In the late 1990s, Michigan’s high energy costs and aging infrastructure prompted the Michigan Legislature to restructure the electricity industry. Two principle goals guided the Legislature: 1) to encourage investment in new, more efficient generating capacity and 2) to introduce competition in energy supply as a means of controlling electricity rates. However, the statute that emerged actually undermined competition and investment by maintaining rate regulation and service mandates on Detroit Edison and Consumers Energy (commonly referred to as the "incumbent utilities"[*]). Simply put, the "Customer Choice and Reliability Act of 2000," popularly known as P.A. 141, constituted a change in regulation more than it did deregulation.
The new law "unbundled" the three elements of electricity service — generation, transmission and distribution. It also established a schedule by which competitive suppliers could market electricity to residential, commercial and industrial customers. (As a practical matter, power suppliers cannot direct the electricity they produce to specific customers. But the total volume of power they add to the transmission grid represents the load specified by their customer contracts.)
However, P.A. 141 also cut by 5 percent the residential rates charged by the incumbent utilities and froze them at that level for five years, which reduced customers’ incentive to seek service alternatives. At the same time, commercial customers of the incumbent utilities were forced to pay artificially high rates to subsidize residential service. Thus, commercial customers had an incentive to opt for an alternative supplier.
Two other elements of P.A. 141 undermined prospects for a competitive market. First, the incumbent utilities were required to maintain at all times enough power capacity to serve the peak demands of all customers in their regions. This required the utility to maintain infrastructure for which it had no current demand. Second, the incumbents were required to restore service at a regulated rate to any customer who left a competing supplier.[†]
DTE Energy and CMS Energy, parent companies of Detroit Edison and Consumers Energy, successfully argued that the incumbent utilities should be compensated for their costs in transitioning to competitive markets. They asserted that competition would pit them against newer, more nimble and efficient competitors unburdened by the costs of less efficient equipment and more expensive overhead. They also claimed that competition would shrink their customer base and deprive them of revenue needed to pay the debt costs of the infrastructure necessary to provide mandated services such as maintaining excess generating capacity necessary to serve all customers during periods of peak demand, as well as a range of programs to assist low-income customers. Thus, they secured in Public Act 142 of 2000 a substantial stream of revenue to recover these "stranded costs," which the Michigan Public Service Commission defined as "(1) costs that were incurred during the regulated era that will be above market prices during competition and (2) costs that are incurred to facilitate the transition from regulated monopoly status to competitive market status."
Executives of DTE and CMS Energy can hardly be faulted for representing the interests of their shareholders, for whom competition would undoubtedly have proved disruptive. For decades the utilities were guaranteed profits from their captive customer base irrespective of efficiency or economic discipline. Indeed, under "rate-of-return" regulation, the utility’s income rose with every dollar the utility spent.
The two utilities were granted state loan guarantees totaling $2.2 billion with which to refinance their debt through the sale of securities.[**] In so doing, the incumbents received a huge infusion of cash to offset future — hypothetical — losses. To ensure repayment, lawmakers imposed a surcharge on all electricity customers in the DTE and CMS Energy service territories, including those who would opt for a competing supplier.
Some investments and commitments by the incumbent utilities may well have been unrecoverable outside of rate regulation. Under federal law, for example, utilities across the country were required to enter into long-term purchase contracts with independent power producers irrespective of price considerations. In other words, they had to purchase and transmit electricity generated by third parties at a cost that did not reflect future market prices. Still, some of the costs defined as "stranded" in Public Act 141 and Public Act 142 were probably not the result of the regulatory environment, but nonetheless were eligible for recovery under the state’s revenue subsidies.
[*] The phrase “incumbent utilities” reflects the two companies’ dominance in the marketplace prior to passage of the reforms in P.A. 141 and P.A. 142.
[†] The MPSC later instituted requirements on returning customers seeking regulated rates.
[**] With the state as a “co-signer,” the utilities were able to refinance their debt based on the credit rating of the state. Michigan’s credit rating was the highest among the states in 2000.