Edition: U.S. / Global

Utilities See Costly Time Warp In '78 Law

Published: October 5, 1994

The 1978 law that shook the utility industry seemed like a good idea to Congress. Aimed at reducing the nation's use of imported oil by spurring the development of alternative energy sources, it requires utilities to buy power from independent generators.

Now the industry is saying that the prices set for that electricity more than a decade ago are so high that utilities are paying hundreds of millions of dollars extra for power they no longer need, hurting stockholders and raising bills to consumers.

Utilities around the country are petitioning their state regulatory commissions, which Congress left to carry out the Public Utility Regulatory Policies Act, to lower these costs or allow them to renegotiate contracts with the independents. Under the law, utilities are required to buy most of the power generated by the independent plants.

The impact is most acute in New York and California, states that had wanted to cut their dependence on oil and provide incentives for a new industry to compete with regulated utilities. In New York, utilities signed hundreds of long-term contracts with the independents at state-mandated rates of about 6 cents a kilowatt-hour.

The Niagara Mohawk Power Corporation, an upstate utility that serves 1.5 million customers, signed more contracts than any other utility in the state, but now says it generates all the power it needs and can buy more from other utilities at a rate of about 2.5 cents a kilowatt- hour. It has asked the State Public Service Commission for help in modifying the old contracts. "This is being watched by everyone in the industry," said Raymond E. Moore, the utility analyst for Dillon, Read & Company. "It could show whether regulators will provide a means for utilities to be able to adapt to competition."

The New York commission estimated this year that in 1997, seven of the state's utilities will pay $1 billion more because of the old contracts than if they were allowed to buy the power in the open market.

The independents counter that they risked capital to build the plants, in some cases enabling utilities to avoid spending billions of dollars to build plants themselves.

Lawrence J. Kostrzewa, senior vice president at Indeck Energy Services, which built a number of plants under the Federal law, including several with Niagara Mohawk, called the strategy similar to what many industries do -- enter into long-term contracts to buy commodities to guard against future price increases.

"They signed contracts that were a hedge against $40-a-barrel oil," he said. "Now they don't want to pay for the hedge."

When many of the early contracts were signed, oil prices were between $30 and $40 a barrel, with forecasts of big increases. And even as oil prices fell in the late 1980's, many analysts kept predicting an upturn. Instead, oil prices gradually declined further, hitting a low of $14 a barrel last year before recovering to about $18 this year.

State regulators around the country are trying to deal with the fallout from the policy. They must decide whether to grant relief to the utilities or continue to provide incentives to the independents, which have been responsible for 53 percent of the nation's new generating capacity in the last four years. About 7 percent of the electricity produced nationally comes from independents.

In 1978, the policy was seen as a logical response to the energy crisis earlier in the decade. Congress, trying to cut dependence on foreign oil, promised entrepreneurs who built generating stations that they could sell power to utilities.

The law required utilities to buy the power at a rate equal to what the utilities would otherwise have spent to generate it themselves. Many states set rates based in part on estimates of future oil and natural gas prices.

In 1979, before most states had established programs, the accident at the nuclear power plant at Three Mile Island, near Harrisburg, Pa., cast the future of nuclear power into doubt. Many utilities began to cancel plans to build nuclear plants.

As a result, the law also had the effect of giving these utilities a cushion of extra power to meet growing demand.

Then, as Eugene R. McGrath, the chairman of the Consolidated Edison Company, said recently, "The world changed."

Oil prices began to drop, and demand was much lower than expected. The long-term contracts that had set rates based on future fuel costs, with some projections of oil hitting $100 a barrel, no longer made sense to utilities. And with the recession in the early 1990's, utilities found themselves generating more electricity than they could sell.

"The projected demand and oil price contracts turned out to be much too high," Peter Bradford, chairman of the New York commission, said in a recent interview. He said the state was looking at ways to provide relief for utilities, such as reducing their state and local taxes or taking over the ownership of their high-cost nuclear plants.

In 1981, New York State had guaranteed independents a floor rate of 6 cents a kilowatt-hour. But in 1992, the state, then trying to reduce the program's impact, eliminated the floor rate for new contracts. No major new deals have been negotiated since then, but hundreds of old long-term contracts are still in effect.