B. DEAN STANLEY
behalf of the
UNITED STATES FEDERAL TRADE COMMISSION
Session IV B
September 14, 1999
Good morning. My name is Dean Stanley, and I am the President and Chief Executive Officer of Kenergy, a consumer-owned electric cooperative located in Owensboro, Kentucky.
I appear today to discuss the views of the National Rural Electric Cooperative Association and its member cooperatives on codes of conduct and I would like to use the examples of Kentucky and Kenergy in particular to illustrate the effect such rules and regulations would have on consumers in "real life." I have been studying these issues since the Kentucky Public Service Commission (“PSC”) issued an order on September 3, 1998 proposing a code of conduct for utilities with nonregulated activities or affiliates and cost allocation requirements. The Kentucky cooperatives and NRECA filed comments responding to the proposed affiliate transaction rules and cost allocation requirements. I have brought with me, and will file with my testimony, the response to Kentucky PSC Order 369 on behalf of the Kentucky Association of Electric Cooperatives (KAEC), our statewide trade association. It touches in some depth on many of the issues under your examination this morning.
Kenergy was established in July 1999 through the consolidation of Green River Electric Corporation and Henderson Union Electric Cooperative. Kenergy is a non-profit rural electric distribution cooperative providing retail electric service to over 48,000 residential, commercial, and industrial customers in 14 western Kentucky counties. Kenergy also provides security systems for homes and businesses, medical alert monitoring systems, telephone and internet services, geothermal heating and cooling equipment, home insulation services, and incentives to promote energy efficiency and a variety of economic development loans.
NRECA is the national service organization that represents the nation's nearly 1,000 consumer-owned, not-for-profit rural electric systems that provide electric service to nearly 30 million consumers in 46 states.
My goal here today is to explain the effect that different proposed codes of conduct could have on competition, consumers, and innovation in the electric utility and other industries. If I can make only one point today, it would be to have you understand the unique characteristics of electric cooperatives within the electric utility industry, and the importance of those differences as regulators and legislators set out the rules for a competitive energy market.
Regulators must act with moderation and flexibility. If a state chooses to impose a code of conduct, it must be carefully tailored to achieve its legitimate goals without imposing unnecessary one-size-fits-all restrictions. A code of conduct that is overly proscriptive or that applies equally to all market participants regardless of their size or ownership will, in practice, reduce competition, increase costs for consumers, and reduce innovation in the market place.
The different experiences of California and Pennsylvania appear to support that conclusion. California has imposed strict rules on incumbent utilities and the result has not been to have many new suppliers entering the market or customers switching suppliers. Pennsylvania, by contrast, has adopted moderate and limited interim rules, and that state is enjoying a significant number of new market entrants (at least in urban and suburban areas) and greater numbers of residential customers choosing alternative suppliers. According to Ahmed Kaloko, Ph.D., Chief Economist of the Pennsylvania Public Utility Commission, 92,904 California residential customers have switched suppliers while 316,317 Pennsylvania residential customers have switched. According to their respective commission web sites, Pennsylvania has about 80 licensed electric suppliers while California has approximately 34 active electric service providers.
Let me begin by saying that electric
As consumer-owned, and consumer-regulated entities, cooperatives have strongly supported state consumer protection efforts, including consumer education programs, licensing requirements for competitive energy suppliers, and truth-in-advertising requirements.
Cooperatives have also supported efforts to prevent cross subsidization. In fact, nearly all electric cooperatives are already subject to federal or state prohibitions on cross subsidization.
We are concerned, however, that some companies and organizations have proposed the adoption of far reaching, inflexible, one-size-fits-all codes of conduct that would not only be far more prescriptive required to achieve these legitimate goals, but would, in fact, be counterproductive. Many of the proposals would reduce competition, raise prices, reduce service quality, and reduce market and technical innovation.
We are particularly concerned about proposals pressed by propane dealers, heating, ventilation, and air conditioning (“HVAC”) contractors, and some others would handicap utilities seeking to enter non-regulated activities, giving a competitive advantage to incumbent businesses already engaged in those activities. While existing monopoly providers of electric service may possess certain market advantages in that service, there should be no such assumption when utilities enter existing competitive markets in non-energy related services or non-regulated energy markets. Electric utilities are often new entrants into an already competitive marketplace. Existing competitors will have the advantage of years of experience in the market place. In other instances, the market place is virtually void of service providers, often because they have deemed entry in that location as unprofitable.
Cooperatives in Kentucky have become involved with affiliate services primarily out of a desire on the part of their members for them to offer these particular services. Electric cooperatives in Kentucky sponsored a statewide research activity relating to electric cooperative customer attitudes regarding expanding products and services. The results were published on July 16, 1999. When asked if the customer generally favored or opposed cooperatives offering a wider variety of products and services, over 50% said that they favored this direction, while fewer than 10% opposed this direction. Another 67% said they would support their own electric cooperative providing customer services such as insulation programs, appliance warranty, and energy audits. Additionally, 64% of the cooperative members supported entry into other types of energy -- such as fuel oil, natural gas, and propane. Lastly, 55% of those surveyed supported entry into telecommunications, internet access, and long distance telephone service.
members want these additional services because they are not either readily
available in their local area, or if they are available, they are not available
at a competitive price. Another reason cooperative
members often want these additional services is because the quality of existing
services is not dependable.
Cooperatives are not being engaging in anti-competitive behavior. They are merely responding to the needs of
their consumer-owners. Cooperatives
believe that businesses with years of experience in already existing
competitive markets are seeking to eliminate any additional competition in
their businesses by handcuffing cooperatives with one
Another point I would like to make is that electric utility industry restructuring and related issues such as codes of conduct/cost allocation at the state level is best handled within the same time frame. Matters pertaining to codes of conduct/cost allocation are best left to be finalized only at such a time as when we know how the basic structure of our industry will be shaped. It makes little sense to us to enact substantive rules or laws pertaining to code of conduct in particular until industry restructuring issues have been resolved.
We are less concerned about addressing cost allocation guidelines now. We believe that existing rules and regulations and our present policies and procedures provide more than substantial protection for our member-consumers. Still, even provisions relating to cost allocation guidelines may have to be modified depending upon the outcome of the restructuring debate in our state legislature.
I think it would be useful here to discuss some of the specific code of conduct proposals that pose risks to competition and consumers, including separation of function requirements, limitations on lines of business, limitations on common use of name and logo, and mandatory information sharing.
Separation of Function Requirements
Some proposed codes of conduct would require electric utilities and their non-regulated affiliates to operate as separate companies with separate employees, separate offices, separate computers, separate employees, etc. Those rules directly conflict with the natural direction of the industry in competition.
In a competitive market, utilities will seek to diversify their product and service offerings to retain existing customers and attract new customers. The belief is that the more products or services a supplier can offer consumers, the more innovative the supplier can be in offering different bundles of services the consumers could want. Enhancing competition then, should also enhance the delivery of new products and services. Greater numbers of competitors will generally result in increased pressure to keep prices low.
Affiliate rules that inhibit utility diversification also deny consumers the benefit of economies of scale and scope, causing consumer prices to stay at present levels or go higher, and slowing the introduction of new and innovative products and services. Economies of scale may be realized when utilities offer a wider variety of products and services, both electric and non-electric related. New electricity market entrants are often sizable firms in their own right, and will also take advantage of any operational efficiencies. Why then should incumbent utilities be precluded under strict affiliate rules from attempting to realize those same operational efficiencies, which would result in their ability to lower prices to consumers?
Utilities may also have the potential for economies of scope by more fully utilizing capital assets. For example, private utility telecommunications networks for system control and dispatch that are not fully utilized (often referred to as “dark cable”) may be used to provide telecommunications services to retail customers. Likewise, utility employees with accumulated skills and knowledge of the communities in which they serve may enhance the utility’s ability to identify consumer needs and design new and innovative products and services to meet those needs. The ability to use a common brand name or logo further realizes economies of scope by giving utilities greater capacity to bear risks associated with new product and service development, as they will not have to incur additional costs of new brand development which would then have to be passed on to consumers.
New electricity market entrants may very well have their own underutilized assets and employee talent to bring to bear (they may also hire that talent away from utilities), and they may have brand names that are just as well recognized in the non-electric markets in which they have been doing business. It should not be assumed that these new electric market participants are without their own resources, brand equity, and ability to realize economies of scale and scope.
Affiliate rules should not be imposed on utilities when such rules eliminate economies of scale and scope and do not provide consumers with commensurate benefits.
Of course, states must balance the benefits consumers can gain from diversification against the risks they may face when they take monopoly services from entities with the incentive and opportunity to cross subsidize non-regulated activities with revenue from regulated activities. However, because of the unique characteristics of electric cooperatives, the balance is easy to achieve with respect to electric cooperatives. Strict separation rules are both unnecessary and anti-consumer when applied to electric cooperatives.
For that reason, during informal proceedings at the Kentucky Public Service Commission, the PSC expressly asked whether separate rules should be developed for different entities and it was suggested more than once by various parties that separate rules and regulations may be in order for electric cooperatives, compared to those for investor-owned utilities. Our very nature as not-for-profit and consumer-owned brings different issues to the table.
Separation Requirements Are Unnecessary For Cooperatives
As consumer-owned entities, cooperatives have no incentive to cross-subsidize. Because they are not-for-profit and owned by those they serve, cooperatives do not have “captive ratepayers” in the sense that investor-owned utilities do, and thus have no incentive to cross-subsidize nonregulated activities with “excess” profits earned from regulated functions. Any margins generated by the cooperative will be returned to its members and all cooperative margins are ultimately used to benefit the consumer-owners.
Even if cooperative management had an incentive to cross-subsidize non-regulated activities, cooperatives’ member-owners could prohibit it. Cooperatives are unique entities in the electric industry in that they are regulated by the consumers they serve. Cooperatives are owned by their consumers, each of whom has an equal vote in electing the cooperative’s governing board of directors. Cooperatives’ member-owners are unlikely to overcharge themselves to subsidize businesses that serve non-members as well as members.
Moreover, any concerns about cross-subsidization by cooperatives can be more than adequately addressed through appropriate cost accounting rules:
Cooperatives that receive RUS funding are subject to RUS cost-accounting and anti-subsidization rules.
Additionally, cooperatives that are tax-exempt under Section 501(c)(12) of the Internal Revenue Code are also subject to IRS restrictions on cross-subsidization. The IRS requires that for tax exempt status, electric cooperatives must operate according to four basic cooperative principles: (1) subordination of capital in control over the cooperative undertaking and in ownership of the financial benefits from ownership (unlike stockholders who earn a return on capital invested); (2) democratic control by the members of the cooperative; (3) vesting in and allocation among the members of all excess of operating revenues over the expenses incurred to generate revenues in proportion to their participation in the cooperative (patronage) (unlike stockholders who own equal shares in a corporation's net worth, regardless of how much business they transact (if any) with the corporation); and (4) operation at cost. A cooperative that overcharged distribution customers to subsidize non-regulated activities would violate the last requirement – that the cooperative operate at cost.
Finally, in some states, including Kentucky, cooperatives are subject to state prohibitions on cross subsidization. In Kentucky, our Public Service Commission has full jurisdiction over cooperatives’ rates, territories, and service standards. The Commission regulates our accounting and closely monitors our rates, operations and services, in part to ensure that we do not use electric revenues to subsidize non-regulated activities.
Separation Requirements Would Be Unduly Burdensome For Cooperatives
Strict separation requirements would also be unduly burdensome if applied to cooperatives. Codes of conduct that include strict separation requirements or prohibitions on certain joint activities may effectively exclude the majority of electric cooperatives from many competitive markets because the compliance costs will be too high.
Most electric cooperatives are far smaller than most investor-owned utilities. The average distribution cooperative has only 57 employees and serves 9,500 customers. Kenergy is one of the larger distribution cooperatives in the country with 193 full time employees and over 48,000 customers. Even so, we are much smaller than the average investor-owned utility, which has 2,206 employees and serves 315,000 customers. On average cooperatives also earn far less revenue per mile of line per year, $7,000, than investor-owned utilities, $59,000.
It is fairly easier for a company with over 2,000 employees and 315,000 customers to absorb the cost of constructing a new building, buying a new computer system, and hiring separate employees to perform regulated and non-regulated functions. In fact, a large company may already own separate buildings and other physical facilities, just to simplify management and accounting. Moreover, a large investor owned utility can spread the costs over far more customers, significantly reducing the cost impact on each customer. And, if the regulations would still impose too great an impact on prices, making them uncompetitive, an investor-owned utility can split the costs with shareholders.
the other hand, most cooperatives are not large enough to establish formal
holding companies, have their operations in entirely separate buildings, or
completely draw a hard line of separation in their formal
operating structures. Our
The enormous burden of strict separation of function requirements could well make it impossible for many cooperatives to provide competitive services at affordable and competitive prices. Yet, their exclusion from competitive markets, particularly in the poorly served rural areas where many cooperatives are located, could severely reduce competition and lead to higher prices and reduced innovation.
Kenergy, today provides some competitive services, including home security and medical alert monitoring services, telephone and internet services, equipment and services to promote energy efficiency, and economic development support to our rural communities. We provide these services because our members asked for them. And, we are able to provide these services at a reasonable price because they complement the work we already do for our members. By providing these services through Kenergy, we can use personnel and physical assets more efficiently than if we provided just energy or just security services.
If we were required to spin these competitive services off into a separate affiliate with separate employees, separate offices, separate computers, etc., it would eliminate the efficiencies we gain providing them together, it would dramatically increase our overhead, and it would deny consumers the convenience of being able to shop for services in a single place. Even if we continued to provide these competitive services, they would cost consumers far more than they would need to. If we found that it was no longer economical to continue to provide these services, consumers would be denied the cooperative choice. If there are other providers, they would no longer face competitive pressure from Kenergy to keep their prices low or to provide good service. Consumers could find themselves paying more for less service.
Separation of Functions Requirements Violate ooperative Members’ Ownership Rights
Some separation requirements would either prohibit any incumbent utility, including a distribution cooperative, from selling energy in a competitive market, or require the utility to form a new subsidiary to compete in the energy market. If such a rule were applied to a cooperative, it would violate the ownership rights of the cooperatives’ member-owners and unnecessarily raise costs for rural consumers.
Most distribution cooperatives have joined with other distribution cooperatives to form generation and transmission cooperatives (“G&Ts”), which then built or contracted for generation to serve their members’ energy needs. In Kentucky, for example, different groups of cooperatives joined together to form two G&Ts: Big Rivers Electric Corp. and East Kentucky Power Cooperative. Like the distribution cooperatives, the G&Ts are cooperatively owned and democratically governed.
In this way, cooperatives’ member-consumers own their own generation. They own their distribution cooperative which in turn owns the G&T. The G&T built or contracted for generation with capital contributed by the distribution cooperatives, capital initially contributed to the distribution cooperatives by their member-consumers.
Strict application of separation rules to cooperatives would thus prohibit consumers the right to buy power from a company they own, or to purchase generation from plants built with capital they contributed. That would be like telling home gardeners that grow their own tomatoes that they have to buy tomatoes from the grocery store. It makes no sense. Although the distribution cooperative could spin its power sales off into a separate cooperative or a subsidiary, the transaction costs would only raise prices for consumers, without providing the consumers any benefit.
Such a rule also denies consumers the critical right to protect themselves from market abuses. Consumers formed electric cooperatives, starting in the 1930s, because utilities would not serve rural areas: it simply was not profitable enough. Consumers had to join together and provide for themselves because the market would not. The same problem is arising again today. In most states with retail electric competition, there are very few options for any residential or rural consumers. Residential consumers in California, Massachusetts, and Rhode Island are not being offered lower cost alternatives to existing service. Even in Pennsylvania, where more choices are available for urban consumers, not one alternative energy supplier is willing to serve any cooperatives’ residential customers. Any regulation that denies consumers the right to buy energy from their cooperative, or increases the cost of buying from their cooperative, denies consumers the ability to protect themselves from an unfriendly market place.
Limitations On Lines Of Business
The same is true with respect to other services. Some states currently deny cooperatives the right to provide consumers with some non-electric services. Others are proposing to expand those limitations through codes of conduct. Because the cooperative was created by its members in order to provide the services the members could not get adequately elsewhere, and if cooperative members want to receive competitive services from their cooperative, they should be able to direct that the assets that they own and control be used to provide them with these services. By denying them that right, such rules reduce consumers’ choices, eliminate competitors from the market, and reduce competitive pressures to lower prices, improve service, and increase innovation in these other services.
Limitations On Use Of Common Name or Logo
Some code of conduct proposals would prohibit incumbent utilities and their affiliates involved in competitive markets the right to use the same name and logo, and the right to jointly market services. Such proposals would deny consumers access to important information they need to make intelligent choices in the market.
A consumer cannot make intelligent choices in the market place without full knowledge about his or her choices. Any rule that denies consumers such information weakens the market. A competitor’s affiliation with an incumbent utility is particularly useful information for consumers. Whether a consumer loves their utility or hates it, it is an entity with which they are already familiar. They have an idea whether their utility rates are reasonable and whether the utility provides good, innovative service. They know whether the utility is consumer friendly. That is exactly what they will want to know about competitive service providers.
To date, few residential consumers have switched power suppliers. In some cases, that is because few suppliers are competing for their business. Certainly, regulatory restrictions that limit participation in markets will not resolve that problem. But, in other cases, consumer confusion and the learning curve associated with understanding the choice available have blocked consumers from taking advantage of choices available to them. Affiliate rules that include impractical restrictions on utilities and affiliates using a common name or logo or on joint marketing or advertising activities can contribute to, rather than help reduce, that confusion. Consumers have a right to know with whom they are dealing. This is particularly true for consumers that are member-owners of their cooperative.
Many electric cooperatives do not have the resources individually to engage effectively in competitive marketing and advertising unless they are allowed to cooperate with one another in such efforts. Without the ability to do so, consumers will not be adequately informed that cooperatives are among their choices for electric suppliers. Further, cooperative consumers have a right to know, and cooperatives should therefore be able to communicate, through coordinated marketing and advertising activities, that cooperatives that are part of a G&T system own the assets of their G&T, and therefore distribution cooperative consumers in turn, own those assets.
Still further, a cooperative’s member-consumers own the cooperative’s name and logo and they own the good will associated with that name and logo. They paid to develop the value of those assets through their rates and their contributions to the cooperative’s capital. They should be free, therefore, to apply those as they wish to an affiliate.
Mandatory Information Sharing
Other proposed code of conduct provisions would violate consumer privacy rights. Some are recommending, for example, that incumbent utilities be required to release private consumer data to all competitors in the energy market or in other markets in which the utility participates.
Depending on the proposal, the information to be shared could include the consumers’ names, addresses, phone numbers, and their load profile. Consumers also have certain expectations that their private, personally identifiable data will not become general public knowledge on the advent of competition. Residential consumers do not want to end up on endless mailing lists, they do not want strangers to know identifying information about themselves, and they certainly do not want dinner-time phone calls from more marketers. Commercial customers have the same concerns. Moreover, their load profiles can be highly sensitive commercial information. Competitors can learn a great deal about the manufacturing processes, their costs, their productivity, and how successful they have been by analyzing load data.
Nevertheless, many new electricity market entrants are arguing that the release of such data is necessary to encourage fair competition. Similarly, existing providers of other services are arguing that their privileged access to their consumers’ data gives utilities an unfair competitive advantage when they start offering those other services.
States must balance these competitive concerns against the legitimate privacy concerns of all consumers, but particularly residential consumers. A regulated electric market afforded consumers protections that their personal information would be protected by the utility that collected and maintained it in order to provide them vital services. Being owned by their consumers, cooperatives are especially sensitive to these privacy concerns. We advocate that states develop reasonable rules to safeguard private consumer data by not requiring mandatory disclosure of such data, unless and until a consumer gives his or her informed consent for disclosure to their chosen power supplier.