Imagine what your life would be like if you couldn't choose where to shop—not because you live somewhere with few options, but because regulations permit only one company to sell a good or service. Imagine what it would be like if there was only one automobile manufacturer, one cell phone carrier or one grocery store.
That was the energy industry before reforms began deregulating the sale and purchase of electricity and natural gas. In a regulated market, consumers cannot choose where to purchase their energy. Local utility companies have long been the easy default option. But in modern times when businesses and residential consumers use considerable amounts of power for their heating, air conditioning, lighting, electronics, machinery and appliances, energy reforms and market competition can mean lower, more flexible prices. In a deregulated market, consumers are empowered to compare rates, services and contract terms and pick the options that best fit their needs.
And that means you may be able to choose a plan with
What We Mean When We Say "Deregulation"
In regulated markets, consumers have no choice but to purchase electricity and natural gas from the local utility at prices regulated by the state and federal government.
The government deregulates energy by reforming old laws and passing new ones that change who can produce and sell energy. When multiple suppliers compete on the market, prices can be determined—and ideally remain lower—because of competition.
When you purchase energy from a competitive source, your electricity or natural gas are still delivered to you through local power lines and pipelines. In most cases, you'll also receive and pay your single energy bill to your local utility, too. What changes is who you're buying power from and how much you pay for it.
But deregulation also opens the door to numerous, more flexible energy options for terms of contract, price structures, market risk exposure and efficiency solutions. Whether you're powering your home or a global business with hundreds of stores, that could mean a big difference in your bottom line.
States and provinces across North America have taken various approaches to deregulation. Some enjoy a completely open market; others deregulate only electricity or only natural gas; some are partially deregulated but limit the number of consumers participating or amount purchased; and others still are restricted by fully regulated markets.
How North America Flipped the Energy Market
Electricity and natural gas were regulated across the United States and Canada until the late 20th century. Described by some as the last large government-sanctioned monopoly,1 utility companies controlled the retail energy industry and were the sole suppliers of electricity and natural gas in the areas they served. But energy, which powers the lights, computers, refrigerators, HVACs, equipment and more in our homes and businesses, was too great a public importance and too large a financial expenditure to remain so wholly regulated by the government.
For deregulation to succeed, three things had to occur:
- Independent suppliers had to win the right to sell energy on the open market, side-by-side with utility companies.
- Governments had to reform the laws that dictated energy retail prices.
- Utility companies had to open access to the power lines and gas pipes used to transmit electricity and natural gas to customer's homes and businesses. (Governments collectively recognized that it would be impractical and wasteful for suppliers and producers to build redundant power lines and gas pipes along similar routes.)
Natural Gas Deregulation in the United States
Problems with natural gas regulation came to a head during the 1970s. The country was experiencing extreme shortages due to government regulations that incentivized retail in gas-producing states, but not consuming ones. As a first step in restructuring the natural gas market, Congress passed the Natural Gas Policy Act (NGPA) in 1978. The act created a single natural gas market while allowing the market to establish wellhead prices up to a defined maximum. With wellhead prices going up, natural gas producers had a new incentive to invest in exploration and production, which helped to level the playing field across state markets. The act also transferred regulatory authority to the Federal Energy Regulatory Commission (FERC).2
In the wake of the NGPA, natural gas prices rose significantly. Consumers, and particularly large industrial companies with significant natural gas spends, began to lobby for changes to how natural gas was sold. They wanted the natural gas production and supply to be sold separately from its transportation through interstate pipelines.3
Consumers had to clear two hurdles before natural gas markets would be open and deregulated. The first regarding natural gas pipelines, split wide open in 1985 when FERC Order 436 allowed pipelines to offer transportation-only services with competitive prices.4 That meant pipeline owners could offer transportation on a non-discriminatory, first-come, first-serve basis to all customers, without favoring their own natural gas customers. Transportation could be entirely separated from natural gas purchases.
Although pipeline owners weren't required to participate in Order 436, all major pipelines eventually began to offer transportation-only services.5 Participation was ultimately mandated in 1992 with FERC Order 636. Together, these orders created the "open access" pipelines we know today.6 Transportation is now the primary function of pipelines and sellers have equal footing to move natural gas from the wellhead to their customers.
With pipelines open, there was one more leap to accomplish deregulation: independent suppliers had to win the right to sell natural gas side-by-side with utility companies in an open market. Consumers cleared this hurdle in 1989 with the Natural Gas Wellhead Decontrol Act. The legislation removed federal price regulations and opened the sale of natural gas to distribution companies and consumers.7 And that meant market competition would encourage affordable prices and flexible choices for consumers.
Electricity Deregulation in the United States
Since the 1930s, utilities have operated as a single integrated system, providing electricity to all customers within their territory at regulated rates determined by the state.8 But this monopoly system left utilities unprepared for fuel price shocks in the 1970s caused by the OPEC oil embargoes. Many utilities responded to the price spikes by replacing their oil-fired plants with nuclear power plants,9 passing off costs to their electricity customers who were already squeezed by rising prices.10
With natural gas prices also high and spurring advocacy for change, consumers began to rally for electricity reforms, believing that a deregulated model could reduce costs.11 High-consumption businesses that depend on utilities to power factory machinery and large corporate buildings are extraordinarily sensitive to changes in energy prices, and therefore had much to gain.
Congress took the first step of electricity utility reforms in 1978 by passing the Public Utility Regulatory Policies Act (PURPA). Designed to diversify power supply and encourage conservation, the law required utilities to purchase power from new producers when their own supply was low. These new non-utility producers, called "qualifying facilities" were held accountable for meeting efficiency standards and often could supply power at a lower cost than their utility counterparts.12 The act opened the door for wholesale electricity from small power producers to be successfully integrated with a utility's own supply. This reform was further cemented in 1992 by the Energy Policy Act, which ushered even more small producers into the power markets.13
But it wasn't until the mid to late 1990s that all power producers received fair access to the power grid with safe and reliable power transmission. FERC Orders 888, 889 and 2000 broke up integrated utilities whose power plants were either sold to a third party or transferred to an unregulated affiliate. To make sure that the shared power grid stayed safe and reliable, the act also initiated formation of two groups: regional transmission organizations (RTOs) and independent system operators (ISOs).14 These groups continue to control and monitor operation of the grid across many regions of the country today.
Soon after the FERC actions, large commercial and industrial customers began to lobby for retail deregulation at the state level, forming coalitions such as Americans for Affordable Electricity. Several states did quickly open their markets to competition through pilot programs that allowed consumers to buy directly from independent power suppliers.
Fallout from the California Crisis:
The Risks of Market Manipulation
Although deregulation can encourage variety and create cost savings for residential and business consumers, careful design of retail choice programs proves to be vital. For California, what started off successfully with more than 200 electricity providers competing to serve customers ended in an energy crisis of large-scale blackouts, huge financial losses and the collapse of the state's largest energy companies. California's energy market suffered a "perfect storm" due to two key flaws.
California's first flaw was that it required utilities to sell most of their power plants while preventing them from signing long-term contracts with producers to meet the expected power demand. This approach left California no choice but to buy power on the short-term market, making it extremely vulnerable to price spikes.
Its second flaw was to put a cap on the retail price utilities could charge their customers while allowing the wholesale price to be determined by the market. The state assumed that the retail price would remain higher than wholesale, allowing utilities to recover stranded costs of expensive nuclear facilities that were no longer operating. This assumption held for a short period. But by spring of 2000, wholesale prices began rising due to high natural gas prices.15
Giant energy wholesalers took advantage of the power shortage by further constraining supply. They arbitrarily took power plants offline for maintenance in the days of peak demand, deliberately created the appearance of congestion by reserving more space on transmission lines than required, withheld the supply they controlled and sold California power to out-of-state customers.
These manipulations drove prices to unprecedented levels, up to 20 times their normal value. Because the state had capped retail prices, utilities could not cover these extraordinary costs. Pacific Gas and Electric Company went bankrupt and was nearly followed by Southern California Edison in early 2001. With their bonds reduced to junk status, these utilities had no buying power and were unable to purchase and deliver electricity. Rolling blackouts hit areas of the state, including the San Francisco Bay.
California was forced to step in and buy power at highly unfavorable terms, incurring massive long-term debt. In total, the widespread outages and losses to businesses and institutions cost between $40 and $45 billion.16
As legislators in nearby states watched California's crisis unfold, they quickly reconsidered their paths to deregulation. Arizona, Arkansas, Montana, Nevada, New Mexico, Oklahoma, Oregon and West Virginia repealed or delayed legislation, ultimately changing and improving on their frameworks to reduce risks of market manipulations.17
Energy History of the United States at a Glance
Natural Gas Deregulation in Canada
Not unlike markets in the United States, Canadian natural gas prices spiked in the 1970s in response to Middle Eastern oil embargoes. In 1980, Canada's National Energy Program responded by giving the government power to negotiate prices with consideration for fluctuating crude oil prices. The program also imposed new federal royalties and taxes, such as an 8 percent tax on oil development.18 Proponents of the program argued that such interventions would protect consumers from fluctuating oil prices. But when world prices began to drop, support for the program dissolved.
On October 31, 1985, Canada passed legislation that separated the cost of gas at the wellhead from the cost of transmitting and distributing it.19 That meant pipelines would be open and accessible. The Agreement on Natural Gas Markets and Prices, also dubbed the Halloween Agreement, replaced government-controlled pricing, opening the industry to healthy market competition.20
Although the agreement caused volatile changes in the natural gas market—and some that were highly contested—the short-term discomfort ultimately paid off. Production grew by more than 46 percent between 1986 and 1992,21 and in the late 1980s, Canada invested in a multibillion dollar project to build new pipelines, which quickly grew exports and sales.22
Retail natural gas markets, however, are under provincial jurisdiction. In 1986, large industrial consumers began to directly purchase natural gas and its transportation, and today most industrial consumers across the country continue to operate under these types of market arrangements.23
Residential consumer choice began in Ontario in 1986, and at one time almost 60% of the homes in Ontario were served by competitive distributors.24 Because of increasingly restrictive consumer protection measures, many suppliers have left Ontario, and today only 10% of consumers remain on contracts, which will not likely be renewed when they expire.25
Although the residential natural gas market in British Columbia has been open to competition since 2005, subtle resistance from the incumbent distributor has resulted in less than 5% market share for distributors under the restrictive and costly market structure.26,27
Residential consumers in Alberta have had natural gas choice since 1996, but the market structure only became effectively conducive to competition in 2003. Today consumers can purchase natural gas from a retailer regulated by the Alberta Utilities Commission, or from a competitive retailer, with approximately 40% of residential customers purchasing their natural gas from competitive retailers.28
Electricity Deregulation in Canada
Unlike the United States, Canada never regulated the price of electricity at the federal level. Except for Alberta, the industry within each province was dominated by legal monopolies. Because of these historical and political differences, the government left deregulation up to each province.
With the Electric Utilities Act of 1995, Alberta became the first and only province to tackle electricity deregulation at both the wholesale and resale levels.29 The act established a competitive market for electricity generation and leveled the playing field for all generators. This act was amended three years later with a change to regulate the grid, while continuing to foster competition with retail supply.30 Alberta's electricity is priced by the hour31 and large consumers can choose from a range of suppliers and products to help them manage their price risks, including wholesale markets. Small consumers can choose between an energy retailer and a regulated "utility-like" power rate. Alberta's is considered to be the most deregulated market in Canada with 40% of consumers opting for competitive products.32
The Ontario electricity market was deregulated in 2002, but a sharp jump in the price of electricity stopped the process until 2005. When it reopened, Ontario introduced a Regulated Price Plan for residential customers and small businesses. The Ontario Energy Board sets 12-month price periods for this plan based on consumer usage patterns and the hourly market price of electricity.33 With such a price limit in place, Ontario is considered to be partially deregulated. Further changes to the wholesale market in the 2010 – 2012 period, including the Energy Consumer Protection Act and introduction of government-backed Feed-in-Tariffs effectively ended electricity choice for residential consumers.34,35,36
Today's Thriving Energy Markets
Today energy is deregulated across much of the United States and Canada. Consumers in these areas are attracted by opportunities to seek energy solutions that are tailored to their needs.
Because competition drives deregulated markets, energy prices in these areas are generally lower than in regulated markets. And with energy often accounting for one of the largest operating expenses, cost savings must be top-of-mind when businesses select a supplier.
Competitive suppliers can also offer customers a greater variety of customized solutions. Flexible energy choices for pricing, terms, service, billing and products may not be available to consumers in areas monopolized by utilities. But these are the kind of valuable options that can help you better manage your energy budget and meet business goals.
Underlying all of the consumer benefits, deregulation is also preparing the energy industry for a dynamic future. Competitive markets give suppliers a strong incentive to be innovative. Developing new solutions for businesses sets a company apart from other suppliers, attracts new customers and retains existing ones. Since major deregulation actions took place in the '80s and '90s, North America has seen rapid adoption of energy management strategies and efficiency conservation products—ideas and technologies which utilities were slow to develop and accept.
Direct Energy Business is a leader in developing innovative energy products and services that help customers make their businesses better. Through energy choice and a suite of innovative products and services, customers can buy less electricity and natural gas and better manage the impact of energy on their budgets and operations. We serve approximately 240,000 business of all sizes and from all industries across North America.
Rely on the expertise of our energy team help you find the right solutions to make a difference for you and your bottom line.
For more information on energy deregulation and other important electricity and natural gas news, read the Direct Energy Business blog.