A Place for Advocacy

Finding 2: The Energy Commission's dual responsibilities as an energy regulator and an advocate for alternative energy solutions are not compatible with its new mission of encouraging competition and consumer choice.

At the time the Energy Commission was created, linking regulatory authority with advocacy programs was seen as the most effective way to influence a highly regulated but highly inefficient market. In more recent years, the Energy Commission's advocacy and regulatory roles have been debated as part of the efforts to defuse turf wars between the Energy Commission and the PUC.

Emerging competition requires that the linkage between regulatory and advocacy functions be reconsidered, along with the long-term need for advocacy programs.

In competitive markets government cannot pick the market solution. It also must be careful about trying to influence the decisions that producers and consumers make.

The PUC describes one of the State's roles in a competitive market as a referee. Some market players have adapted as a mantra that government's role in a competitive utility market is to create a level playing field.

While there is much skepticism about the need for a specialized utility referee -- and concern that one company's level playing field is another company's obstacle course -- the common interest is that the State be neutral in its actions.

The Purpose of Dual Responsibilities

The Energy Resources Conservation and Development Commission was a product of its times. In the early 1970s, environmentally minded policy makers became concerned about the environmental and fiscal fallout of plans to build dozens of nuclear power plants to meet growing electricity needs. At the same time, development-minded policy makers became concerned about increasing delays in approving new generation facilities -- the consequence of 30 different local, state and federal permits required of new facilities.

After several attempts, the Legislature in 1973 passed a bill to create an Energy Commission that would forecast energy demands, assess efforts to reduce that demand through efficiency and provide a consolidated approval process for generating facilities. For environmentalists, the Commission's approval process would provide the energy-based needs test that the PUC's rate-related review of new projects had failed to provide. For project supporters, the plan offered consolidated permitting. The bill was vetoed.

Within months, however, the Organization of Petroleum Exporting Countries, in response to the United States' political policies in the Middle East, cut their shipments of crude oil to the West. Energy prices skyrocketed and shortages spread. At the request of the Governor, a nearly identical bill to the one that had been vetoed was passed by the Legislature. In May 1974 the Warren-Alquist Act was signed into law.

In giving the Energy Commission authority to approve new power plants, the Legislature expected the agency to consider those projects in light of anticipated energy demands, the ability of efficiency efforts to reduce demands, the environmental consequences of new plants and less damaging alternatives. Just as the Public Utilities Commission had been created in response to the failure of the market to economically provide competitive utility services, the Energy Commission was created inresponse to the failure of the PUC to consider these other policy concerns when approving new plants by the investor-owned utilities.

The Legislature also gave the Energy Commission a range of public purpose programs intended to spur the market to develop those less- damaging alternatives -- ones that were less polluting, less reliant on imported fuels and less consuming of existing energy supplies. The Warren-Alquist Act specifically established four mandates that are the basis for the Commission's organizational divisions:

1. Energy Forecasting and Planning. These functions were intended to produce a State energy policy that was established through an open process of determining trends, making projections and assessing options for meeting anticipated energy needs. A natural byproduct of this planning is the creation of a state contingency plan for responding to energy emergencies. While most of these activities were similar to those often assigned to departments, the Commission has relied on its quasi-judicial authority to develop the policy documents and forecasts.



2. Technology Development. This function was largely intended to compensate for the market's failure to invest in research, development and demonstration of technologies that would use alternative and cleaner energy sources -- particularly in the area of transportation fuels. This function is similar to ones often assigned to departments.



3. Energy Efficiency and Conservation. This function was a hybrid of grant and loan programs for making improvements to hospitals, schools and public buildings, research programs and public education programs, and the establishment of building and appliance efficiency standards, which the Commission adopted through its process of public hearings and deliberations.



4. Facility Siting and Environmental Protection. This function most heavily relied upon the Commission's quasi-judicial procedures to establish a record for making decisions that satisfied a number of environmental, public health and due process laws.

As the Commission has matured, the value of its independent components has become clear -- saving residents money, generating jobs and encouraging the technological innovation that could help solve a variety of expensive policy problems. Some of these accomplishments are also the product of the Public Utilities Commission, which has administered rate-based surcharges for research and development, over time eliminated disincentives to conservation and created incentives for the utilities to invest in efficiency measures.

Efficiency investments, for instance, have saved businesses and residents billions of dollars. From 1976 to 1993, the State's economy grew by 60 percent while energy use grew by only 23 percent. The Energy Commission estimates that the various efficiency efforts have saved the State $27 billion in the last 20 years. Because of the State's appliance standards, refrigerators now use only one-third the electricity of those built a generation ago. Building efficiency standards alone have prevented the need to build an additional 13 power plants at a cost of $11.6 billion. Those savings are expected to nearly double during the next 13 years, and could compound even quicker if the standards are revised to include recently developed construction techniques.⁽³⁷⁾

Technology programs have made California a capital of innovation. The Energy Commission reports that 30,000 jobs are associated with the $6.9 billion alternative energy industry. Many of these businesses are pioneering innovations that have strong export potential, adding to the State's position as a global trader.

And alternative energy programs are making it easier to meet other environmental goals. The research, development and commercialization of alternative fuels and renewable energy sources have helped the State to meet energy needs in cleaner ways, reducing the health costs of air pollution and avoiding the costs of stricter air pollution controls. Technological advances continue to bring renewable sources closer to market rates. Wind power, for example, has dropped from 25 cents a kilowatt-hour to between 4 and 5 cents a kilowatt-hour -- nearly the price of the cheapest fossil-fueled generator.⁽³⁸⁾

Some policy experts believe the success of these programs is in part the result of Commission oversight. The Energy Commission is thought to be able to more vigorously defend these programs during tight budget times and to insulate them from radical changes in policy in the wake of an election. Other policy analysts, however, argue that these types of programs could be better managed as part of a department, without the time-consuming procedures and conflicting priorities expressed by plural body governance.

As early as 1979, policy analysts recognized the problem created by the Energy Commission's combination of regulatory authorities and program responsibilities. The report to the Joint Committee on Energy Policy and Implementation concluded the regulatory process was compromised by placing Commissioners in charge of "line-item" programs often performed by departments. The report said: "The Warren-Alquist Act has placed the same individual in the impossible dual role of judge and advocate." In addition, the law -- while requiring the Commission to generate electricity forecasts for its plant approval process -- did not give the Commission authority to require applicants to use different fuels or technologies.⁽³⁹⁾

The analysis recommended separating the department functions -- such as promotional and educational efforts, research and development programs and proposing efficiency standards -- into a department. It recommended preserving the Commission to perform the pure regulatory functions associated with facility siting and enacting regulations.

In the interim, the Energy Commission's dual responsibilities have been successfully defended as essential to influencing heavily regulated energy markets. As those markets are restructured, the drawbacks associated with the structure become more significant.

Separating Programs from Oversight

Since the Energy Commission was formed, energy-related markets have undergone significant changes: Oil prices have dropped and remained low. Electric cars have advanced as a possible alternative to gasoline-powered fuels. Market forces and regulatory reform have encouraged natural gas exploration and development. Technology is encouraging smaller and more efficient electricity generating stations. These and other changes raise four issues about the validity of the Energy Commission maintaining its advocacy responsibilities while assuming oversight of the competitive market.

1. Linkage Encourages Intervention. The Energy Commission cannot be a light-handed effective oversight agency if it also is responsible for programs intended to influence market choices. The value of a remade Energy Commission will be the ability to -- reliably and without bias -- aggregate confidential market data, administer a one-stop siting process and identify areas where prices are not set by competition. In other government arenas, policy makers have recognized the importance of separating regulatory roles from promotional roles. The Nuclear Regulatory Commission was created to separate the federal regulatory and promotional roles concerning the nuclear power industry. The Federal Aviation Administration is under fire today for putting its promotional duties ahead of its regulatory duties in airline safety.

2. The Original Rationale is Diminished. The fundamental purpose of linking a siting authority's "needs analysis" and development of alternative technologies will be obsolete in a competitive generation market. The Energy Commission already has recognized that its siting process should not include the classic needs analysis, eroding the original rationale for linking the siting authority with the advocacy function.

3. Federal Funding is Declining. The funding for many of the Energy Commission's grant and loan programs came from the federal Petroleum Violation Escrow Account, comprised of fines assessed oil companies that overcharged customers during the energy crises. Those funds are declining, requiring a reassessment of state programs funded by them.

4. Need for Programs May Change. Competitive markets will likely yield different "failures" than regulated ones, maybe even fewer ones -- changing and maybe reducing the need for the Energy Commission's public purpose programs. No one knows for sure what market failures will exist in a competitive market -- whether private research will hold out the same rewards as it does in the computer business, or whether consumers will be willing to pay more for "green" power. A remade Energy Commission will play the critical role of identifying market failures as well as market abuses. But the task of responding to those failures should in most cases be left to others -- such as the Attorney General in antitrust matters, the Governor and Legislature when new policy issues arise, or a department when research and development might spawn a market solution.

As competitive utility markets develop, policy experts are concerned about the need for the state to maintain funding levels for research into efficiency and alternative fuel technologies. The Energy Commission testified that given the limited rewards of research and development for private companies in competitive markets, the State should rethink its role:

Consumers will clearly lose in the long-term if government does not find a way to ensure that "public goods" research and development in a collective and coordinated fashion replaces the utility-sponsored research and development that has done so much to advance electric industry technology over the past several decades.⁽⁴⁰⁾

The electricity restructuring act of 1996 continues the surcharges placed on investor-owned utility bills for research that has been conducted under PUC oversight. The act will generate $62.5 million a year through 2001. The funding for projects related to transmission and distribution will be allocated by the PUC. Funding for projects related to generation will be allotted by the Energy Commission.

Two-thirds of the Energy Commission's budget already represents pass-through funds -- money from state or federal sources that the Energy Commission passes through to other agencies, nonprofit groups or private companies that qualify for loan and grant programs. Advocates of a department structure have raised convincing arguments that the ministerial duties associated with these programs can be more efficiently performed by a department.⁽⁴¹⁾

Those concerns, along with the advent of competition and the need to reorganize the Energy Commission and the PUC, provides the State with an opportunity to reassess the governance, scope and goals of the State's public purpose energy programs.

Other states, responding primarily to the decline in federal funding, are consolidating energy programs into other departments that administergrants and loans or encourage business development. According to the National Conference of State Legislatures and the California Research Bureau: 11 states have the energy-related programs in economic development offices and nine have them in the resources department. Seven states have stand-alone energy offices, not including California, which is the only state with a stand-alone commission. Seven other states have their energy office in the housing agency. Five states have the energy function combined with the PUC.

According to a 1995 survey, 56 percent of the state energy offices expected their budgets to shrink over the next five years.⁽⁴²⁾ Some offices already have shuttered their doors, including New York's, which was replaced with a research and development financing authority.

Public Purpose Programs in the Marketplace

The role of government in the energy industry is premised on the need to protect environmental values, particularly those related to air pollution and public health and safety, and the need to guard against marketplace abuses of collusion and other unfair business practices in the provision of an essential service. When a large portion of the energy industry, the utility sector, was dominated by monopolies and their regulators, the level of government intervention in the market was high. Little distinction was made between State's regulatory and advocacy roles.

In a competitive market, the distinction takes on greater importance. The director of the University of California Energy Institute described the values of -- and distinctions between -- effective public goods programs, such as investment in new technologies, and the need for effective government oversight.

There is a clear argument for government supporting research and development of technologies and energy sources due to the public good value of the knowledge that such research produces. The argument for direct government intervention in the generation market, however, has not been made convincingly.

Certainly society should be concerned that alternative generation technologies will be available as the supply of fossil fuels declines and their prices rise. Like nearly everyone, I would welcome a low-cost, non-polluting, renewable energy source. Yet I think there is a reason for concern that direct intervention in the generation market will result in subsidies for technologies that will be obsolete before they are needed.⁽⁴³⁾

Consumer groups approach this issue from a different perspective, but have similar concerns. They favor efficiency investments provided they yield cost-effective benefits to customers. But they also are suspicious of continuing the same institutional arrangements when the market structures dramatically change. The consumer group Toward Utility Rate Normalization (TURN) testified:

One area that may be ripe for a reduced utility and regulatory role is demand-side management, including energy conservation and related services. The funding and administration of these programs should be removed from the utilities and vested in an independent administrator that would award ratepayer-derived funds on a competitive bid basis to service providers.⁽⁴⁴⁾

Prior to the legislative action in 1996, a PUC-sponsored working group was exploring a new governance structure for administering research money: the California Energy Research Institute would be sponsored by the University of California and governed by a board made up of academic experts, public officials and representatives of customer groups. Supported by a small staff, the institute would solicit applications for research proposals and award grants.

After the legislative action, the University of California proposed creating a Joint Powers Authority involving the university and the two commissions to coordinate the allocation of research money. The university believes the plan would provide accountability and flexibility.

Likewise, the Energy Commission believes that in a competitive market the State will want to reconsider the organizational structure for collecting and allocating research dollars. The Energy Commission advocates a structure that would capitalize on the accountability of a public organization and the flexibility of a private one.

The Governor's energy reorganization plan reviewed by the Little Hoover Commission in 1995 was designed to consolidate energy-related programs in a department framework. The department, it was argued, was a better venue for modifying these programs as funding and other conditions change. The assessment that those functions would be better managed by a department are still sound. The designers of that plan, however, did not have the benefit of knowing which oversight responsibilities would be required in a competitive market and which agency should be responsible for those functions.

Rather than creating a new government agency, which takes considerable time and resources, the evolution of an existing agency to fill this roll is more appropriate. The Department of Conservation is vested with a broad range of environmentally and energy-related responsibilities, including the regulation of oil, gas and geothermal wells, and other mineral extraction activities. It implements the surface Mining and Reclamation Act, does geological hazard assessment, administers farmland and other resource conservation. The department would be a logical venue for the Energy Commission's public purpose programs.

The task of a remade Energy Commission will be to facilitate the market: by handling siting applications uniformly and efficiently, providing technical information to all market players and monitoring for market abuses. Its goal is a market that puts a constant downward pressure on prices.

It is still in the State's best interest to maintain the Commission's other functions that have induced investment in alternative fuels, new technologies and conservation measures. These programs have kept a constant upward pressure on efficiency and diversity.

Recommendations

Recommendation 2-A: The Governor and the Legislature should transfer from the Energy Commission to the Department of Conservation the public purpose programs concerning transportation fuel research, business development, public education and market transformation programs, including the setting and implementation of building and appliance efficiency standards.

Placing these functions in a department will make two significant reforms: It will separate advocacy from oversight and it will enable more significant changes in how the programs operate to reflect new funding and market needs. At the same time, the move would preserve the important functions that have saved Californians considerable amounts of money and facilitated the advancement of other energy-related public policies, including clean air and responsible use of other resources.

Recommendation 2-B: The Governor and the Legislature should amend the electricity restructuring act of 1996 to consolidate the administration of energy research and development programs in the Department of Conservation. The department should establish a broad-based advisory panel to set funding priorities, review applications and advise the department director on allocations.

The advisory panel should include key legislators, representatives of environmental and consumer groups, the home building and manufacturing industries. The director of the department should be instructed to explore other institutional arrangements for managing the research program, including a joint powers agreement involving energy policy officials and representatives from public and private universities.