PUC by dandanhuanghuang

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									Xcel, The Colorado Public Utilities Commission, and Green Energy



        Economic students the world over are taught that governments are formed to provide

public goods and to mitigate externalities. And there is no more classic example of a market

externality than environmental degradation. This paper will analyze the role of the Colorado

Public Utilities Commission in generating inefficient green energy initiatives. My argument

is that, where the commission, a utilities regulator, is designed to have interests that counter

those of Xcel’s natural monopoly, in green energy projects, the bias of the commission aligns

its interests with Xcel’s, which creates unnecessarily high rates and inefficient green energy

initiatives.

        This paper will first explore the relationship that should occur between the

commission and Xcel. Then it will address how that relationship changes in the presence of

green energy policy. Both sections will use game theory models to assess where the interests

of the two parties lie in relation to increasing costs to consumers. It will then address why the

green energy initiatives created in this situation are not representative of consumer

preferences, overly burdensome to poor consumers, and ineffective at preserving the

environment.


Regulation of Natural Monopolies

        The traditional assumption of public utilities like Xcel energy is that they are natural

monopolies, and serve the pubic best as such. Because they are economies of scale, it makes

the most sense to have one infrastructure providing electricity to a city full of consumers.

Two sets of power lines, generators, transformers, and staffs would simply be socially

inefficient. Admittedly other schools of thought have devised ways to introduce competition
into public utilities (Saplacan, 2008), the traditional view is that natural monopolies exist in

utility generation.

        In order to capitalize on these natural monopolies, some form of regulation is

necessary. Without regulation, monopolies would be free to raise their prices indefinitely

because consumers have no other option to satisfy their demand for electricity. Each

American state, as well as Guam and the Virgin Islands, has their own version of this

regulatory agency (“State Public Utilities Commissions,” 2010).

        Colorado’s variant is the Colorado Public Utilities Commission a board of three

commissioners and their staff that regulates the state’s public utilities. Their website states

that “The Colorado Public Utilities Commission (COPUC) serves the public interest by

effectively regulating utilities and facilities so that the people of Colorado receive safe,

reliable, and reasonably-priced services consistent with the economic, environmental and

social values of our state” (“Mission of the COPUC,” 2010). In a perfect world, this would be

a prime example of the government intervening to ameliorate the externalities of free market

capitalism. But, if that were the case, this would make a terribly boring public choice paper.

Instead, this paper argues that the COPUC’s method of pursuing their mission leads to

inefficiencies.



Methods of COPUC

        The way COPUC regulates monopolies like Xcel is by limiting the maximum amount

the company can charge consumers. Xcel compiles all their data and presents a rates case to

the COPUC stating what they would like to be able to charge consumers. COPUC then

listens to a series of testimonials, including that of their own staff, and determines what Xcel

is permitted to charge their customers. For example, in 2006, Xcel argued for a $178 million

dollar hike in the base rate, the amount that determines what they can charge consumers.
COPUC countered with $83 million, to which Xcel requested $172 million. Eventually they

agreed on a base rate increase of $107 million. This amounted to a 7.7 percent increase in

electrical bills for the average residential or small business consumer

        The reason this system works, in theory, is that it pits the interests of the consumer,

with the muscle of the consumer-representative COPUC, against the monopolistic strength of

Xcel (“PUC Continues Hearings in Xcel Rate Case,” 2006). When put into terms of Game

Theory, the outcome should resemble the following:


        Allow Increase          Limit Increase
             Xcel: ++               Xcel:+
Price
Hike




            COPUC: --             COPUC: +

              Xcel: --             Xcel: +/-
Maintain
Current




           COPUC: +/-            COPUC: +/-
Rate




Xcel is always going to suggest a price hike. The worst scenario that might occur is that they

do not get as much money as they would hope for. The best-case scenario is that they get to

raise their rates exorbitantly. Because of this, the bottom cells of the table are highly unlikely.

There is really no practical circumstance where, as a monopoly in the current situation, Xcel

would not want to ask for an increase in rates. But if they did not ask for the increase when

COPUC would have granted it, they have extremely high opportunity costs of missing that

increase in revenue. If they do not ask for an increase, and the increase would not have been

granted, the outcome is essentially neutral, but practically very unlikely.

        COPUC is expected to prevent prices from increasing excessively for consumers. So

if they do not limit Xcel’s rates increase, they will be held accountable for failing in their

purpose when consumer’s bills rise suddenly, in the top left outcome. The bottom left could
yield either mildly positive or mildly negative outcomes depending on circumstances, but is

an unlikely outcome, as Xcel is always going to ask for a rate increase. The bottom right

square is similarly ambivalent. Limiting a price increase that was never suggested is neither

positive nor negative, but it is highly unlikely. The top right square is the likely outcome.

COPUC gets to claim effectiveness in limiting price increases, and thus has fulfilled their

mandate.

        The way the situation should work, ideally, is that each time Xcel asks for a base rate

increase, COPUC limits the amount they are allowed to increase. Xcel gets to expand their

business and revenue, and COPUC fulfills their mission. Because of their opposing interests,

prices rise as slowly as costs rise, allowing for the optimal energy provision for the

consumer. Unfortunately, movement towards green energy technologies has altered the

alignment of the two parties’ interests.


Green Energy, COPUC, and Xcel: The Unholy Trinity

        In keeping with the international movement to protect our environment, public

utilities and energy producers the world over have been asked to clean up their production.

From the Chinese Renewable Energy Law calling for greater use of renewable resources

(Clark II & Li, 2010, p. 55), to Colorado House Bill 1001, which requires Xcel to generate 30

percent of their energy from renewable resources by 2020 (Ritter Jr, 2010), legislation the

world over has been pushing for greater use of renewable resources. While such pressure is

undoubtedly necessary to preserve our environment, its effect on the relationship between

COPUC and Xcel is troubling; they both agree that rates should increase for green initiatives.

Contrary to initial appearance, this does not benefit the consumer.

        Xcel’s interests in promoting green energy is that they get to increase their rates with

the increased fixed cost of infrastructure and increased marginal costs of operations from
green energy projects. The phrase generally used in legal documentation is that public service

commissions may request in their rates case “return of and on investment” (Selecky, 2004),

(Rulemaking on Pricing Safeguards, 2004). That means that with each investment Xcel

makes, Xcel can recoup all their initial fixed cost and get return on investment beyond that.

The more investments that they can justify making, the more they are granted in revenue.

Renewable energy projects provide this justification.

        Xcel provides a wealth of projects and opportunities for green energy. With the

installation of a photovoltaic system, Xcel will grant a price rebate as a part of their Solar

Rewards program (“Current REC Pricing,” 2010). Effectively this is a subsidy from Xcel to

encourage customers to install the systems, and they can count in when calculating the rates

they charge consumers, pending review by the COPUC. Similarly, their Windsource program

allows Xcel customers pay extra to encourage the use of wind energy (“Pricing, Terms and

Conditions,” 2010). But Xcel can also ask for a rates increase for this investment as well.

Requirements like the 30 percent renewable portfolio required by 2020 serve only to

encourage Xcel to engage in green projects (Ritter Jr, 2010). If these projects were cost

effective in terms of preservation, or if they were reflective of the consumers’ tastes for green

energy production, that would be justifiable. This paper will assert in the next section that

neither of these considerations is true.

        Should Xcel’s projects go in opposition to the public interest, it should be the public

utilities commission that calls them into order by denying their rates case. As it turns out,

however, the COPUC has a soft spot for green projects. It is worth noting that the

commission is principally comprised of three commissioners chosen by the governor,

currently Bill Ritter. Bill Ritter’s web page lists first among his accomplishments that he

“established Colorado as a national and international leader in renewable energy by building

a New Energy Economy that is creating thousands of new jobs and establishing hundreds of
new companies” (“About the Governor,” 2010). Governor Ritter defines much of his success

by his green energy policy, and it keeps him in office. He has every incentive to encourage

such policies. And from that framework, it makes a lot of sense that one of the three

commissioners, Matt Baker, “served as the Executive Director of Environment Colorado,

where he was the architect of Colorado’s Renewable Energy ballot initiative, Amendment 37.

Matt was a leader in efforts to double Colorado’s renewable energy goals, implement policies

to greatly expand utility energy efficiency programs and promote state goals to reduce carbon

dioxide emissions” (“About the Colorado Public Utilities Commissioners,” 2010)When it

comes to green energy policy, the commissioners (and the governor that appointed them) are

biased, and have incentive to support green energy projects.

        The balance between the natural monopoly and the regulator should come from

opposing interests. However, in the case of green energy projects, they align in favor of such

projects:


               Allow             Limit
               Increase for      Increase
               Green Project
                Xcel: ++(+)         Xcel:+
of green
because

project
Price
Hike




                COPUC: ++          COPUC: -

                   Xcel: --        Xcel: +/-
Maintain
Current




                 COPUC: -          COPUC: -
Rate




        From Xcel’s perspective, their incentive is quite similar to the original model, except

perhaps having additional incentive to raise rates to incorporate a green project, which may

generate additional income, depending on the project. They have nothing to lose from asking

for a rates raise, and so always will. If they do not ask for a raise that would otherwise have
been granted, they face the opportunity cost of a missed chance for additional revenue

(bottom left), and if they do not ask for a raise that would not have been grated, the outcome

is essentially neutral (bottom right), but both of those situations are highly unlikely.

        The COPUC’s incentives have shifted more noticeably. Given that their motivations

are now often to encourage green energy initiatives, if Xcel does not develop these projects

(bottom left), or if the commission does not allow the funding for a new green energy project

(top right), or if neither party moves towards green energy production (bottom right), they are

held accountable to the governor that appointed them for not fulfilling their underlying goal

of promoting green energy initiatives. So the incentive of the COPUC is going to be in favor

of supporting Xcel’s proposed projects, even if they raise rates for consumers.

Social Inefficiencies

        Because there is no longer a balance between Xcel’s interests and COPUC’s

regulation, rates can increase far beyond their socially optimal point, leading to a variety of

negative consequences. The first is that the commission’s actions are not representative of the

consumer interests they claim to protect. If the aggregate opinion of all consumers was to pay

for the extra green energy initiatives, then the commission’s actions could not be said to have

a bias. Then they would merely be representing the wishes of consumers. However, when left

to decide the matter for themselves, consumers would likely not make the same decisions.

This can be seen in the operations of Tri-State Generation and Transmission Association is an

electric co-op that provides energy to many rural areas of Colorado.1 As a co-op, Tri-State is


1
  It does bear mentioning that the area in which Tri-State is primarily rural farming and
ranching communities that have different political orientations than areas covered by
Xcel, which includes Denver and Boulder. This may sway them away from green energy
initiatives, where the more liberal areas may be politically inclined towards green energy
initiatives. However, Xcel’s service area includes significant conservative areas as well
and ultimately the economic incentives should be similar, even if the political incentives
vary, so the comparison between Tri-State and Xcel is still very useful.
essentially governed and regulated by the consumers it serves, rather than by the corporate-

government paring that Xcel and COPUC employ. And when given the choice, those

consumers regularly choose coal-powered energy to increased renewable portfolio standards

that Xcel observes. Tri-State is regularly accused of being a “coal company,” which is

demonstrative of consumer preference towards coal powered generation rather than

renewables (Williams, 2009). By advocating for green energy initiatives, even at the expense

of the consumer, the COPUC is no longer representing the interests of the consumer. Instead,

they are biased relative to the Colorado consumer, leading to an excessive preference towards

green initiatives.

        If it were the case that the population needed some sort of social conscious to steer

them towards a good solution to global warming (or at least the best available solution), a

biased COPUC may have merit. But the problem is that both Xcel and COPUC find utility in

advocating for any green energy solution; it does not need to be a good one. Xcel gets to

increase their rates and COPUC and governor Ritter get the accolades of steering Colorado’s

energy in a nominally environmentally friendly direction. This leads to suboptimal solutions.

For two reasons, the solutions that are being implemented are inefficient. The first reason is

that even if photovoltaic solar panels and wind energy generation can provide a significant

amount of energy, there will still need to be coal-fired power plants to provide energy when

the sun is not shining or the wind is not blowing. While some have argued that this problem

of intermittency can be overcome (Sovacool, 2009), the fact that the COPUC only has

incentive to appear to be fighting for environmental preservation, not to actually pursue

environmental preservation means that overcoming the problem of intermittent generation

can not be overcome in the present system.

        The second reason that the solutions being implemented are leading to

environmentally inefficient outcomes is that the technology being used is not nearly as
developed as it needs to be to make a real difference. The Intergovernmental

Panel on Climate Change (IPCC) created the estimations of technological requirements that

are often used for such projects, but “The technological challenge has been

seriously underestimated by the IPCC” (Pielke, Wigley, & Green, 2008). The result is that we

are encouraging the use of inefficient technologies with no real incentive to improve them,

rather than dedicating the money to the generation of more efficient, effective technology.

        Finally, the current system of green energy initiatives is overly burdensome on poor

consumers. If a relatively wealthy consumer, we’ll call him Billy, installs a photovoltaic

system on top of his house, Xcel gives Billy a rebate on his bill. But Xcel has to ask the

COPUC to raise their rates, which they approve, because COPUC is incentivized to allow

any green energy practice. So the cost of Billy’s rebates is redistributed through other

consumers, like the impoverished students of Boulder. And since the poor students spend all

their money on books and food, they will never generate the capital to install their own solar

system, so the costs of the systems are passed from the wealthy, who enjoy their benefits, to

the poor. Ultimately, the practices currently implemented are overly burdensome on poor

consumers.

Conclusions

        While it is certainly necessary to pursue green energy solutions to protect our

environment and ameliorate the damage of the externalities of electricity production, the

development of these solutions through the Colorado Public Utilities Commission is an

inefficient way of doing so. By aligning the interests of COPUC and Xcel, which would

normally be in conflict with one another, the current system is subject to a host of public

choice problems. The COPUC’s incentives should be protecting the consumer from rates

hikes, bearing in mind a wide variety of other concerns. But green energy has risen to the

forefront, and the COPUC is now permitting green energy initiatives that unduly raise prices
for consumers. Xcel’s incentive is to capitalize on this system because they gain returns of

and on investment for all their projects. Because both these parties agree that green energy

initiates are in their interest, and not necessarily in best interest of the consumer or even the

environment, they produce practices and initiatives that are not representative of consumer

preferences, that are overly burdensome to poor consumers, and that are ineffective at

preserving the environment. Instead of these inefficient policies, further research should

consider the viability of simply taxing energy usage and using the revenue to fund research

and development of more efficient systems.




                                           Works Cited

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