OBSERVATIONS ON AFFILIATE RULES
Kenneth W. Costello
Federal Trade Commission Workshop on
September 14, 1999
Affiliate rules are being debated in a belligerent environment where different interest groups are exploiting the political or regulatory process to gain favorable treatment. The debate over affiliate rules is being motivated by rent-seeking objectives. Of course, affiliate rules are not new, PUHCA and regulatory constraints on utility diversification activities have been around for some time. Regulators, as it often happens, are placed in a position where they have to form decisions in view of conflicting information. The challenge regulators face is, "Who do I believe?" Rivals of a utility's affiliate, of course, want to handicap the affiliate and be given special treatment; the utility on the other hand, would prefer its affiliate to confront less competition from other entities.
Major policy questions that should be asked
Challenge for state regulators is to protect retail consumers against the possible exercise of market power by a utility and its affiliate without giving up significant efficiency gains that could otherwise benefit consumers.According to some regulatory participants, a utility can subsidize its affiliate by way of
Are all of these activities anti-competitive or can some be regarded as pro-competitive?Perhaps the most important benefit of affiliate rules lies with their up-front character (uncertainty-reducing) that attempts to mitigate market abuses that would otherwise require an after-the-fact investigation and possible litigation. Affiliate rules have the advantage of providing clear and coherent signals to utilities about what they can and cannot do. Affiliate rules can be viewed as "safe harbor" rules or before-the-fact regulatory safeguards against potential market abuses.
The major costs of affiliate rules include oversight and enforcement costs, and the possibility of "going too far" in terms of trying to prevent market abuses. Excessive restrictions on an incumbent utility or its affiliate may prevent (a) the realization of certain efficiencies that could otherwise be beneficial to retail electricity consumers, society as a whole, and (b) the strengthening of competitive forces. "Going too far" may also be interpreted as pushing beyond antitrust principles and mandates, thereby raising legal questions
Areas of disagreement
This stance by state PUCs places a great deal of emphasis on fairness and much less on efficiency. A possible outcome is excessive entry of firms and harm to retail consumers. As I heard one commissioner say, "the floor of the arena is level but the lions always win." This view asserts that big firms always dominate small firms, with the implication that attention should be given to assisting small firms.Regulators need to understand certain basic but important terms - namely, market power versus abusive market power, cross-subsidies, cost-shifting, fair or efficient competition (e.g., rules falling equally on entrants and incumbents, or avoidance of both undue entry barriers and incumbent burdens), anti-competitive versus pro-competitive, barriers to entry. Much disagreement exists over these terms, fueling the current debate over affiliate rules. As an example, a distinction should be made between cost-shifting (which arguably can be a legitimate barrier to market entry) and economies achieved through integration (which is never a legitimate barrier).
Key issues in identifying the appropriate policy for addressing market power abuses include
A point to keep in mind: assisting the competitors of a utility and its affiliate does not necessarily benefit consumers; an assessment of affiliate rules should place primary importance on the short-term and long-term price effects on consumers - not the effect on the utility's competitors; i.e., it is not the role of the regulator to pick winners and losers; instead it is to protect consumers
What constitutes anti-competitive behavior by a firm is disputable (it is assumed that such behavior makes firms better off at the expense of consumers). Some actions assumed to be anti-competitive may actually be pro-competitive, with associated efficiency gains benefitting consumers .
Even if utilities have the opportunity to demonstrate efficiency gains under a rule of reason test, quantifying the gains would be difficult. Because of this, the opportunity would arguably have little effect on a regulator's decision. Rigorous demonstration of economies or other efficiencies is not apt to be feasible, but just a mere showing that some economies and other sources of efficiencies would be plausibly realized would probably fall short of convincing regulators. A reality is that claims of efficiency are easy to assert but real efficiencies are hard to prove and specious efficiencies to disprove.As a matter of both economics and law, it can be argued that the entity with access to relevant information should shoulder the burden of proof on an issue dependent upon that information. This would apply to the case of asymmetric information, where the utility would have more and better information than the state regulator and other parties.
Five general options for state PUCs
(Note: a rule that permits only practices that can be proven to increase consumer welfare will permit no such practice, while a rule that prohibits only those practices that can be proven to decrease welfare will stop no such practice.)