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Kemper failure shows obsolescence of regulated monopoly utility model

SCRAPPED: The Kemper Project will become a natural gas plant after a deal was reached between Mississippi Power and regulators this week. Photo by Mississippi Power

Last week's decision that largely ended the battle over the Kemper Project clean coal power plant might be the biggest example of why the regulated monopoly model of utilities needs to be scrapped.

As a bit of background, the regulated monopoly model made sense when a U.S. Supreme Court decision in the Binghamton Bridge case of 1865 created the blueprint for the Mississippi Public Service Commission and other similar regulatory bodies nationwide. Under the regulated monopoly model, a utility is given exclusive rights over a market area to sell electricity, with the PSC or similar body acting in place of the market to determine prices, authorize investments and determine a rate of return.

This made perfect sense in an era when the nation's electrical infrastructure was being constructed to electrify rural America and competition could lead to needless and wasteful allocation of scarce resources.

Under the model, a utility receives a rate of return for its capital investments such as transmission lines and power plants, subject to regulator approval. With this guaranteed rate of return, public utilities became a popular and safe place for investors to park their money.

Regulators were supposed to balance the company's need for return to satisfy investors with the needs of rate-paying consumers.

There was one crucial weakness to this scheme. What if the regulators became thralls for the utility? That phenomena, known as regulatory capture, happened in Mississippi nearly nine years ago as a repeated 2-1 votes from the Public Service Commission ensured that Kemper would be constructed despite signs that the project might not live up to its billing.

The Southern Company's Magnolia State subsidiary, Mississippi Power, tried to build and operate what amounted to an experimental power plant that would gasify lignite coal mined on site, remove pollutants such as anhydrous ammonia, sulfuric acid and carbon dioxide for off-site sale and use the now-clean synthesis gas to fuel a pair of electricity-generating turbines.

The company repeatedly insisted that the plant would ultimately be cheaper to build and operate than a conventional natural gas plant — which ironically ratepayers will receive — after using natural gas price forecasts that showed a future filled with price increases that would make the lignite plant more financially palatable. The original price was $2.4 billion and it was supposed to be operational by May 2014.

Kemper never worked as intended, but if the company would've been able to get it operational in some form, ratepayers could've been stuck with a $7.5 billion price tag in the form of double-digit rate increases. Instead, customers will save billions and pay for what amounts to an expensive natural gas plant.

Under the regulated monopoly model, Mississippi Power had a perverse incentive to construct the most costly plant design that it could sell to regulators. If nothing is changed with the model, it could easily happen again.

In the case of the Mississippi PSC, customers need to have a voice at the negotiating table. Indiana and several other states have an office of consumer advocate that argues on behalf of ratepayers during rate hearings and investigates issues relating to utility rates. With inexpensive, reliable energy being a crucial requirement for economic growth, states literally can't afford to suffer from regulatory capture.

Another option is junking the old model and allowing the market and not a regulatory body to determine prices on electricity. In the present model in Mississippi, producers not only own the generation capacity, but the distribution network as well.

Texas went to a deregulated plan in 2002 where incumbent utilities still own the distribution networks, but 117 different residential electric providers compete for the business of 85 percent of the state's electricity consumers.

Since 2004, Mississippi's average electric price has increased 23 percent, while Texas customers' bills have increase only 6 percent during the same span. Speaking of regulatory capture, Alabama's average utility rates have increased 57 percent since 2004 despite the Southern Company subsidiary there not building any large, new power plants in recent decades.

Adhering to a model that is obsolete in a decentralized economy is a recipe for higher prices and weaker economic growth. Not to mention the specter of the perverse incentive that still remains for utilities to build more expensive capital projects to maximize their rate of return.

Steve Wilson covers state and local government for the Mississippi Independent News Service. You can follow him on Facebook and on Twitter.

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