.

Plant and equipment costs in the power industry were high. In fact, it was, and is, one of the most capital-intensive industries. In order to minimize the start-up costs of creating new plants, company owners began to take part in holding companies, a system devised by equipment manufacturers like General Electric. A holding company owns large portions of stock of operating companies. The holding company then issues its own stock, which was generally considered more appealing to investors due to the diversity of the holding company’s holdings. This allowed the operating companies to purchase their equipment using stock instead of cash, leading to quicker turnaround time in both plant building and profit-making. Holding companies also offered expert advice to the operating companies they owned stock in, giving the operating companies access to technical and managerial resources well beyond their own means.

Holding companies were exceptionally good at what they were designed to do. The expansion of the power industry in the first three decades of the 20th century was phenomenal. Between 1907 and 1927, electrical output grew from 5.9 to 75.4 million-kilowatt hours. At the same time, another economic principle became evident: the economy of scale.

As more power was produced, using larger turbines and more efficient technological systems, the production cost per kilowatt hour dropped. This savings, as per the regulatory agreements, was then passed on to the customer. In the 20 years between 1907 and 1927, companies saw the production price of electricity drop 55 percent.

As with many successful systems, it wasn’t long before the businesses involved discovered how to exploit the holding company structure. The initially intended short pyramid structure of the holding company ballooned. Now, instead of holding the stocks of an operating company, holding companies that only owned stocks of other holding companies were created. As the base widened and the peak rose, an investor in the top company could, for a comparatively small investment, obtain a measure of control over a very large base of industry. For example, Samuel Insull, one of the pioneers of the power business, took control of electric companies and other assets spread over 32 states totaling well over $500 million. His investment? A mere $27 million.

It wasn’t long before such abuses became evident to the federal government. In 1928, the Federal Trade Commission began what was to become a six-year investigation of the activities of holding companies and businessmen such as Insull. This investigation, coupled with public outcry and the political promises of then presidential candidate Franklin Roosevelt, set the groundwork for the total reform of the regulated industry.

The new regulation: a second chance to do it right

Up until the 1930s, the power game had been played mostly in the urban areas of the United States. Most of rural America was still without the benefits of an electric lifestyle, deemed by the power companies not to be a lucrative enough market to warrant attention.

President Roosevelt proved that notion wrong. Through the creation of federally supported power authorities like the Tennessee Valley Authority, created in 1933, Roosevelt brought power to the people of rural America. After this was done, the privately owned power companies found they couldn’t enter the rural market even if they wanted to; it was taken care of by municipal or cooperatively owned companies.

Roosevelt also took actions on other promises he had made on the campaign trail and began the process of returning the regulated industry to a more consumer-friendly state. Through the Holding Company Act of 1935, high pyramid holding companies were outlawed, dissolved and forbidden to hold non-contiguous operating companies. New and restructured holding companies were also required to register with the new Securities and Exchange Commission, which among other things, required public disclosure of financial records for publicly owned companies. Roosevelt refrained from having the federal government take over the industry as a whole, instead giving the private sector another chance to do right by the people they served.

Even with this reform, there was little change in the overall makeup of the American electrical landscape. The majority of power was still produced by privately owned companies. Those companies still had monopolies in their areas. And, above all, the stage was set for the next step in the evolution of electricity in America, the totally electrified lifestyle.

Next time: Electricity permeates all levels of society, becoming a necessity. Then, the bottom falls out.