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Public Utilities

Public Utilities

BIBLIOGRAPHY

Public utilities are firms that are sometimes synonymous with natural monopolies. Some examples of public utilities include the Tennessee Valley Authority and Illinois Power.

These organizations are generally so called because there is structurally no room for market competition one firm can naturally produce at lower costs than competitors who are eventually priced out of the market. Thus, natural monopolies tend to be regulated by governments in the public interest. However, being a natural monopoly is not a necessary prerequisite for government regulation. Industries that are not natural monopolies may be regulated for a number of reasons, including service reliability, universal access, and national security.

Public utilities generally supply goods or services that are essential, like water, electricity, telephone, and natural gas. For example, the transmission lines for the transportation of electricity or natural gas pipelines have natural monopoly characteristics in that once these lines are laid by one utility, duplication of such effort by other firms is wasteful. In other words, these industries are characterized by economies of scale in production.

Left to themselves, private utility companies would make decisions that are most profitable for them. Such decisions generally involve too high prices and relatively little service compared to competitive conditions. These decisions may or may not be in the best interests of the society. The government or the society would like to see these services being economically accessible to all or most of the population.

Not all utility companies are in the private sector. In many countries, utilities are owned by the government. Generally, in these cases, the government creates autonomous bodies for government utilities to prevent them from day-to-day political interference. In such instances, the government utilities goals are better aligned with societal goals; however, they tend to be less efficient than their private sector counterparts.

Two main issues facing public utilities are coverage of service area and pricing. Alternately stated, the regulators try to balance the competing aims of economic efficiency and social equity. Economic efficiency generally requires that markets be left to work by themselves with little intervention. Such instances are usually not equitable or fair (some consumers might be priced out of the market). Equity issues demand that everyone gets the service at a just price. However, these instances can turn out to be inefficient (think about the cost to an electric utility of having to run cables a number of miles especially to serve one or two remote fishing cabins that are used sparingly).

In general, the pricing of the services of public utilities is problematic. As mentioned above most public utilities are structural monopolies, implying that there is no room for competition in the market for services they provide. However, if they are left alone to price like monopolies, the resulting price is too high and a large part of the market area may not be served. While the utility companies have no complaints about such arrangements, given the essential nature of the services they provide, the society would like to provide such services to all or most of the population. Think, for instance, about the undesirability of denying heat to someone in the winter. Hence, their pricing actions are regulated.

However, these decisions are somewhat problematic. If these utilities are mandated to set prices at the low competitive levels, they generally end up making losses. So there continues to be an ongoing tussle between regulators and the utility companies regarding a fair price between the monopoly and competitive levels.

Common alternate pricing actions include (1) setting prices equal to average production costs and serving the maximum area possible; (2) rate of return regulation; and (3) price cap regulation. Under average cost pricing, the utility is assured of breaking even, since the prices equal average costs. The equity aspects are somewhat met since most of the market is being served. However, the regulated firm lacks incentives to minimize costs. Under rate of return regulation, the regulators let the firms charge any price, provided the rate of return on invested capital does not exceed a specified rate. Whereas such regulation is flexible in allowing pricing freedom and frees the regulators from monitoring prices, a key drawback is that such regulation can lead to overcapitalization. In other words, when the rate of return is fixed at 5 percent, then the firm can charge higher prices by investing more in capital than it would otherwise (i.e., 5% of $10 million is greater than 5% of $6 million). Price cap regulation directly sets a limit on the maximum price charged by regulated firms. This type of regulation can result in a loss of service area. A (somewhat debated) plus point of price cap regulation is that such regulation induces firms to seek cost-reducing technologies because they offer a way to increase utility profits.

With technological changes over time, the nature of regulation changes in that some functions of the utility companies are unbundled and thrown open to free competition. New technologies might make it possible to break up the different stages of the electric generation process or natural gas transmission such that competition might be allowed to function in some stages. For example, in twenty-first-century United States and elsewhere the electricity generation market is relatively competitive and consumers are able to purchase electricity from competing vendors (generators). However, the transportation of electricity still remains a natural monopoly and continues to be regulated. Further, often times the deregulation of some or all functions of public utilities might occur over time due to political-economic compulsions.

In practice, however, both deregulation and increased regulation are plagued by uncertainties, both for regulators and the firms they oversee. For instance, the firms do not know when and whether they will face additional regulation (or deregulation). The regulators, on the other hand, are unaware whether new technologies would mandate additional regulation. Another related issue facing nations involves how to make the regulations somewhat consistent across international borders so that utilities from one nation do not have undue advantages over utilities from other nations (U.S. and Canadian utilities have faced such issues following the North American Free Trade Agreement [NAFTA]).

There is some criticism of public utility regulation in that over time the regulated utilities tend to take over the regulatory agencies that oversee them (called the capture theory of regulation). Thus the societal interests that the regulatory agencies are supposed to further are somewhat compromised. The evidence regarding the capture of regulatory agencies is mixed, however. Further, some researchers, including John Galbraith in his 1973 work, have questioned the supposed underproduction by monopolies.

To summarize, whereas over time changes in environment and technology warrant changes in regulation of public utilities, the nature of markets that utilities serve generally warrants they be overseen in some form or another by government bodies.

SEE ALSO Energy; Energy Industry; Public Sector

BIBLIOGRAPHY

Berg, Sanford V., and John Tschirhart. 1998. Natural Monopoly Regulation. Cambridge, U.K.: Cambridge University Press.

Galbraith, John K. 1973. Power and the Useful Economist. American Economic Review 63: 111.

Kahn, Alfred E. 1971. The Economics of Regulation: Principles and Institutions. 2 vols. New York: Wiley.

Rajeev K. Goel

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utility, public

public utility, industry required by law to render adequate service in its field at reasonable prices to all who apply for it. Public utilities frequently operate as monopolies in their market. In the United States, public utilities are most commonly involved in the business of supplying consumers with water, electricity, telephone, natural gas, and other necessary services. Such an industry is said to be "affected with a public interest" and therefore subject to a degree of government regulation from which other businesses are exempt.

Opinions differ as to the characteristics that an industry must possess to merit classification as a public utility, since all industries in a sense serve the public. By its nature a public utility is often a monopoly and as such is not prevented by competing companies from charging exorbitant prices. It usually operates under a license or franchise by which it enjoys special privileges, such as the right of eminent domain. Finally, it may supply an essential service, such as water or light, the unavailability of which would injuriously affect public health and welfare. From an early period there was public regulation of canals, turnpikes, toll roads and ferries, inns, gristmills, and pawnshops. Docks, sleeping cars, commodity exchanges, warehouses, insurance companies, banks, housing, milk, coal mines, and (in the 20th cent.) broadcasting, are other types of goods and services held to be affected with public interest. Important utilities that satisfy the vital needs of large populations include water, gas, and electric companies; transportation facilities, such as subways, bus lines, and railroads; and communication facilities, such as telephones and telegraphs. In most European nations such industries have often been owned by the state, although many have been privatized in recent years. In the United States, however, many public utilities are privately owned.

Regulation of Utilities

Public utility rates and standards of service are established by direct legislation and are administered by state regulatory commissions and by such federal agencies as the Federal Energy Regulatory Commission (FERC), the Securities and Exchange Commission (SEC), and the Federal Communications Commission (FCC). These federal agencies supervise utilities conducting interstate business. Rates are subject to review by the courts, which have held that they must provide a "fair" return on a "fair" valuation of investment. How valuation is to be determined, whether on the basis of prudent investment, present earning power, or present cost of production, has been the subject of much controversy. That a utility may not earn excessive profits is an established principle of regulation. The means of regulation include supervision of accounting and control of security issues.

Municipalities dissatisfied with the results of public regulation of privately owned local utilities have often acquired ownership of such enterprises, especially in the case of urban public transportation systems (see public ownership). To keep rates down and make utilities available to more people, the United States has formed public corporations or agencies, such as the Tennessee Valley Authority, which also has served as a yardstick for measuring the efficiency of privately owned utilities, and the National Railroad Passenger Corporation (Amtrak; see railroad), which operates virtually all intercity passenger rail lines in the United States.

In the 1970s and 80s, U.S. government agencies broke up some utilities and deregulated others. In 1974 an antitrust suit was filed against American Telephone and Telegraph (AT&T); in 1982 the company settled the suit by agreeing to divest itself (1984) of 22 local telephone operating companies. In return, AT&T was given the right to enter new businesses. Since then federal regulators have made it easier for companies to enter the telecommunications industry and for phone companies to set rates for long-distance services. Legislation passed in 1978 partially deregulated natural gas prices in 1985 and legislation passed in the late 1970s and early 80s deregulated trucking, railroad, and airline rates, which had been set by the federal government.

In the 1990s state regulators began to end utilities' monopolies, by permitting business and residential consumers to select utilities (primarily electricity and gas suppliers) based on rates and service; lower rates were expected to result. Such deregulatory efforts have not been entirely successful. In 2000–2001, parts of California experienced an energy crisis that was due, at least in part, to the way deregulation had been set up several years earlier, The deregulated electrical companies had been required to divest themselves of their power plants and purchase power on the spot market (rather than through long-term contracts) and were not allowed to pass the price increases they eventually experienced along to consumers. Evidence also later emerged that other deregulated energy companies had contributed to the crisis through market manipulation and price gouging.

Tighter regulatory controls designed to limit acid rain and other environmental problems have, however, been imposed on electricity companies that run coal-fired generators or nuclear power plants. The cable television industry, which had been regulated by local governments, was deregulated in 1984, and cable operators were allowed to set their own rates. Consumer complaints, however, led to a 1992 law that allowed the FCC to regulate cable rates.

Bibliography

See E. Hungerford, The Story of Public Utilities (1928); M. Crew, The Economics of Public Utility Regulation (1986); L. Hyman, America's Electric Utilities: Past, Present and Future (1988).

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Public Utilities

PUBLIC UTILITIES

PUBLIC UTILITIES. In the United States, public utilities supply consumers with electricity, natural gas, water, telecommunications, and other essential services. Government regulation of these utilities considered vital to the "public interest" has waxed and waned. In the nineteenth century, canals, ferries, inns, gristmills, docks, and many other entities were regulated. However, in the early twentieth century, emerging electric companies initially avoided regulation These rapidly growing power companies often merged, creating monopolies that controlled the generation, transmission, and distribution of electric power. By 1907, entrepreneur Samuel Insull of Chicago Edison had acquired twenty other utility companies. He and others argued that building multiple transmission and distribution systems would be costly and inefficient. Nevertheless, reformers clamored for state regulation of the monopolies. By 1914, forty-three states had established regulatory polices governing electric utilities. Insull and other electric power "barons" found a way past regulation by restructuring their firms as holding companies. A holding company is a corporate entity that partly or completely controls interest in another (operating) company. Throughout the 1920s, holding companies bought smaller utilities, sometimes to the point that a holding company was as many as ten times removed from the operating company. Operating companies were subject to state regulation, holding companies were not. Holding companies could issue new stock and bonds without state oversight. This pyramid structure allowed holding companies to inflate the value of utility securities. Consolidation of utilities continued until, by the end of the 1920s, ten utility systems controlled three-fourths of the electric power in the United States. Utility stocks, considered relatively secure, were held by millions of investors, many of whom lost their total investment in the stock market crash of 1929.

Public Utility Holding Company Act

With strong support from President Franklin D. Roosevelt, Congress passed the Public Utility Holding Company Act (PUHCA) in 1935. PUHCA outlawed interstate utility holding companies and made it illegal for a holding company to be more than twice removed from its operating subsidiary. Holding companies that owned 10 percent or more of a public utility had to register with the Securities and Exchange Commission and provide detailed accounts of all financial transactions and holdings. The legislation had a swift and dramatic effect. Between 1938 and 1958 the number of holding companies fell from 216 to eighteen. This forced divestiture continued until deregulation of the 1980s and 1990s.

Deregulation

Many politicians and economists argued that the marketplace, not government regulation, should determine utility prices. Many consumers also sought lower prices through deregulation. Near the end of the twentieth century, while government oversight of safety remained, price and service regulation were removed from several industries, including telecommunications, transportation, natural gas, and electric power. As a result, new services and lower prices were often introduced. The increased competition among investor-owned utilities also led to mergers and acquisitions and a concentration of ownership. Deregulation is also credited with the rise of unregulated power brokers, such as Enron, whose historic collapse in 2002 laid bare the vulnerability of consumers and investors when corporations control essential public services. About a dozen states repealed or delayed their deregulation laws; many consumer groups maintained that PUHCA's protections should be reinstated.

BIBLIOGRAPHY

Euromonitor International. "Electric Power Distribution in the United States." http://www.MarketResearch.com.

Lai, Loi Lei. Power System Restructuring and Deregulation. New York: Wiley, 2001.

Warkentin, Denise. Electric Power Industry in Nontechnical Language. Tulsa, Okla.: Penn Well Publishers, 1998.

LyndaDeWitt

See alsoMonopoly ; Robber Barons ; Trusts ; andvol. 9:Power .

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Public Utilities

PUBLIC UTILITIES

Businesses that provide the public with necessities, such as water, electricity, natural gas, and telephone and telegraph communication.

A public utility is a business that furnishes an everyday necessity to the public at large. Public utilities provide water, electricity, natural gas, telephone service, and other essentials. Utilities may be publicly or privately owned, but most are operated as private businesses.

Typically a public utility has a monopoly on the service it provides. It is more economically efficient to have only one business provide the service because the infrastructure required to produce and deliver a product such as electricity or water is very expensive to build and maintain. A consequence of this monopoly is that federal, state, and local governments regulate public utilities to ensure that they provide a reasonable level of service at a fair price.

A public utility is entitled to charge reasonable rates for its product or service. Rates are generally established according to statutes and regulations. The utility usually files a proposed rate schedule with the state public utility com mission for approval. The commission holds public hearings to help decide whether the pro posed schedule is fair. The commission may also require increased levels of service from the utility to meet public demand.

Until the 1930s public utilities were subjected to minimal regulation. The enactment of the Public Utility Holding Company Act of 1935 (49 Stat. 803 [15 U.S.C.A. §§ 79–92z-6]) signaled a change. A holding company is one that owns stock in, and supervises management of, other companies. The law regulates the purchase and sale of securities and assets by gas and electric utility holding companies and limits holding companies to a single coordinated utility system. The law ended abuses that allowed a small number of public utilities to control large segments of the gas and electricity market and to set higher utility rates.

Public regulation of utilities has declined since the late 1970s. Public policy is now based on the idea that competition rather than regulation is a better way to manage this sector of the economy. Airline and telephone deregulation are the most prominent examples of this shift in philosophy. Telephone deregulation was enabled by a 1982 agreement between American Tele phone and Telegraph Company (AT&T) and the federal government. The federal government had sued AT&T, alleging that its monopoly on virtually all telephone service in the United States was illegal. AT&T agreed to divest itself of all local telephone companies, while retaining control of its long-distance, research, and manufacturing activities. This resulted in the creation of seven regional telephone companies with responsibility for local telephone service. Other companies now compete with AT&T for long-distance service.

At the federal level, numerous commissions oversee particular types of public utilities. These include the Federal Energy Commission, the nuclear regulatory commission, the federal communications commission, and the securities and exchange commission.

cross-references

Nuclear Power; Telecommunications.

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public utility

pub·lic u·til·i·ty • n. an organization supplying a community with electricity, gas, water, or sewerage.

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public utility

public utility: see utility, public.

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